How to and how not to cut UK electricity bills
The cost of renewables subsidies is beginning to cause alarm even amongst those who think they are necessary for decarbonisation, with some analysts acknowledging that rising electricity prices inhibit the adoption of heat pumps, and thus represent a barrier to decarbonisation of household heating. In response, the think-tank and public affairs company Public First has proposed shifting part of the cost of renewables subsidies onto direct taxation in the first instance, then recovering the cost from a new carbon tax, mostly on natural gas. Does Public First’s proposal stand up to scrutiny, and who are the real beneficiaries?
Total income support subsidies to renewable electricity generation in the United Kingdom now amount to about £10.8 billion per year: £6.4 billion under the Renewables Obligation (RO), £2.9 billion under the Contracts for Difference (CfD) scheme, and £1.5 billion under the Feed-in Tariff (FiTs). All three schemes are projected to grow somewhat in cost over the coming years, reaching and perhaps peaking at a total of about £12 billion a year in the mid-2020s. Costs will continue at high levels for several years after that, before finally declining in the late 2030s as the subsidy entitlement contracts expire.
These astonishing costs are charged to consumers of all types through their bills, with households paying approximately 40% of the total, slightly more than their share of all electricity sales, since industrial and commercial consumers can buy closer to the wholesale price. Ultimately, however, all of the burden falls on householders, since industrial, commercial and public sector consumers pass on their own share of the costs as higher prices for goods and services and an increased demand for taxation. Households are also likely to be affected indirectly by the subsidy burden on businesses through reduced rates of employment and a downward pressure on wages.
It is hard to find anything positive to say about the subsidies to renewables. They haven’t reduced costs significantly, they mainly benefit overseas manufacturers of wind turbines and solar panels; and any jobs they create in the UK are not only costly but more than offset by jobs destroyed elsewhere in the economy. Furthermore, the cost of any emissions savings they deliver is so far in excess of any rational estimate of the harm caused by emitting a tonne of carbon dioxide (the ‘Social Cost of Carbon’) that there is no exaggeration in saying that the renewables cure is far worse than the climate change disease.
And on top of all this, there are the indirect costs of renewables, such as the grid reinforcement and multi-billion-pound interconnectors they require, and the greatly increased cost of balancing the grid – including such scandals as the hundreds of millions paid to induce wind farms to reduce output. Indeed, Balancing Services and Use of System (BSUoS) charges on the GB grid have risen from about £400 million a year in 2002, at the start of the renewables policy, to nearly £1.5 billion in 2019, increasing sharply in 2020 to about £2 billion as public health measures reduced demand and made the management of the grid still more difficult. Even allowing for inflation these are highly significant increases.
Bad though all this is, there is more. Deep decarbonisation of the economy is critically dependent on electrification, but renewables have increased electricity prices, thus inhibiting the adoption of electrically powered replacements for fossil fuels. This self-defeating aspect of climate policies has long been a joke amongst engineers and economists, and is now beginning to be evident even to supporters of the renewables agenda. The London think-tank and public affairs company, Public First, has released a study, Options for Energy Bill Reform, focusing on the difficulties of replacing domestic gas-fired boilers with heat pumps. They argue that progress in this area is being prevented by high electricity prices – the result of renewables subsidies – and say that support should be delivered from central taxation or a carbon tax, or a combination of both.
However, in considering only policies to ‘remove the running cost disincentive on electrified heating’, the authors constrain themselves needlessly, and thus reach flawed conclusions. The first constraint arises from their incorrect claim that renewables subsidies ‘are necessary to achieve decarbonisation’; there are in fact several cheaper options, such as rapid adoption of high efficiency gas fired and nuclear generation.
The second constraint is their unwillingness to accept that government should provide subsidies from central funds, where they would be visible for all to see, saying they do not want to put ‘an undue fiscal burden on the government finances’. However, since the subsidies are the result of government policy it is hard to see the burden as ‘undue’. While it might be politically embarrassing – these subsidies were hidden in consumer bills for a reason – government should be made to face the music. But Public First is clearly unwilling to fight that battle.
Thus hobbled, Public First will not contemplate an absolute reduction in subsidies to renewables – which is the simplest option to encourage heat pump adoption – since such support is considered sacred flesh and not to be touched. However, while seeing no realistic option but to recommend funding by taxation in the first instance, they are so fearful of Treasury displeasure that they feel obliged to sweeten the deal by proposing a new tax to offset the increased cost to the Chancellor.
This option, Option 2 in the study and Public First’s preferred option, proposes that the cost of subsidies that would otherwise be currently levied on domestic household bills should in future be paid by the Treasury, and that to recover some of that cost a carbon tax should be levied on both electricity and gas consumption, starting at £54/tCO2e and rising to £75/tCO2e. This would result, they estimate, in an initial cost to the Treasury of about £5.7 billion a year in 2030 (no earlier dates are given; the study is vague concerning key details and the ‘model’ employed is an opaque black box), but this would be almost completely offset by carbon taxation receipts delivering a net cost to Treasury of £200 million, implying that Public First’s estimate of carbon tax receipt is in the range of £5.5 billion a year.
That is a plausible figure and can be approximately replicated without difficulty: Assuming total (domestic and non-domestic) annual gas consumption of about 500 TWh as at present, and emissions from gas at 0.18387 tCO2e/MWh (DEFRA’s recommended figure for carbon reporting) such a measure would yield about £5 billion a year at a tax level of £54/tCO2e. Income from a carbon tax on electricity is harder to estimate due to uncertainties around electricity consumption levels and grid emissions in 2030, but if consumption stood at 270 TWh, as it does today, and emissions were very low, say 0.05tCO2/MWh, the tax income would amount to just over £700 million a year at £54/tCO2e.
