Where will the government draw the line on energy support?

The situation with energy costs has reached crisis point this year, but the origins of the issue go back a couple of years and are global in nature.

The key factors influencing today’s prices are the drop in production as the world went into lockdown, followed by the rapid bounce back which saw demand outstrip supply, together with the restrictions in supply from Russia in retaliation for Europe’s stance on the war in Ukraine.

Energy is inherently prone to boom and bust cycles but today’s geopolitical uncertainty is making prices even more volatile.

Wholesale energy prices have been high since late last year, but a combination of fixed price contracts and the price cap meant the impact didn’t feed through to most households and businesses until this year.

In his role as Chancellor, new Prime Minister Rishi Sunak announced his first energy package for households in the spring, reducing most bills by £400 with additional help to those on low incomes, but it was clear by the summer that more was needed.

The previous PM and Chancellor opted for the Energy Price Guarantee. It works like the Default Tariff Cap by capping unit costs and standing charges so that an average household faces bills of £2,500 per year. The government makes up the difference for energy providers.

Without intervention, the cap would have increased to the equivalent of £3,549 per year in October, before rising higher in January.

Even with the price guarantee, energy bills are twice what they were a year ago and remain a real worry for many households.

Businesses have been offered the Energy Bill Relief Scheme: suppliers freeze prices to business, then the government compensates the supplier.

The support extends to any business that contracted in at a higher price since December 2021. This package of support will last until April next year, and the government has committed to come forward with a proposal for how the most acutely impacted businesses could be supported beyond that.

The support scheme for households was originally intended to last for two years. However, in one of many changes since the infamous ‘mini-budget’, current Chancellor Jeremy Hunt has announced that universal support to households will last for six months only, with support targeted to the most vulnerable thereafter.

Better targeting is crucial to keeping a lid on the cost to the taxpayer of both schemes – but is easier said than done.

The treasury will conduct a review to inform the difficult decisions around targeting. This will be important for identifying those businesses and sectors for which energy costs are existential and which would need ongoing support if prices stayed high.

The government will want to help efficient businesses through a temporary crisis but avoid propping up so-called ‘zombie businesses’ – those kept alive recently only by low interest rates, covid support and now subsidised energy.

Crucially the government needs an exit ramp; backing out of price support schemes is politically very difficult. A famous example is rent control in New York which was introduced after World War Two to help returning servicemen and is still in place.

So how might the government go about identifying those businesses that need further support? It will want to focus on businesses that can’t reduce their energy costs, can’t absorb them within profit margins, and can’t pass them on through higher prices – and which make an important economic contribution to the UK.

Key questions will include whether to look at sector deals or identify eligible businesses on an economy-wide basis. During covid the government shied away from sector deals but could take a different view this time. It will also need to consider whether to focus support on small and medium-sized businesses or offer support to large businesses as well – potentially in a different form.

Gas prices have been falling over the last month or so, and if that continues there may be no need to extend support beyond April. But prices have yo-yoed all year, so the government will need plans in place in case this luck doesn’t hold.

And of course, energy prices are not the only challenge facing businesses or the government. Food and other prices are also rising, as are wage demands, and this impacts both the cost base of the hospitality sector, and customers’ disposable income.

Businesses looking to the government for support beyond April will need to explain their challenges clearly to government and make a compelling, evidence-based case for support. And they should start doing so early.