The UK is exploring a radical intervention in the power market under which the state would make payments to energy suppliers when wholesale gas prices rise sharply in a bid to soften the blow to consumers
The proposal, which is being promoted by energy companies, is described by government insiders as “plausible” and “logical”, but they admit there are also many downsides to such a step.
Under the initiative, energy suppliers would receive payments from government when wholesale gas prices exceeded a certain threshold so they would not then have to pass the hike on to consumers.
Some suppliers say the proposal — known as a temporary price stabilisation mechanism — could be self-funding over the course of several years as energy companies would have to return money to the government when wholesale prices traded below the agreed level.
Rishi Sunak, chancellor, accepts this could leave the taxpayer heavily exposed if wholesale prices remain high, but he has been discussing with Boris Johnson, the prime minister, ways to mitigate a cost of living crisis, officials say.
Without action by Downing Street, a price cap on household energy bills could rise from £1,277 a year to over £1,900 in April — fuelling inflation — and coming at the same time as tax rises take effect.
Johnson faces local elections on May 5 that could decide his political fate and is looking for “red meat” policies in the coming weeks to shore up his weakened premiership ahead of those polls.
Other options to cushion the impact of soaring energy prices have their own problems. A cut in VAT on domestic energy from 5 per cent to zero is still on the table, but has been described by Johnson as a “blunt instrument” helping both rich and poor households.
Ministers have also gone cold on providing government-backed loans to energy companies. Some estimates put the scale of the required lending at £20bn and one person briefed on discussions said: “Some of the firms would not be able to take on any more credit risk.”
Sunak is looking to offer targeted support to poorer households — possibly through an expansion of the warm home discount scheme — but ministers are looking to go considerably further.
Emma Pinchbeck, chief executive of the trade body Energy UK, confirmed on Monday that suppliers were discussing with the Treasury a mechanism to smooth out spikes in wholesale prices for consumers.
“The Treasury has asked industry to look at options for spreading the cost of the gas itself over a longer period of time,” she told BBC Breakfast.
She added that under such a mechanism, in “a year where the [wholesale gas] price is lower, the industry pays back government and in a year where it’s higher, the government helps the industry to spread the costs”.
Government insiders admit there is no easy way to manage the huge spike in energy costs, but say this scheme might at least offer some prospect of the Treasury recouping money when gas prices eventually fall.
“If this was a non-starter, we wouldn’t still be talking to the energy companies about it,” said one person briefed on discussions being held with the business department and the Treasury. “There are quite a lot of delivery issues, but it’s a plausible option.”
The mechanism would be similar in design to “contracts for difference” that support renewable energy generation in Britain by guaranteeing a minimum electricity price for power producers.
But the idea is not universally popular with suppliers. One senior industry executive said it was “unclear how you could bring it to an end and at what point do you bring it to an end?”
The executive added that such a mechanism would effectively be “shutting down the market to competition” as no consumers would want to move on to fixed-price deals while the stabilisation mechanism is protecting prices for households whose bills are dictated by Britain’s price cap.
Investec, an investment bank, on Monday revised its estimate for April’s rise in the price cap, due to be announced next month, following drops in wholesale prices in recent weeks. It is now expecting a £630 increase to £1,907 per household versus a previous forecast of £2,000.
But the bank’s energy analyst Martin Young warned the cap will have to increase for a second time to £2,100 in October, when it is next scheduled to be revised. Other analysts have estimated the cap will have to increase in October to £2,300-£2,400 based on forward energy prices.