At best, then, this should be more or less neutral for most consumers, with the costs removed from electricity for the most part relocated on gas. In fact, and realistically, Public First estimate that ‘cost would increase slightly – by £38 (+3%) a year for the mean consumers and £40 for the fuel poor.’ That will not seem slight to all families, but further state intervention through social policy might provide a remedy, and it is not an overwhelming objection to Public First’s suggestion.
But would Treasury find this offsetting proposal attractive? Almost certainly not, for two reasons. Firstly, the burden of paying for the renewables subsidies would be clear and unavoidable while the consoling carbon tax revenue would uncertain and difficult and possibly costly to collect. Secondly, and much more importantly, the carbon tax revenue would decline over time, eroding the offsetting measure. As with all environmental taxes, one can have environmental benefits or revenue, but not both. If the measures were successful in removing the barrier to deployment of heat pumps, and the carbon tax on gas and electricity incentivised the adoption of low carbon replacements, then UK gas consumption would fall very significantly and, in spite of the rising character of the carbon tax, so would the offsetting revenue to the Treasury. Public First must have understood this – it is elementary environmental economics – but does not discuss the problem.
There are other difficulties. Public First’s proposal is to relieve domestic consumers of the cost of renewables subsidies but to leave the cost recovery of these schemes unchanged for industrial and commercial consumers. This introduces considerable complications of administration. For example, if the Renewables Obligation no longer applied to electricity sold to domestic households this would reduce the overall Obligation itself, resulting in an oversupply of green electricity, and a crash in ROC prices, destabilising the entire renewables sector. To avoid this, the Obligation would have to continue as it does today, except that the cost would be calculated by electricity suppliers and then billed to the Treasury, or to some intermediary organisation. That is quite feasible, but will create overheads and uncertainties, as well as adding further complexity to the UK electricity markets, already a nightmarishly intricate cobweb of regulations. It is not, on the face of it, a particularly attractive idea.
However, the five large electricity suppliers: Ovo, E.ON, EDF, ScottishPower and Centrica, who funded Public First’s study are presumably more or less content with the recommendation. Why? The answer to this is straightforward. As the cost of renewables subsidies is recovered through consumer bills, these companies are in effect licensed tax-collectors or tax-farmers, but this is a tax that is increasingly difficult to collect. Households are finding rising electricity bills hard to manage. This has been the case for several years, but the situation has been exacerbated by the impact of the coronavirus pandemic, and now gives real cause for concern. In December 2020, for example, Citizens Advice suggested that some 2 million households were in arrears on their energy bills, and that there is now a real prospect of widespread defaults.
For energy suppliers, debt recovery from households is extremely difficult and expensive, and carries the potential for PR disasters. But defaults do not remove the obligation on energy companies to pay over the cost of subsidies to low-carbon generators. Energy suppliers are thus faced with increasing outgoings, and a growing likelihood that they will be unable to recover that cost from their customers. Lenders will not be happy; ratings agencies will draw unpleasant conclusions.
In these circumstances, transferring the renewables subsidy cost to the Treasury, forcing them to collect their own taxes, becomes highly attractive. An energy company need only send one large bill to No. 11 Downing Street, knowing that it will be paid on the nail. Lenders and ratings agencies will relax, and refinancing and further borrowing against such a secure state-guaranteed revenue will become that much easier. In other words, Public First’s proposals would be neutral or slightly negative for consumers, and might remove one obstacle to heat pump adoption, but the real winners from their ingenious scheme are the energy companies themselves.
The imposition of a £10.8 billion a year bill for renewables subsidies on the UK consumer is becoming a matter of critical concern. Insofar as Public First’s study draws attention to that problem, it is a step in the right direction and to be welcomed. But in the details of their proposed remedy, the authors have stumbled badly. The suggestion that one part of this burden – the domestic household share –should be transferred to the Treasury and then offset with a carbon tax, mostly on gas, is an amateurish and craven fudge that appears to be overwhelmingly driven by the commercial interests of the energy companies that sponsored the paper.
British electricity consumers, from households to shops to factories, deserve a real break from the absurdly large and counterproductive income support to renewables, not Public First’s too-clever-by-half attempt to hide the costs in a different place and hand their friends in the energy business a gilt-edged cash flow.
What should be done instead to reduce electricity costs? The problem is so grave that only a radical and thorough approach to reform will be sufficient. For example, one might lift subsidy costs from all consumer bills, domestic, industrial, commercial and public sector, transferring that cost in its entirety to central taxation. Such a measure would expose this huge and currently hidden public expenditure to democratic audit. It is unlikely that the subsidies would long survive such an audit, and cancellation with or without compensation would soon follow. Since that is a necessary step towards revitalising the British economy and putting it on a truly sustainable path, it really can’t come too soon.
 For information on the RO and CfD schemes see the OBR Economic and Fiscal Outlook for March 2021 (https://obr.uk/efo/economic-and-fiscal-outlook-march-2021/). For reasons that seem hard to justify the OBR does not include the Feed-in Tariff costs in its estimates, but these can be found in the annual reports on the scheme published by the regulator, Ofgem: https://www.ofgem.gov.uk/publications-and-updates/feed-tariff-fit-annual-report-2019-20.
 Strictly, a tonne of carbon dioxide equivalent.
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 See https://www.citizensadvice.org.uk/about-us/about-us1/media/press-releases/citizens-advice-one-in-seven-fall-behind-on-essential-household-bills/; and further reporting: https://www.theguardian.com/money/2020/dec/16/more-than-2m-uk-households-in-arrears-on-energy-bills