The cap on energy prices is a gamble that is about to pay off

Critics of ‘Trussonomics’ – and there are many – have been quick to claim that the new energy price plan puts its economic credibility at risk. Indeed, early estimates suggested that the ‘Energy Price Guarantee’ could cost the taxpayer £150 billion or more over two years, making it the most expensive economic policy in history. More than the furlough scheme, more than even the bank bailouts. Fortunately, the bill looks like it will be a lot smaller and sceptics are set to be proved wrong.

The Prime Minister proposes to cap the unit price of energy for households for two years, starting next month, with the government compensating suppliers for any additional costs. Similar support has been offered to businesses and other energy users (such as schools) for an initial period of six months.

Let’s be clear: it’s a massive state intervention in the markets which will subsidise the energy bills of every consumer regardless of need. An oligarch heating the swimming pool in his London mansion will benefit from the capped cost just as much as the pensioner in Blackpool trying to survive winter. Any half-decent economist could have come up with a better-targeted, more efficient and potentially cheaper ‘Plan A’.

Nonetheless, the chosen ‘Plan B’ is at least simple. Easy to communicate. It should be far more effective than a patchwork of smaller measures in lifting the huge cloud of uncertainty hanging over households and businesses. It will also not have to be continually revised and extended (as the furlough scheme was) if energy prices remain high.

In fact, it’s not so bad in terms of its distributional impact either. Oligarchs aside, the biggest benefit will go to households that use the most energy – so people in colder rural areas, or the north. Lower-income households should see the biggest gains as a percentage of their budgets. Market signals will still be there. As of next month, when the new rate kicks in, household energy will be twice as expensive as it was a year ago – giving strong incentives to save energy.

But what about the cost to the tax-payer? Paul Johnson, the head of the Institute for Fiscal Studies, has said this could be ‘the biggest single fiscal announcement in my lifetime, because this could cost £150 billion’. Concerns about writing a blank cheque to the energy companies has already contributed to a sharp rise in the UK government’s cost of borrowing – and to the fall in the value of the pound.

Europe’s gas supplies are now expected to remain adequate even during the colder months

But there are two reasons the headline-grabbing cost estimates are misleading. The first is that the upfront costs of the freeze itself will be at least partly offset by savings elsewhere. For example, the fuel subsidies will keep inflation down – making it more likely that the economy will avoid deep recession. This should, in turn, mean higher tax revenues and lower spending on other welfare benefits.

Yes, the cost of the Energy Price Guarantee is uncertain – but this is not so much a bug as a design feature. The whole point of the plan is to transfer a huge risk to the broader shoulders of the government, rather than expect individual households and businesses to take the full hit. Over time, this should also be seen as a positive for UK assets – including sterling. The new government’s response has been much more decisive than that of many other European countries, notably Germany, where the risks of a deep recession are now much greater.

The second point is that gas prices have been falling recently, and the wholesale cap might not cost nearly as much as people fear.

Mr Johnson’s colleagues at the IFS made their forecasts based on estimates from August on what will happen to gas prices next year. Those estimates have since come down quite a lot. Back then, for example, wholesale gas for delivery in January was priced at 824p per therm but now it’s around 550p. Throughout next year, gas prices are expected to be significantly lower than was feared in August. Suddenly, things don’t look so bleak. This isn’t just crystal-ball-gazing. Earlier this week, the actual price of wholesale gas plunged to 320p per therm – almost half the August peak.

Why such a sharp fall? Perhaps we should ask why people panicked so much last month. At the time, western European countries were building up stocks ahead of the winter, compounded by speculation of widespread shortages as Russia closed the Nord Stream 1 pipeline to Germany. These pressures have now eased. Gas stocks are now at comfortable levels, with Germany at an impressive 90 per cent.

Europe’s gas supplies are now expected to remain adequate even during the colder months. Underlying demand is also weakening, as economies slow and governments, households and businesses all look for new ways to save energy. In some cases, energy-intensive businesses such as aluminium, ceramics, even loo roll, are cutting production – or even, unfortunately, closing entirely. Turning wood into toilet paper is surprisingly energy-intensive, and when prices surge, the business risks becoming unviable. Hakle, one of Germany’s oldest loo roll suppliers, went bust last week.

Meanwhile, imports of liquefied natural gas (LNG) have been strong, helping to ease overall prices. Russia’s military failures in Ukraine have raised hopes of an early resolution to that crisis – though that may be wishful thinking. But in any case, it is reasonable to speculate that gas prices may end up far lower than has been feared. This suggests the final bill for the UK energy bailout could be less than half of the £150 billion that was originally suggested.

Rather than damaging economic credibility, the Energy Price Guarantee could prove to be a masterstroke. It is a pragmatic response that reflects the scale of the economic and social crisis – but thanks to a collapse in the wholesale price of gas, the final bill should be much smaller than anticipated. ‘Trussonomics’ 1, conventional thinking 0.

This article was first published by The Spectator on 22nd September 2022

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