ile political events are moving at breakneck speed, the UK’s economic challenges continue to mount. Looking at the cost of energy, the current Chancellor Jeremy Hunt announced that the Energy Price Guarantee for households will be reviewed by April 2023 rather than being in place for two years. This reduces the exposure of the public purse to swings in wholesale energy prices, but at the cost of transferring the associated risks to private households.
Shortly after the two-year guarantee was scrapped, energy market analysts circulated their first estimates of a potential price cap from April 2023 onwards, suggesting the average household could face annual costs of up to £4,350.1 Under this scenario, households’ energy costs could rise by more than 120% on the year. Compared to 2021 prices, energy costs could nearly quadruple. An increase of this magnitude would contribute around 4 percentage points to inflation on the Consumer Price Index, suggesting a new inflationary peak of 13% next April – the highest rate since 1980.
Even more concerningly, the increase in energy bills would further deplete household resources which are already under considerable strain from inflation for other essentials such as food and transport. Moreover, rising housing costs are also adding to the cost of living in the form of higher mortgage interest payments and rents. Our discretionary income models show that an unmitigated increase in energy bills to such levels would knock a further £136 off average monthly household spending power by April next year. A stark implication of the model is that all but the highest earning 40% of households in the UK would have negative discretionary incomes by Q2 2023. For households between the 40th and 60th income percentile, spending on bills and essentials would take up virtually all gross household income, while the bottom 40% of income earners would face a considerable shortfall. These figures underline the need for the next government to find a sustainable solution to shield the most vulnerable households from such high energy costs.
Another lifeline for both public and household finances might come in the form of falling wholesale energy prices. In a fortunate turn of events for governments in the UK and elsewhere in Europe, gas prices over the past two weeks have fallen substantially. As we pointed out at the time of the ‘mini-budget’, lower gas costs over the winter would mean that the cost of the Energy Price Guarantee won’t be as large as previously expected – instead of the £31 billion costs which the Treasury put aside it, a more realistic estimate seems to be around £15 billion if the current trend of falling prices is maintained.
The main driver of this fall in prices is the fact that European gas storages have been filled well ahead of winter as well as the current mild climate. Without further storage capacity and due to moderate levels of demand, spot prices have fallen back considerably. However, once temperatures fall and countries start looking for more LNG again to replenish their gas storage, prices are likely to rise again. For the UK especially, demand for gas will also depend on the amount of electricity generation through wind power. While an unusually cold or windless winter could still add a blow to gas markets in the coming months, for now it looks like Europe’s chances of getting through the winter without suffering gas shortages have improved, especially if households and industry boost their energy saving efforts.
This is also suggested by UK natural gas futures. Prices for Q1 next year have fallen from 555 pence per therm at the time of the publication of the ‘mini-budget’ to 368 p/therm.2 While this is still more than three times the level of prices a year ago it is a large improvement compared to recent highs of over 860 p/therm at the end of August.3
However, this should not be seen as a reason to be complacent as the past months have shown how quickly market prices can shoot up in situations where global LNG demand outstrips the relatively fixed supply. Moreover, energy supplies are still likely to be very tight next year, with the added difficulty of Europe not having received any Russian gas at all to fill up storage ahead of winter. Other global factors could also work to push prices up over the next 18 months. For example, in 2022, Europe has benefitted from a drop in Chinese demand for LNG, partly due to the ongoing lockdowns amid the ‘zero-Covid’ policy, which we anticipate the country gradually moving away from.
Whoever will be the next PM, a priority will need to be working on a solution to shield the most vulnerable households from further increases in energy prices next year, while at the same time doing as much as possible to boost domestic energy production and secure imports for next year.
1 https://www.cornwall-insight.com/energy-price-guarantee-to-end-in-april/ Energy Price Cap published on Twitter: https://twitter.com/CornwallInsight/status/1582027160973238272?s=20&t=VPUvuTJz5mXQ3w6aA753gw – Retrieved 20/10/2022, 16.00h
2 As of 19 October 2022
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