Will the EU’s new plan cut your energy bills?

What will my energy bills be this winter? That is what most people want to know, And a gap is opening up between how EU countries and the UK under a new prime minister are planning to address this. Liz Truss is promising to freeze household energy bills for the next two winters, ensuring they won’t exceed £2,500 (€2,878) a year, a hugely expensive measure.

The European approach is different — under the European Commission’s current proposal energy bills would still rise, but revenue would be created to compensate households and consumers by taking the excess profits accruing on the generation of electricity from fuels other than gas. This is a key part of the proposal which EU energy ministers will discuss on Friday — this won’t hold down your bills this winter but it could give the Government a bit more cash to compensate businesses and households. The amount involved is however likely to only meet some of the cost.

So is the UK doing too much, or the EU not doing enough?

1. The central dilemma

There is a clear problem at the centre of this. The EU and UK are both energy importers — though countries do of course produce some of their own power from nuclear, oil and gas fields and renewables. So the rapid increase in wholesale energy prices involves an unavoidable economic cost. The question is how much of this is borne by energy consumers and how much by taxpayers.

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There are a host of other associated issues too — such as the need to ensure energy supply, how to promote investment in renewables, the best way to reform the electricity market and how to tax those making above-normal profits as a result of the crisis. These are all important.

But the key question in terms of energy bills is where the tab is picked up.

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2. The EU versus the UK

The UK’s answer is that taxpayers should pay a huge amount of the bill. Or rather, future taxpayers, as it plans to fund its massive intervention through borrowing. The UK has a system of caps on household bills which means they go up every three months, based on the wholesale market. The current cap is £1.971 per year and the UK government proposes to cap it at £2,500 for the next two winters. This is still way above last year’s cap level of less than £1,300, but would ward off an increase to over £3,500 in October and projections that the cap could go to around £6,000 next year, on current wholesale price trends

But it would be hugely expensive — costing at least £100 billion, or 5 per cent of GDP, and around £150 billion when business supports are added in. Massive amounts will have to be paid to electricity suppliers, who will effectively be asked to sell to customers below cost. Households will also get additional financial supports.

It is hard to estimate what the cost of a similar price promise might be in the Republic, but on the basis of national income figures it could be in the €7 billion to €10 billion region in a year (it depends where you set the cap and what future wholesale prices) The UK prime minister has said she is not in favour of a windfall tax on energy producers, so no additional cash is coming from there.

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The EU plans a different intervention. It is targeting the excess profits being made by companies who produce energy from sources other than gas. Energy produced from wind, solar and other sources is generating big profits. This is because electricity prices are set on the basis of the gas price — and while the wholesale price of gas has risen, the price of, say, wind power has generally not climbed. The charge on these excess profits would be used to provide revenue to help to compensate households and businesses.

Crucially, this part of the EU plan will not affect the actual price paid by households, and thus will not hold down bills. The idea is that it generates some cash to allow governments to help households via direct cash supports. Other aspects of the plan, including strategies to reduce demand, especially at peak time when gas often kicks in to the system, may help to reduce the scale of price increases to an extent. However the EU plan will not offer the kind of certainty on price offered to households by the UK proposal.

3. What are the risks?

The risks of the UK plan are clear enough. They are that wholesale prices keep rising and the support needed for energy suppliers and the overall cost of the plan continues to increase. Already, the cost to the UK government of borrowing is rising above 3 per cent and with the promises to cut taxes as well, and a significant deficit on the current account of the balance of payments, the UK needs to be able to keep borrowing and attract investment, The Truss plan is therefore a significant financial gamble. If sterling keeps collapsing and the cost of borrowing to the UK state keeps rising, it could all fall apart. Another key part of the UK plan is that is does not offer the same incentive to households to save on energy - if households get their full bill, but get cash back to help, arguably they are more likely to save on usage. But can they afford the bill?

The EU plan, if agreed — and there are different views across Europe — is less financially risky but leaves households more exposed. On current wholesale market trends, which of course could change, another hefty round of increases for consumers is on the cards later this year. On the basis of UK forecasts, average Irish annual household energy bills based on current wholesale prices could be heading from the €3,500 to €4,000 per annum level they have now reached to the €6,000 to €7,000 level. These wholesale prices are hugely volatile — it may not get that bad. But it could.

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Energy suppliers argue that they are using the cheaper energy from wind and other sources to effectively avoid passing on the full rise in wholesale prices to consumers. And they say there is a risk that meddling could lead to yet higher increases. For the Government, the extent of excess profits accruing — and who they benefit depends on supplier contracts in the wind market in particular — is politically difficult. If an EU windfall charge is agreed, the Government here will likely follow in some form.

While the charge plan is cleaner than a full windfall tax charged on profits, we need to remember too that while the sector is profitable, it is also facing big liquidity challenges. Companies need huge amounts of extra cash to back up their normal purchasing strategies as prices surge. The whole sector across Europe is facing a big liquidity squeeze which will only get worse if consumers can’t pay their bills.

4. Can governments do anything else?

The idea of fully separating gas and electricity prices is likely to be re-examined, but is technically difficult in a market which has existed for a long time. It is a reform which could take a few years. A key goal of governments in the short term is to encourage the supply of energy and in the long term to encourage investment in grids and in renewable energy. Any shake-up of the overall market needs to keep this in mind.

5. What is the politics of this?

The UK plan looks financially risky — but a cap on household bills is much clearer to communicate than the EU plan. So that will play into politics here. Sinn Féin is already pushing for some kind of price cap. The Government may calm the atmosphere in the short term via big once-off giveaways in the budget. But what happens if energy prices are still sky-high next year?