With prices set to soar as part of the UK’s energy crisis, we asked or resident expert Harry Spencer to explain what is happening to energy bills and why.

Annual energy bills are set to rise by nearly £700 in April – a huge spike to UK inflation at a time when many costs are already going up.

There is a short explanation for this, and a longer one.

The short answer is that energy bills are rising because the wholesale cost of natural gas is rising.

 

That is a big challenge for the UK, because the vast majority of our homes and businesses rely on natural gas for heating. Gas provides roughly 30% of our electricity needs as well. The increase in the wholesale price of gas accounts for 80% of the total increase in bills taking effect in April.

The surge in the price of natural gas has sent shockwaves through the UK’s energy market. If your business is primarily in extraction and processing of natural gas, then the last few months have been a great time.

 

But if you are an energy retailer, it has been a very tough time. Many energy retailers, particularly smaller ones without the resources and reserves of larger firms, found it impossible to bear the cost of the surge in gas and have gone bust as a result – affecting more than 4 million consumers who have been placed on default tariffs at other suppliers.

 

If you’re wondering why the struggling energy retailers didn’t simply push up their bills, then the answer, for most customers, is the energy price cap. This sets an absolute limit on what default tariff customers can be charged and is based on a complex formula which considers wholesale prices, network costs, policy costs and allowing for a fair rate of return.

 

However, because the price cap is a lagging indicator, which means the data resets every six months (in April and October), it is based on data from two to eight months before it came into effect. So, when your bill goes up in April, it’s reflecting energy prices from between last August and February, not current prices. Therefore, energy retailers were limited in what they could charge based on gas price data which quickly became obsolete last year.

The increase in consumer bills now reflects the surge in gas prices last year, which puts energy retailers on a more even keel – but is unlikely to be much comfort to everyone facing higher bills.

 

The Government has recognised this challenge and taken two steps to address the sudden surge in consumer bills. Firstly, it will discount council tax by £150 in all Band A-D households. Secondly, it is implementing a rather convoluted scheme in which it will loan energy retailers sufficient funds to give all customers a £200 discount on bills this year – to be repaid in £40 instalments over the following five years. Whether the Government will find it congenial to make energy bills £40 a year more expensive than they would be once the next election comes around is another matter.

 

We also suspect that pressure for a windfall tax on oil and gas producers, and to reduce subsidies for green energy is likely to remain high. Especially as the factors driving the surge in gas wholesale prices remain pertinent. These factors are:

  • A complex mixture of surging demand for gas as economies recover from Covid
  • A depletion of reserves due to a cold winter in 2020/21
  • Relatively low wind power production in summer 2021 and reduced global production due to problems at many key sites across the world
  • In the case of Ukraine, a decision by Gazprom to supply lower volumes of gas than would typically be expected

 

The consequences of military conflict in Ukraine for energy bills in the UK are very difficult to forecast in size, but very easy to predict in direction. Therefore, it is clear that consumers should prepare for further price rises in the future.

 

The Madano Energy team provides strategic communications to companies seeking to shape the future with sustainable energy. To find out more or talk to one of our team, please contact [email protected].

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