As the dark nights draw in and temperatures drop, it is not the time to take the foot off the pedal: fundamental change is needed to steer out of the energy crisis

This article was originally written as a Nutwood in Energy Spectrum. Find out more about Energy Spectrum and request a free trial here.

Author: Sharon Darcy

Sharon Darcy, Director of Sustainability First, raises six questions that need to be addressed if we are going to get the fundamental change needed to steer out of the energy crisis.

The crisis on the petrol forecourts has diverted some attention, for the time being at least, from the crisis in the energy retail market. The Supplier of Last Resort (SoLR) arrangements have – at the time of writing – helped get the sector through some of its immediate short-term problems.

This is clearly important for those consumers impacted by firms going bust. But it is unlikely to be enough. The energy sector is not in a ‘steady state.’ It is going through fundamental transformation, both in the UK and globally. Some factors, including international gas wholesale prices, are largely beyond our immediate control. Others, including who pays for what and how we distribute costs and risks fairly within the UK, are down to us.  The challenges faced are multiple and inter-dependent. They are both longer-term and immediate.

In the UK, one consideration rising up the decarbonisation policy agenda is how to shift the current significant burden of environmental and social policy costs from household electricity bills. Eventually this could be handled through a transfer to a mix of taxation and/ or gas bills. The aim is to provide more effective price signals – albeit in a phased way – to shift home energy usage away from gas boilers to electric heat pumps.

But the immediate crunch is the very significant number of households facing big hikes in the cost of living. Whilst it may make sense to load costs away from electricity and onto gas in the medium term, when faced by the reality of cold homes and people struggling between heating and eating, the need to proactively address the wider social impacts and ‘soften the pain’ must be urgently grasped.

The energy price cap, which has seen many bills increasing by 12%, is currently due to be reviewed again in April 2022. The bets are on that it will then go up again. On top of an end to the universal credit uplift, the increase in national insurance contributions, and wider inflationary pressures (green and otherwise), this is likely to lead to a rapid growth and deepening in financial hardship. The new Household Support Grant, just announced, whilst welcome, is unlikely to be enough to tackle the scale of the problem.

In this context, making the case for hard pressed families to pay even more on gas bills to cover green costs will become more challenging. And this is even before those who are struggling to keep afloat are required to find the up-front money needed to install heat pumps or make their own switches to electric vehicles.

BEIS should shortly announce its long awaited call for evidence on affordability and fairness in the energy market. This will need to consider how to balance these competing goals of net zero and the affordability of one of our most essential services – whilst keeping the lights switched on.

As the SoLR safety net creaks and groans, it is vital that all sides use any breathing space to look at these challenges strategically and in the round.  We need to not just get through the crisis but use it as a catalyst to create a fundamentally different market that can deliver a cleaner, greener, and fairer energy system. Below we identify six inter-linked questions that a review of energy markets and social protections needs to consider. At their heart lies the need to recognise that to decarbonise and provide resilient services in a fair way a substantial proportion of the population will need at least some form of access to favourable finance / lending and / or social protection. Market solutions will take us so far but on their own won’t solve the problem.

  1. How do we protect all the customers of failed companies – especially those already struggling? This issue has understandably perhaps received the most attention to date. Although the SoLR arrangements have so far prevented interruptions to consumer supplies, these arrangements need to work for everyone, particularly those who may already have payment difficulties or those who may no longer be able to budget given the price hikes experienced as they are move across to a new supplier.
  2. How do we ensure that only healthy companies that are ‘fit to play’ are licensed to operate? Ofgem sets the bar for which companies can enter the energy market. In the light of the current crisis, these rules need to be reviewed to ensure they give sufficient protection to enable the company to address underlying social, environmental, and economic risks and to withstand a range of shocks. This is likely to include, but not be limited to, company credit insurance / hedging arrangements for wholesale gas prices.

