The Cost of Energy

There is, understandably, a lot of chatter about energy costs and what can be done to prevent them from causing serious hardship this winter.

Unfortunately most of what’s being suggested, not least by politicians (in power and opposition), won’t be much help because of the way that the wholesale energy markets work.

The primary aim of energy producers and the people who operate in the energy futures markets is to extract as much profit as possible from their activities. It is in the interests of all of them to operate what is effectively a cartel in order to keep prices high. Subsidising household energy bills and nationalising energy retailers – our politicians’ favoured solutions – will not change this.

The recent leap in energy prices can partly be attributed to constraints in supply caused by the Ukraine war, but the root causes are our over-reliance on hydrocarbon fuels, and control of production and the wholesale market being in the hands of a few corporations who care only for their own gain.

The current price hikes are as much opportunistic as they are circumstantial, and they affect everything that we buy, everything that is contributing to the cost of living crisis. Energy price increases are the root cause of inflation.

A strategy to ensure affordable energy is, therefore, vital for a healthy sustainable currency as well as the entire economy.

The primary objectives of such a strategy must be to encourage less energy use and prevent opportunist price-gouging.

Things that we can do immediately are:

  • cap the standing charge (domestic and commercial) at the actual cost of distribution (i.e. stop energy suppliers from hiding profits in inflated standing charges).
  • cap the price of the first (say) 20kWh of energy consumed each day at (say) 10p/unit, and mandate that every kWh metered thereafter must be progressively more expensive using a standard logarithmic scale.
  • tax the profits of energy companies according to the number of kWh sold beyond the 20kWh allowance, with the rate of tax increasing in proportion with the price per unit of energy.
  • provide a generous tax credit for energy companies for every customer whose home/workplace has been energy-proofed by the energy company to an independently-inspected standard; make the value of the tax credit significantly more than the cost of the kWh tax over the course of a (say) 5 year energy supply contract so that there is good profit in providing energy-efficiency.
  • 100% 1st year capital allowances and zero VAT on all materials, equipment and labour used in energy-efficient installations.
  • zero capital allowances and punitive VAT on all technologies that do not meet current best standards of energy efficiency.
  • apply the basic corporation tax rate to the profits of energy traders/wholesalers where the profit margin is lower than a reasonable percentage; apply 100% corporation tax rate to profits over the reasonable percentage threshold.

These actions will bring down the price of essential energy for vulnerable customers and protect them from future energy price hikes.

They will also incentivise the installation of energy-efficient technologies and adoption of energy-efficient practices in homes and workplaces.

Most importantly they will curb opportunistic extraction of profit from the production and supply of carbon-based energy, and encourage energy companies to move into the supply of energy efficiency as the primary source of their profits.

In the longer term we need to establish a universal Sustainability Tax that replaces most of our current tax code, getting rid of VAT, National Insurance, income tax, corporation tax, and all other taxes that are energy agnostic. A well-designed Sustainability Tax will accelerate the move away from profligate use of inherently expensive hydrocarbon fuels towards sustainable use of inherently cheap renewable energy.

4 thoughts on “The Cost of Energy

  1. Hi Malcolm

    All looks sensible, however we should also address the massive regional injustices where we see people in the highlands paying double for their energy from what they paid a couple of years ago, whilst the cost of production has actually gone down.

    Owners of domestic wind turbines in Orkney are constrained off the system due to an excess of power whilst their energy charges soar. Is that fair or sensible?

    Scotland produces nigh on 100% of all net electricity consumed from renewables and the cost of that production hasn’t increased. OK, there is timing mis-match, but the wholesale market should act as a large battery, because even when the wind is blowing and Scotland is exporting renewables, there is still gas being burned in other parts of the UK. So every kWh of wind displaces a kWh of gas. Hence when buying back gas power for times when the wind doesn’t blow, we should only pay the costs of transmission, not the base energy price. In other words pay for net kWh not gross kWh.

    The numbers here are absolutely colossal. Scottish consumption is 30TWh. The average cost to consumers has gone up £150/MWh (approx.) That equates to 4.5 billion a year, or £1000 per head of population in Scotland. That is a direct subsidy by Scottish consumers to the rest of the UK, and is needed because of Tory councils refusing to allow wind power developments in England.

    Thinking ahead, a national electricity company that buys direct from generators and sells to local customers is the way forward. Note that in the latest CfD round for offshore wind the strike price was around £45/MWh. That is what the cost of coal fired generation was back in the 1990s. So, there is no excuse whatsoever for prices going up. Either the generators are making a massive amount or the retailers are. BUT – there is a 3rd party in the CfD equation – the Low Carbon Contracts Company which is owned by the UK government.

