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Why are UK energy bills through the roof?

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Typical household energy bills in Britain will rise above £3,500 in October and could exceed £6,000 in April. But why are they suddenly rising so much and what can be done to mitigate the impact on households and the wider economy?

Why are bills skyrocketing?

The simple answer is that the price of gas has already skyrocketed over the past year, but it has started to rise even faster in recent weeks.

Over the past decade, the price of gas on the UK wholesale market has traded between about 20 pence and 75 pence per therm. In January 2022, after Russia began cutting supplies to Europe last year and as demand rebounded after the pandemic, gas rose to around 200 pence per therm. It rose again after the invasion of Ukraine at the end of February.

But since June, when Russia limited supplies to Europe limiting flows on the Nord Stream 1 pipeline, prices more than doubled to 555p per therm.

Nord Stream 1 gas pipeline in Lubmin, Germany. Russia has cut supplies to Europe by cutting pipeline flows © Hannibal Hanschke/Reuters

At these price levels, a 10 percent price increase — as happened over the past week — is like adding the full regular annual wholesale price of gas back to your bill. This is why the price cap predictions started to jump by such large amounts.

Another factor is recent movement regulator Ofgem to pass on increases in wholesale gas and electricity prices to consumers more quickly. Previously, the price ceiling changed twice a year in April and October. It will now change every three months with another rise in January in the dead of winter.

A month ago, Ofgem criticized Investec, the investment bank, for proposing a limit above £4,000 until next spring. But the wholesale market price is rising as the consensus forecast is for the average household’s annual bill to top £6,000 a year by April. Before the crisis, a typical household bill was around £1,200.

How long will it take?

One of the most alarming aspects of recent weeks is how much forward contracts have started to rise in the wholesale markets for gas deliveries months or years ahead.

Traders now expect extremely high gas prices to persist into 2023 and possibly into 2024. They expect Russia, which before the crisis accounted for 40 percent of supplies to Europe, has little prospect of returning to its one-time role as a reliable supplier to the market .

The UK does not have large gas storage tanks like other European countries, filling them up in the spring and summer for the coming winter. It is planned open again Rough, the UK’s largest storage facility closed in 2017, will arrive too late this year.

Assuming Russian supplies remain tight and the warehouse is emptied over the winter, supplies across Europe will start from a lower base. While Britain is not directly dependent on Russian gas, shortages in the rest of Europe will still impact prices in the UK as competition for supplies from elsewhere increases.

Norway supplies about 40 percent of the UK’s gas and the rest of Europe about 25 percent of total demand. It will also compete with Asia for seaborne shipments of liquefied natural gas.

In a limited Russian supply scenario, the most likely way they could eventually fall would be if demand fell enough, but that would mean a deep recession.

What can the next prime minister do?

Proposals that might once have seemed bold – such as reducing green levies or removing VAT from energy bills – increasingly look like window dressing.

Before the crisis, wholesale gas and electricity costs made up less than half of bills. The rest was made up of taxes, levies and maintenance costs for pipelines and networks. By April, wholesale costs are likely to account for more than 80 percent.

This leaves the next Prime Minister, either Liz Truss or Rishi Sunak, with some difficult decisions to make. The immediate need is to protect consumers from bills that could exceed £500 a month by April without government intervention. But to do this for all 28 million UK households would be incredibly expensive.

Liz Truss, the favorite to be the next prime minister, opposes measures such as additional windfall taxes and wants to “maximize” oil and gas production in the North Sea © Rui Vieira/AP

One proposal being considered by Scottish Power is to cap a typical bill at around £2,000 a year for two years at a cost 100 billion pounds, which would be financed by government-backed loans that would either be repaid through bills over 10 to 15 years or incorporated into general taxation. If gas prices continue to rise, this estimate would be too low.

Encouraging energy saving measures would also help, as the price cap is the unit price of energy. This means that lower consumption could reduce the annual bill below estimates based on normal household use. So far, unlike other European countries, the government refuses to promote energy saving measures.

Should the government be bolder?

Some have proposed a more radical solution, arguing that the UK must move ka “war base” given the scale of the crisis.

Dale Vince, founder of energy retailer Ecotricity, proposed to mitigate high prices and reduce them at source by capping the prices UK producers receive in the North Sea. He claimed it would “solve half the crisis at once” as around 50 per cent of Britain’s gas supply is domestic.

The industry would fiercely resist such a move, but in theory, if the price cap were set at a high enough level, it would still provide manufacturers with comfortable profits. Truss, who is the favorite to be the next prime minister, has also said she opposes measures such as additional windfall taxes and wants to “maximize” oil and gas production in the North Sea, despite production peaking two decades ago.

Lifting the de facto ban on onshore shale mining has also been proposed but has little public support, even in Tory-leaning rural areas.

Another option is to explore with Norway a return to long-term oil-linked gas contracts. Oil is currently trading near $100 a barrel, while UK gas prices are nearing $360 a barrel of oil equivalent and above $500 a barrel in continental Europe.

Others have argued that the UK needs to speed up plans to “degas” the UK economy, arguing that net zero targets are no longer just about the environment, but the country’s economic resilience.

But this would require huge investment in domestic supply chains, building wind, solar farms and nuclear power, as well as overhauling the UK’s housing stock, as the vast majority of homes are heated by gas. Such a transformation would take many years.

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