Generating solutions: responses and reforms for the energy price crisis

Direct and indirect impacts of high energy prices

It is well known that higher energy prices have direct, negative impacts on households and businesses by raising their energy bills and reducing discretionary income and output. As well as direct impacts on energy bills, however, there are also substantial indirect effects of high energy prices.

Many businesses must pass on the rising costs of production to consumers, stoking general price inflation. For example, households will face even higher food prices because food and beverage processing industries are energy intensive. Likewise, many businesses will find the intermediate goods they purchase to produce their output (such as mineral products, basic metals, chemicals, pulp and other raw materials) are more expensive, because most energy use takes place in the supply chain. This raises concerns for international competitiveness. For example, my research with co-authors has found evidence that high indirect energy costs in the supply chain make industries less internationally competitive, reducing their exports.

The transition away from oil use in transport, which is essential to meet our climate goals, particularly with the use of electricity cars, will further increase the vulnerability of our economy to high electricity prices. Lower consumption of petrol and diesel fuels will also reduce government tax revenues, leading to less fiscal headroom to undertake reforms and support households in future.

Impact on health and government responses

It is not just economic impacts that should be highlighted. High energy prices also pose a risk to human health. Even for the period before the current energy price shock, there was evidence that the poorest households in the UK and other developed countries face a choice of whether to heat or eat their home for the winter. Energy use is a key adaptation mechanism for individuals to protect themselves against extreme weather. If vulnerable groups like the elderly cannot afford one of the main forms of protection against winter conditions (domestic heating), this will further increase the excess winter deaths in the UK.

For all these reasons, the current environment of high energy prices certainly fully justifies the term “energy crisis”. The UK has announced energy price caps for both households and businesses, but they are only a temporary solution, and the poorest households will need additional support. Furthermore, they will increase government borrowing by billions of pounds, which is clearly not sustainable in the long-term.

No one single policy can resolve the energy crisis. A portfolio of responses is needed that target the underlying market fundamentals by reducing energy demand (in ways that do not put vulnerable individuals at risk) and increasing supply from low-cost sources of generation (primarily onshore wind and solar). Support should be provided for both large scale projects and local energy projects delivered by community groups. For example, my work with co-authors demonstrates the importance of de-risking community energy projects through price guarantee schemes to realize the sector’s potential.

Reforming the energy markets

Fundamental reforms are needed to address price formation in energy markets. Currently, energy prices in the UK and European markets are determined by the marginal unit of generation, which is (now prohibitively expensive) natural gas-fired generation. Decoupling the price of non-fossil fuel sources of electricity from natural gas prices would mean that consumers (and not just energy companies) benefit from the low cost of renewable generation.

A green power pool model would involve effectively splitting the wholesale electricity market in two: one for fossil fuels and one for renewables. The market centred around renewables would involve long-term fixed price contracts with renewable energy generators, and the contracts are aggregated and sold to consumers and suppliers. When there is not sufficient renewable energy due to the intermittency of wind and solar, the contracts would allow the purchasing of back-up generation from the wholesale “on-demand” fossil fuel market to balance supply and demand.

Although there may be concerns that a green power pool would disincentivise investment in renewable energy by reducing profits, the main advantage is that it would allow consumers to receive renewable energy at a far lower price. So the contracts would have to be designed carefully to balance these interests, or additional renewable investment incentives may need to be introduced. However, a fundamental redesign of the wholesale electricity market would take a number of years to be agreed and implemented. Policies with more immediate impacts would therefore still be needed, such as windfall taxes on energy companies that are used to fund further price support beyond April 2023.

It should also be remembered that the main barriers to renewable development in the UK are planning regulations. The 2015 planning laws that gave local councils strong powers over the building of onshore wind turbines have made it almost impossible to build an onshore wind farm. Given the severity of the current energy crisis and the damaging effects it will have on living standards, as well as the fact that onshore wind is extremely cheap and easy to install, these planning restrictions can no longer be justified.

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