Lights Out: The Energy Crisis Explained
Introduction
In March of this year, we wrote about the cost-of-living crisis affecting the UK, and the proposals in the Spring Budget that were designed to protect against it (1). However, it is now impossible to ignore the most fundamental driver of inflation in the UK: the cost of energy.
Prices are forecast to reach huge new highs so in this article we explore.
→ Why prices are continuing to rise
→ Why the UK is so vulnerable to rising energy prices
→ The proposals from political leaders on how to tackle the crisis (and whether they’ll work)
→ What might come next
Recap
When Russia invaded Ukraine in February, the Western response was two-fold; the first measure was to arm the Ukrainian military, and the second was to impose heavy economic sanctions on Russia. Given that Russia is the world’s biggest exporter of natural gas and the second greatest exporter of crude oil, exports which are both important to the Russian economy, many of the sanctions were designed to target this particular sector (2).
In practice, this has meant many European and other western countries not purchasing Russian oil and natural gas. This has resulted in the price of the remaining oil and natural gas ‘on the market’ being driven higher in response (3).
UK Exposure
So given the continued rise in prices, is the UK particularly dependent on Russian energy? The surprising answer is no, not really.
Only 4% of the UK’s natural gas needs are supplied by Russia and only 11% of its oil needs. In fact, in 2021 the vast majority of the UK’s natural gas came from Norway and Qatar, while the crude oil was supplied by Norway and OPEC (an international group of oil exporting countries) (4).
So why are prices rising?
As the war in Ukraine has continued throughout the summer, countries including the UK have looked at ways to increase the amount of energy available on the market, hoping that increased supply will bring down prices for consumers (5).
Has this happened?
Well, sort of.
It was reported last month that Saudi Arabia, the world’s most significant oil exporter, had doubled their imports of Russian oil for their domestic usage, in order to free up oil produced in Saudi oil fields to be sold abroad at a greater profit (6). In addition, US President Joe Biden recently visited the Kingdom of Saudi Arabia to encourage their increased production of oil.
However, it is the increased cost of natural gas that has really driven up the cost of domestic energy bills. So with respect to natural gas output, it is expected that the US, Qatar and Norway will all export record levels of natural gas this year, much of it to Europe, in order to fulfil demand that will no longer be met by Russia (7, 8, 9).
And is energy going to continue to become more expensive?
While it might sound like everything is in hand, given the war has been taking place for nearly 6 months, and other countries have had the time to increase exports in response to demand, we all know that prices are still going to rise.
In fact, Cornwall Insight, the company recognised for offering highly accurate calculations on OFGEM’s price cap, have said that they expect the annual price cap to rise to around £3500 in October (10) (We should take a moment to note here that OFGEM is the government regulator of energy prices in the UK, and the price cap they are responsible for setting limits the amount you can be charged on an energy suppliers default tariff).
But the prices rises don’t stop there, as they are expected to rise again up to £4200 in January 2023, where they will stay until at least March 2023. Contrast this with the fact the price cap was roughly £1200 before the war broke out. This continued rise can largely be explained by the increased energy demand in the winter months, where the amount of gas and electricity consumed reaches a peak (11).
And what are the plans to solve the problem?
This is perhaps the most important question, and there is currently no settled plan for this, in part because the outgoing Prime Minister Boris Johnson does not want to be seen to make significant political interventions shortly before he is about to be replaced. The Spring Budget also outlined an additional, universal £400 that would be given to consumers from October 2022 as an additional form of support for energy costs.
What are the candidates planning to do?
Both Rishi Sunak and Liz Truss have outlined their different policy approaches to help deal with the increase in the OFGEM price cap that is contributing to the ongoing cost of living crisis.
Neither candidate appears to want to intervene with the price cap put forward by OFGEM, but Rishi Sunak has come out in favour of universal direct help in the form of cash payments like those in the Spring Budget, while it has been reported that Liz Truss will target help to the most vulnerable through the universal credit and pension systems, while tax cuts will be aimed at those with greater incomes (12, 13). However for it is unlikely that either of thesr proposed forms of support will make up the financial shortfall that households could experience due to the energy price increases, particularly as low income households pay less in tax.
Keir Starmer, leader of the opposition, has recently outlined a plan in which the cap would remain at its current level of £1971, and states that this would also lead to lower inflation across the economy due to keeping the cost of energy down (14). The Labour party have also outlined that they would backdate a windfall tax on energy company profits to January 2022, as the record profits made by energy companies due to inflation have been widely reported on. To cap the cost of energy the Labour party’s proposal involves government subsidising the cost of energy for suppliers, who are still subject to the high whlesale price being charged by oil and gas companies.
Energy costs are impacting low and middle income households
One important thing to consider is that it is not just energy for domestic consumption where the price has increased, but also for services, industry and transport. This is one of the key drivers of the inflation that we are currently experiencing beyond just the price of energy for our own homes.
Notably, the ongoing energy crisis has brought conversations around energy independence and public ownership of energy back into the national conversation. Recent polling data published by Survation has shown that 66% of people believe that energy services should be run by the public sector (15). Grassroots campaigns such as Don’t Pay UK, an organised mass non-payment of energy direct debits, and Enough is Enough, a general campaign to fight the cost of living crisis, have also gained traction with the public in recent weeks (16, 17)
And what of the wider cost of living impact? How are people going to manage this winter, even if more financial support arrives from central government?
The Resolution Foundation think tank have recently reported that households with incomes in the lowest 10% will have to cut back on 24% of non-essential spending, while those in the wealthiest 10% will have to cut back on just 8%, by comparison (18). A report published by researchers based at the University of York found that with the new price caps that are expected to be introduced in October and January, over half of all UK households will be living in fuel poverty (where fuel poverty is defined as spending over 10% of net income on fuel) (19). In reality this will mean that some families and households will be simply unable to heat their home over the winter whilst paying for other essentials such as food, clothing, transport and housing. A choice will need to be made about which of these things should be prioritised.
Conclusion
It is difficult to see an endpoint for energy bills returning to anything like the levels before the start of the war in Ukraine. What is clear is that the winner of the leadership election to be the next Prime Minister needs to quickly implement policies that will not only help the most vulnerable but now also those on middle incomes too.
TL;DR
The cost-of-living crisis in the UK is becoming worse, and it is primarily driven by high energy costs that started due to the war in Ukraine. Recent research has reported that over half of all UK households could fall into fuel poverty over the winter.
References
2. https://www.iea.org/articles/energy-fact-sheet-why-does-russian-oil-and-gas-matter
3. https://www.bbc.co.uk/news/58888451
8. https://www.middleeasteye.net/news/qatar-becomes-worlds-top-natural-gas-exporter-followed-us
11. https://www.gov.uk/government/statistics/gas-section-4-energy-trends
12. https://www.bbc.co.uk/news/uk-politics-62471778
14. https://www.reuters.com/article/us-britain-energy-labour-idAFKBN2PK087
18. https://www.resolutionfoundation.org/publications/cutting-back-to-keep-warm/
19. https://cpag.org.uk/news-blogs/news-listings/fuel-poverty-updated-estimates-uk
