The rising cost of energy has been a significant driver of high inflation. Gas prices have increased 11-fold since 2019. 85% of UK households use gas boilers to heat their homes and around 40% of electricity is generated in gas-fired power stations. Gas is also a critical source of heat for industry.
The UK government is trying to ensure households and businesses have enough energy this winter by turning to booming US liquefied natural gas (LNG) and reinstating retired storage capabilities. Russia’s recent decision to switch off its Nord Stream 1 pipeline has proven that Europe is still very much at the mercy of changes in global gas market supply and demand. Such events are likely to continue to cause gas price volatility until more supply is available, which could take at least three years.
The government continues to be under great pressure to step in and deter energy companies from profiteering. Energy companies however argue that profits are constrained by rising wholesale gas prices.
THE ENERGY PRICE CAP
To aid economic recovery and protect households from fuel poverty, the Office of Gas and Electricity Markets (Ofgem) introduced the concept of an Energy Price Cap, providing stability and ensuring households pay a fair price for their energy bills. Essentially, it prevents energy suppliers from charging whatever they want per kWh of energy used, while at the same time taking into account the real wholesale price, to prevent suppliers from purchasing energy at a higher price than they are selling.
But this measure was counteracted by energy companies essentially setting their new pricing at the level of the energy price cap, thereby maximising what they were allowed to charge under the legislation. And within two years of introducing the price cap, the UK government has been unable to prevent further increases in energy price, which at the time of writing this paper is nearly 2x the original price cap introduced in January 2019.
WHAT ABOUT BUSINESSES?
With energy prices soaring and inflation out of control, the cost of living in the UK has caused great strain on households. Businesses meanwhile are arguably under even greater pressure as the energy price cap is confined to households only; if energy companies’ profits are as they claim, constrained by rising wholesale gas prices, it is conceivable that energy companies will shift any further price increases onto businesses, to compensate for losses arising as a result of the energy price cap in the residential sector.
There are a number of issues that need to be addressed in relation to the current energy crisis.
Cost of living
High inflation is putting great strain on UK households. Rising inflation will drive up the cost of goods and services as the value of the pound – and therefore purchasing power – continues to fall. US investment bank Goldman Sachs estimates that in a scenario where gas prices remain elevated at current levels, we can expect the price cap to increase by over 80% versus the current level in January 2023 (vs 19% assumed in the UK’s baseline). This would imply headline inflation peaking at 22.4%, well above our baseline forecast of 14.8%.
Add to this the staggering increase in energy prices – an essential raw material – and many households are already struggling to pay their utility bills which, along with mortgage payments, are amongst the last bills people will default on.
In addition to the above, if one were to assume energy companies’ profits are indeed constrained, the elevated price of energy for businesses will put pressure on businesses to further increase the price of good and services. So not only will we see price increases resulting from inflation, but also a passing on of the higher cost of energy. This is a circular problem and if it is not quickly addressed, we will see the cost of living spiral out of control.
The current cost of energy has unfortunately left some 6 million households in poverty. If Goldman’s forecast turns out to be true, this figure will rise to a staggering 22 million by January 2023. The majority of these households will already be just above the breadline with the current cost of living. The social housing sector is therefore exposed to a particularly high risk, as are the elderly on pensions that are an increasingly insufficient source of income to cover household expenses.
The cause of the increase is multifaceted, with a global rebound in post-lockdown energy demand, a particularly cold winter that left stores depleted, the geopolitical situation in Ukraine and macroeconomic factors such as inflation and the US LNG market. It is a complicated conundrum for the UK government but one that does need to be addressed with urgency to avoid public anarchy!
WHAT IS NICL DOING ABOUT IT?
These are difficult times for us and there is no one solution that will be appropriate for everyone. But in these times, we turn our attention to those that are most in need of support.
The team at NICL is in dialogue with a number of local authorities to roll out a “free solar” solution, whereby NICL finances the development and installation of rooftop solar and energy storage solutions across local authorities’ social housing portfolios, in turn locking in a long-term, fixed energy price for consumers.
“Prosumers” – those that produce their own energy – benefit by hedging themselves against energy price volatility. There is no cost to the tenant nor the local authority for installing these systems. And in the spirit of transparency, the asset owner – a subsidiary of NICL – receives a fixed, predictable revenue stream from the tenant for each kilowatt hour of electricity consumed.
We are determined to start with those that are most in need of this solution and hence our initial focus is on social housing. We will look to replicate the model across the private housing and business sectors.
As readers will appreciate, this is by no means a new concept. But, whereas in the past investors have cherry-picked properties with the most attractive location and roof space in order to maximise economic return, NICL will go a step further by making the product available to any property with adequate roof space and energy utilisation in our ongoing efforts to make investments that deliver sustainable, social and economic benefits without discrimination.