Questions and answers about
the economy.

#studentviews: Is the UK’s energy price guarantee an effective policy?

The energy price guarantee is expensive, poorly targeted and fails to reduce the UK’s dependence on scarce fuel. As winter sets in and many people face serious hardship, a variable price cap would be a more effective way to cut energy use and lower bills for the poorest households.

The energy price guarantee (EPG) announced by Liz Truss during her brief premiership should have been a ‘Plan B’, according to Julian Jessop, an economic adviser known to have shaped her policies. He admitted in The Spectator that ‘any half-decent economist could have come up with a better-targeted, more efficient and potentially cheaper “Plan A”’.

The guarantee must go. But with over a quarter of the UK’s 25 million households in fuel poverty, we urgently need an alternative. It should be one that targets households struggling to pay their bills while also addressing the UK’s energy insecurity and climate crises.

Did someone say variable energy price cap?

Under a variable cap, the unit price of electricity and gas increases with usage. The gold standard – a so-called ‘revenue-neutral’ design – ensures that reduced costs for low energy use households are completely offset by the raised costs for bigger energy users.

Although the policy is simple, its impacts are highly targeted. This results from the nature of energy consumption: it rises with household income. Under an illustrative variable price cap modelled by the National Institute of Economic and Social Research (NIESR), the poorest 35% of households would have lower bills on average than under the EPG. The poorest 10% would have their yearly energy costs halved from £2,000 to £1,000, and the richest 10% would pay roughly £9,000 annually (3% of their income), helping to finance the lower costs for poorer families.

Lower-income families that are large, live in poorly insulated homes or have additional needs due to disabilities would be provided with allowances to reduce their burden.

The EPG is also targeted – but towards the wrong groups. The guarantee limits the amount that households can be charged per unit of electricity and gas until October 2024, with the government compensating suppliers if their costs rise above the cap. An oligarch heating the sauna in his Mayfair apartment will gain more than a pensioner heating her home to survive winter. This is simply because the more energy you use, the more you save compared to the uncapped cost.

This highlights another fundamental flaw of the EPG – its relatively weak incentives to save energy. Fuel prices are high because Europe faces serious gas shortages in the coming months and years, intensified by Russia’s invasion of Ukraine and ensuing sanctions. The only solution is for energy users to reduce their usage.

Utility bills are currently twice as high as last winter – providing some incentives to save energy. Nonetheless, households will be paying two-thirds of what they would have paid without the guarantee. They will consume energy as if the price is 60% of its true cost. The government’s subsidy is dampening powerful incentives (resulting from high fuel prices) for households to reduce energy use, either by boosting energy-saving measures or otherwise cutting consumption.

Equally concerning is the fact that families who cannot afford the energy but need it are forced to cut back usage, while wealthy households can take the hit.

This is not the case with the variable cap. The steeply rising cost of using energy would encourage the greatest reductions from bigger energy users. Simultaneously, there is a strong incentive for all households to try to use less energy and either to cut their costs dramatically or avoid incurring any costs in the first place. For the UK to have any chance of meeting its 2050 net-zero target, we need a green policy like this.

The final nail in the EPG’s coffin is its unjustifiable price tag. The Institute for Fiscal Studies (IFS) estimates the scheme will cost the government over £150 billion, equivalent to giving £2,000 to every person in the UK and costing the taxpayer 75p for every extra £1 a household spends on energy. We, the taxpayer, will be forced to delay retirement to pay off a debt that is bankrolling the growing dividends paid to energy giants’ shareholders.

The only state spending required for the variable cap policy would be on allowances.

Some governments have tried price caps and learned the hard way. According to Reuters, Hungarian government recently had to narrow eligibility for its energy price cap to reduce the risk of shortages and to plug holes in the strained public budget as fuel prices soar worldwide. Households in Hungary will be charged capped prices for gas and electricity up to ‘average’ consumption. ‘Above-average’ usage of these utilities will incur a considerably higher price. Now resembling a variable cap, the adjustment has so far proved successful –  The European Conservative reports that many Hungarians have already reduced their energy use.

The variable cap would pair incentives to decrease energy use with lowered bills for the poorest households – precisely what is required when addressing a cost of living crisis, a fuel scarcity crisis and a climate crisis all at once.

Author: Madeline Thomas
Editor’s note: This article is from the University of Bristol’s communicating economics class of 2022-23.
Picture by Leon Woods on iStock

Related Articles
View all articles
Do you have a question surrounding any of these topics? Or are you an economist and have an answer?
Ask a Question
Submit Evidence