Energy prices – PwC looks at the options

Published at 14:33 PM on 25 October 2013

Since the proposal at September’s party conference to freeze energy prices until 2017, should Labour win the next election, energy prices have rarely been out of the headlines.

Four of the largest suppliers have now announced tariff increases of between 8% and 10% with the remaining suppliers expected to follow suit.  Windfall taxes, competition enquiries, energy price caps, rolling back green levies: the sector is having to stand up to unprecedented levels of criticism, scrutiny and regulatory debate, all in the name of reducing the burden on customer’s bills.

Electricity and gas prices are taking a growing share of household budgets and energy poverty is a real issue. But at the same time it is clear that energy companies are facing a growing burden from green obligations – including the funding of energy efficiency measures, renewable energy and smart meters. The cost of all these measures is ultimately funded by energy consumers, through our bills.  Even Feed-In Tariffs are paid via our bills.

With wage rises lagging inflation, even without energy price hikes, it is obvious why this has become such a hot political issue. But policy makers also have to think about the longer term issues – energy security and climate change.

What are the options?

We still need to reduce our energy consumption and our carbon emissions, and ultimately this will mean decarbonising our energy supply. But what are the options for government to cut the burden of energy prices for retail customers, particularly for the less well off, without risking the lights going out or blowing the carbon budget?

Roughly 75% of the typical energy bill is made up of transport costs and the underlying commodity prices, driven by global energy markets outside the control of the energy companies and which, by their nature, tend to be volatile. The remainder of the bill is made up of the suppliers’ own costs, the cost of the government’s environmental and social schemes, VAT -  currently at the reduced rate of 5%, and a profit margin.

One way to cut energy bills would be to temper the impact of the government’s environmental and social obligations on energy companies, by reducing or delaying these obligations, or by transferring the cost from energy consumers to the tax payer. Some potential options are set out below.  All of these will have implementation challenges but are probably no more difficult than the challenge of freezing prices.

Push back the starting date of carbon tax increases to 2017: There is a clear recognition of the need for a robust carbon price signal in the medium to long term to encourage investment away from high carbon technologies towards green investment. However, it is a bit of a blunt instrument, adding to costs for business in the UK and risking carbon leakage to the rest of Europe whilst prices in the EU ETS remain low. Delaying the impact of the tax would reduce the upward pressure on consumer bills and help the economy, but would reduce the tax take and could disrupt some investment in renewables and other green technologies. When business has long argued for clarity and consistency in policy. Constantly moving the goal posts on carbon pricing makes investment planning very difficult.

VAT on consumer bills: Provide a temporary reduction in VAT on consumer bills (or, if practicable, at least for those more at risk of fuel poverty).  As an alternative, the government could introduce an escalator on VAT as they have done with petrol duty.  As energy prices rise, VAT would fall, and vice versa, to keep the absolute tax take constant. But the logistics would be tricky. VAT is part of a European system and the Government would need derogation from the EU for any changes.  There is precedent for granting super-reduced rates below 5%, but it’s less likely that the European Commission would be willing to grant successive and varying super reduced rates below 5%.

Slow down the roll-out programme for the Energy Company Obligation:  The government estimates the costs of this programme will be £1.3bn by 2015, so a delay in its roll-out would ease the pressure on tariff increases.  However an important feature of the programme is the focus on efficiency measures for vulnerable customers, so care would need to be taken to ensure that these customers don’t end up worse off, if the roll out was delayed.

General taxation:  Sweeping the costs into general taxation would alleviate the impact on those who are least able to pay but it would disconnect the total cost of energy from its consumption.  This would reduce the need for consumers to use energy efficiently and could lead increased emissions.

Energy efficiency: A more enduring solution would be to help less well-off consumers to slash their energy consumption. This would deliver a win win for consumers and the environment, without meddling with markets or discouraging investment. Increasing incentives for energy efficiency, for example, switching to high efficiency combustion boilers and more efficient home appliances, would deliver quick wins for government and for consumers. While ratcheting up standards in construction other high end-use carbon sectors would provide a lasting low carbon legacy.

To address the immediate concerns of fuel poverty, incentives could be focused on the less well off, with at least some of the money raised from energy taxes being committed to energy efficiency investment to benefit the fuel poor.

Doing nothing - Climate Change isn’t going away

The debate about energy prices and cost of green measures highlights the challenge that politicians are facing everywhere on climate change. The costs of many forms of low carbon energy are coming down quite rapidly. But whichever path you choose to get to a low carbon future still requires substantial investment.

The option of doing nothing (or at least doing a lot less), though, isn't cost free. And if we fail to contain global warming to within 2 degrees C, the economic and social costs of dangerous climate change are likely to dwarf anything we save now by putting our head in the sand.

The economic case for action hinges on a broad coalition of action internationally, both to avoid a competitive disadvantage for early movers and to have a realistic prospect of avoiding dangerous climate change. Progress to date on this has been too little, too late (more on that next week when we publish the 2013 Low Carbon Economy Index).

The bigger picture

Meanwhile even if politicians stick with the green agenda, they need to decide who picks up the tab for all this investment, as well as for subsidies for green energy and penalties for brown power. Putting the costs on the energy companies helps to keep taxes down, which from some perspectives may appear politically convenient. But wholesale increases in energy prices are very regressive, hitting the poorest hardest, and it is this burgeoning legacy that is now exercising the politicians.

While the UK remains committed to its 2020 renewable energy targets, the investments required in renewable energy (and nuclear from the 2020’s) will add costs to energy bills to the extent these are funded by consumers. Moving some or all of these costs into general taxation would ease the pressure on customer bills, but it’s worth remembering that, ultimately, that still means we, as taxpayers, have to pay the bill.

It would also blunt the incentive to reduce our carbon emissions. It is difficult to motivate the general public to cut their emissions just from a social conscience, but they will cut emissions if prices increase.  The solution must be to focus support for those least able to pay, rather than to reduce incentives for energy and carbon efficiency for everyone.

For more information contact PwC media relations

Gill Carson - Energy
Telephone: +44 (0) 7715 487 553

Rowena Mearley - Renewables, Climate Change
Telephne: + 44 (0) 7841 563 180

Ronan O’Regan, energy policy specialist, PwC

Jonathan Grant, Richard Gledhill, carbon and climate policy specialists, PwC

Jayne Harrold, Jonathan Main: environmental taxation specialists, PwC

About PwC

PwC firms provide industry-focused assurance, tax and advisory services to enhance value for their clients. More than 184,000 people in 157 countries in firms across the PwC network share their thinking, experience and solutions to develop fresh perspectives and practical advice. See pwc.com for more information.

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