Ofgem will need to carefully consider what assurance and disclosure it needs that a company has a sufficient grasp of its risk universe. Some have pointed to the move to prudential regulation in the financial services sector post 2008 as a way forward. Whilst the risks in energy may be different, understanding how the people, culture and governance of a business shapes their approach to risk will be important. Our research has shown that a focus on a company’s purpose, getting a diverse mix of people around the board table and meaningful stakeholder engagement can be vital to build intelligence and pick up on the early warning signs of problems. These are core to a ‘Sustainable Licence to Operate’ in energy.

  • How do we define and track what a healthy energy market looks like? For too long, we have judged the success of the energy market by short-term metrics such as switching rates and the number of suppliers, rather than the extent to which it is delivering on fundamental and enduring societal goals. We all know that competition is not an end in itself. The long anticipated BEIS Energy Strategy and Policy Statement for Ofgem provides an opportunity to refocus the system on the key desirable outcomes for the sector, for both today and tomorrow. It will need to consider how Ofgem should approach trade-offs between different goals, such as security of supply/resilience, decarbonisation, and affordability, particularly when these will lead to significant distributional impacts. These are political questions and politicians need to lead.

To get assurance that the market as a whole is healthy, will require a review of the social, environmental, and economic metrics that all market participants across the value chain are required to disclose. Due consideration is also needed of how policy makers / regulators analyse and use this information to track leading indicators, trends, and carry out scenario analysis and stress tests of the market in the round.

  • How do we protect citizens going forward? Even if the above points are addressed, there are still some fundamental ‘fairness’ questions left around who is best placed to take risks in the market, who should pay for failure, how social and environmental policy costs are shared and what priorities for action should be. Our traditional policy and regulatory arrangements, by focusing on energy supply and the interests of individual consumers rather than outcomes, communities, and citizens, have historically either assumed customers will bear the risks and costs or ducked these issues. This crisis has brought to the fore the urgent need to reframe and refocus policy and regulation so that it takes a wider and longer-term perspective. Crucially, this needs to give more focus to solutions that deliver co-benefits.

Tackling the energy efficiency of cold and leaky homes – which will cut carbon, reduce fuel poverty, and provide good jobs – has to be top of the list. In this sense, Insulate Britain have got it right. We just need the political will to address this. To decarbonise at the scale and pace needed, this needs to be accompanied by suitable loans and grant-aid for people on low incomes to buy heat pumps etc.

Government will need to consider who then pays; whether environmental/social policy costs should go on gas bills and then groups of consumers get loans/grants to insulate their homes, or whether these distributional issues are more effectively tackled through progressive taxation. All this has implications for retail market models. There is a strong case for radical thinking but change needs to work in practice. An essential energy allowance charged at a lower unit rate, as we proposed in our 2019 What is Fair? Paper, needs proper consideration.

  • Do we have the right arrangements for enduring energy security of supply and resilience? The current complex and historic web of duties and responsibilities on energy security – across the full energy supply chain – needs a full ‘drains-up’ review. The new Future Systems Operator presents an opportunity here.
  • Are failing companies worthy of state support? If a larger energy players folds, the Special Administration Regime will need to kick in – the true test of ‘too big to fail’. Failing companies are part of most competitive markets. If no failure is allowed, there’s a risk of sclerosis and reduced innovation. In many ways energy is different as we rely on it 24/7 and 365. But that doesn’t mean supporting companies at any price.

If state backed loans are needed, it will be crucial these are not a blank cheque. There should be clear conditions attached – in terms of the outcomes this support should be used to deliver. In such an eventuality, Government could use the crisis and its intervention to drive purposeful business and to support its wider social / environmental goals. Robust governance in the public interest will be essential.

As we move into winter and the cost-of-living crisis plays out, having a government backed company in the sector might have its attractions. Could a ‘bad bank equivalent’ for energy also be used as a vehicle to deliver the universal service obligation and/or provide services for those who will need protection as we go through the transition? Let’s seize the moment and use the current energy crisis to reshape the energy market and how it is regulated for the better.

This article was originally written as a Nutwood in Energy Spectrum. Find out more about Energy Spectrum and request a free trial here.