    Under the CfD arrangement, if a generator has a strike price of (say) £45/MWh and the wholesale price is £200 (average at the moment) then the generator has to pay the excess to the LCCC. So the generator doesn’t get any more. The retailer on the other hand has to pay the wholesale market price, so has higher input cost which then gets passed on to consumers. Where does the difference go? Answer is it goes directly to government via the LCCC. So this is in fact a stealth tax on efficient renewables production, and a stealth tax on consumers who are already struggling to afford the costs.

    Now that I have written this out, (and please check it because I might be wrong), it is utterly shocking. What needs to happen is that all revenues received by the LCCC go straight back to the poorest in society to pay for their energy costs. Perhaps this does by reversing the levvy on electricity retailers? I don’t know. I am however pretty sure that the system was designed when Ofgem thought that the average wholesale price would be below the CfD strike prices, not above, so not designed for reversing the money flow. Also, I don’t know what happens with all the ROC schemes which will be being paid wholesale price, plus ROCs and hence making a killing!

    It all needs more investigation and is a complex problem to which I don’t have the answers. What I do know however is that people living beside hydro reservoirs and wind farms should be getting reliable and affordable power.

    Hope you are well – and lets keep this conversation going to drive out solutions that can be implemented within the constraints of a highly regulated market place.



    • I am aware that there are many aspects of the murky depths of the energy markets that need to be binned, not least the electricity distribution charges applied to so-called remote generation regions like the north of Scotland and Cornwall. It’s not only unfair, it’s bonkers.

      A national energy retailer sounds good, and it might do the job cheaper and better than the private ones (wouldn’t be hard) but it wouldn’t do anything to stop excessive profit extraction by the hydrocarbon fuel producers, wholesalers, and the futures guys who use vast reserves of spare cash to buy cheap and then sell dear for no effort and no reason other than greed.

      If we want equitable and sustainable use of energy the focus must be on energy efficiency, converting the energy market into an energy efficiency market where energy supply is merely one of the components. The trick is to find ways that penalise profligate use of energy (especially non-renewables) while encouraging sustainable use.

      I think that we can do this immediately via tax and regulation, without the hassle of taking everything into public ownership. A bonfire of the current egregious market manipulations that you have highlighted should be done at the same time.

  2. Hi Malcolm.

    I agree, but would add/edit/expand with the following:

    Insulate, insulate, insulate – with incentives (lower power costs per EPC rating?), not grants. Mandate more in all new builds and extensions NOW. Stop ‘permitted development’ unless meet high sustainability standards. ie don’t wait until 2025 Future Homes policy…. My own Borough Council doesn’t mandate renewables and has only just issued an SPD on climate and Sustainability, for consultation – it’s years behind Central Government’s so called net zero ambitions.
    Encourage renewables with incentives ie proper FIT etc for excess power. Oh we used to have that…. We need fast track training on renewable skills.
    Suspend the model where all electricity is priced off the marginal cost of gas. 70% of UK power comes from non fossil fuels. Consider a pricing model that is cost plus, with threshholds and caps. Central buying then averages the different electricity sources.
    Smart grid and smart buying – lower prices for off peak use etc. Residential and Business.
    Target Subsidies for the poor.
    Mandate manufacturers to develop low power kit – all those lights on (TV, microwaves, fridges, wifi, smoke alarms, security alarms, plug extensions). Allow the kit to turn on and off without having to reset passwords etc. Get Smart.

    [As an aside, the renewable producers are making ultra windfall profits – yet it is just the Oil Cos that are getting hammered. I don’t support windfall profits but understand the political pressure to bring them in, but oil co will just go elsewhere. Shell, BP and others have purchased rights for enough GW to make us 100% windpowered already – the issue is capacity to build, install and connect to the market. eg the new grid needed to get new offshore wind through East Anglia, is crippled by nimbys]

    And on we could go – no strategy, no planning, no enforcement teeth. Every sector wants more money, with labour and unions angling for a general strike to get into power. Awful government, even worse opposition. And the data tells me the rest of Europe are no better, and in many cases worse off – but the papers won’t tell you that. OH and little capacity to borrow more. 25 years of poor government coming home to roost, with a root cause being 10 million extra people over the last 25 years, with no infrastructure growth properly planned……no strategy……circular debate. How do you think we can absorb the combined population of Ireland and Denmark without significant new infrastructure….

    My colleagues in County and Borough Councils are fed up – unloved, on the back foot, dominated by dealing with providing social services, hence no time or money to do the stuff that residents want. Young people don’t want to go anywhere nr this sector…. We need to pay civil servants well to attract better people…



    • Can’t argue with any of that, Anthony. Good to see that lots of us are thinking along similar lines. How we get the political machinery to pay attention and do something useful is less encouraging.

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