New energy rebates would mean ‘pay less now, but more later’

The energy regulator Ofgem is about to announce what is likely to be a very large increase in the cap on domestic gas and electricity bills, to take effect from April, prompting a scramble for ways to limit the damage.

The Times is reporting that officials are finalising plans to limit the damage for a new system of temporary rebates on energy bills, financed by government loans to suppliers.

This proposal is better than many of the alternative ways to reduce energy bills, including a poorly-targeted cut in VAT, an arbitrary and counter-productive windfall tax on energy producers, and ditching the hikes in National Insurance. (The government should be scrapping the latter anyway, but this would not do much to help the most vulnerable here.)

Nonetheless, the new scheme still deserves only a lukewarm response.

The proposal is a form of ‘price stabilisation mechanism’. The government would lend money to energy suppliers when wholesale prices are above a certain level, allowing companies to cut bills. However, when prices fall below this level, suppliers would be expected to pay these loans back, rather than pass any savings on to customers.

This should be a better deal for the taxpayer than simply gifting money to suppliers to lower bills. It is also right that consumers ultimately pay the going rate for the energy that they use, to give price signals and other market forces a better chance of working properly.

But there are four dangers in going down this route.

First, while the scheme would mean that customers pay less when wholesale prices are high, they would pay more than otherwise when prices fall. This smoothing of bills over time will still be helpful, but is it important that people understand that any rebates now would be clawed back later. Headlines like ‘£200 off energy bills for every household’ do not accurately convey this.

A price stabilisation mechanism would lower the peak in inflation in the spring (depending on how it is captured in the consumer price index). But it would also keep the headline rate higher for longer in future, potentially leading to an increase in medium-term expectations for inflation.

Second, it would be better (and potentially less expensive) to target more support at those that really need it. The savings being suggested (£200 per household, at an upfront cost to the taxpayer of around £6 billion) would still leave many poorer families struggling with their bills.

This scheme would therefore need to be part of a more comprehensive package that includes extra help for low-income households, such as a further top-up to the Warm Home Discount (though this seems likely to be part of the final announcement too).

Third, the taxpayer will bear the risks of fluctuations in wholesale energy prices, and the risks of loans not being repaid. This might be justified in an emergency and the loans should be relatively safe (large utility companies are usually a good credit, and this scheme would itself directly address the biggest problem they face).

But, in general, businesses should be expected to manage and hedge their own exposure to changes in their costs. It is not the government’s job to do this for them, or to replicate the role of a well-functioning futures market. No wonder energy suppliers are so keen on this scheme.

Fourth, the proposed scheme is described as ‘temporary’ and ‘self-funding’, but it cannot really be both. The scheme would need to be in place for an uncertain, but probably long, time if taxpayers are ever going to get their money back.

During this period, the government would effectively be setting prices, which should not be its job either. It is essential that the government uses this time for a fundamental rethink of its energy policies, many of which have actually contributed to the crisis, particularly around environmental targets and levies. The proposed price stabilisation mechanism is another heavy state intervention that could easily backfire.

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