13 Sep 2022
Talk about energy prices is relentless, as are the price hikes that consumers in the UK are facing this winter. What does the landscape look like, how will the latest announcements impact the consumer and how will this affect global markets and investments going forward?
Let’s go back to basics. The energy price cap is put in place by Ofgem, the government regulator for the electricity and downstream natural gas markets in Great Britain and represents the maximum amount that households can be charged for a unit of energy. The regulator caps the rate to protect households, ensuring that the energy provider charges a price that’s reflective of the true cost of buying energy and supplying it to households. The cap also limits the price that energy companies charge customers for being connected to the grid.
The new cap was due to come into force on 1st October, affecting around 24 million households, raising energy prices by around 80%. However, the new Prime Minister recently announced a limit on the unit price of energy meaning that average household bills should be around £2500, roughly £1,000 cheaper on average than what they would have been with the proposed October cap.
Households are still looking at a significant uplift in their bills in a general backdrop of hefty consumer price hikes, so what additional help will be available from the government as we approach the more expensive season? The £400 subsidy offered to every household by the previous government, spread over the winter months, remains in place. With the new cap from the PM and the subsidy combined, the average monthly bill should be roughly the same as it is now, but where do lower income households stand who are already struggling to make ends meet? And how will businesses cope? There’s extra help of up to £650 for those on means-tested benefits and in the commercial sector, businesses have a 6-month reprieve with more targeted help to come after that.
How did we get to this crisis point? Energy prices ramped up rapidly around the world after pandemic lockdowns were lifted and global economies returned to normal, putting pressure on suppliers. Russia's invasion of Ukraine in February then led to cuts in gas supplies to Europe, sending European natural gas prices through the roof. Russia previously supplied 40% of the gas used in the EU via the pipeline, so the cuts left Europe scrambling to find alternative sources for their energy, causing the colossal rise in prices.
In the UK, we have no direct supply link with Russia so the impact from gas cuts isn’t as marked as it has been for our European counterparts so why do we pay some of the highest gas prices in Europe? We rely on gas more heavily than Europe to generate electricity making the UK a net importer. Storage is an issue, so we buy on short-term contracts, making us more vulnerable to the prevailing price in the market. Is this ultimately down to how the UK energy market is designed and regulated? Some critics believe that the country's fully privatised energy market is partly to blame.
How do UK energy prices compare to those across Europe? Norway has a lot of oil and gas reserves, making them more self-reliant and keeping their bills reasonable. Hungary struck up a new deal with Russia and now have a constant supply of cheaper gas, keeping their bills stable. France is also in a less volatile predicament than the UK as they have greater nuclear capabilities, are more self-sufficient, and their most prevalent national supplier EDF is owned by the state, meaning that more than a quarter of its production is offered at a huge discount on the current wholesale price. Electricity price increases are capped to 4% this year in France and the government is offering a one-off payment of 100 euros to households, making the comparatively moderate increase in energy bills more bearable. Germany on the other hand has faced the full brunt of increased energy prices with little resource internally and a heavy reliance on Russian energy. Desperate times call for desperate measures - the government has appealed for a reduction in usage so they can store gas for the winter and there’s a 170 billion euro plan in place to help the country navigate the storm.
Not surprisingly, oil and gas companies have been making record profits this year. In the first quarter, Shell made a £7.2 billion profit, Exxon made a £7.4 billion profit and BP £5.2 billion so why not raise money by taxing energy operators? Companies providing renewable energy via wind farms and solar farms are also classified as energy operators but are not benefitting from the surge in wholesale prices - when these farms were set up, they sold their future energy generation on long-term contracts. Oil and gas companies are in a league of their own when it comes to profits so taxing energy operators across the board isn’t a viable option.
The measures proposed to curb energy bills should reduce headline inflation by around 5% and as the UK has the largest inflation-linked debt in the developed world, we need all the help we can get to service it. Freezing prices could provide an estimated £25 billion for the pot which will in turn attract investors as they will be reassured that the UK is not over-leveraging itself.
But what effect will the subsidy have on global markets’ views of UK assets? Borrowing to pay for imported gas would worsen the trade deficit as we could be viewed as living beyond our means. We don’t yet know how we’re going to plug the gap and there’s the potential of more debt having to be issued and paid for which the market views as an unfunded subsidy, making the UK less attractive to investors. If the stimulus does turn out to be funded through some form of tax, global markets will view that more positively and the depreciation that we’ve seen in our currency may start to reverse.
What does this mean for investors? Borrowing costs will impact the investment markets and industry in the UK when it comes to gilts and corporate bond markets and understanding how severe the impact could be on portfolios is key to investment strategy. Investors could opt for more flexible strategic bonds managers that are able to invest across different geographies, sectors, and currencies. For the longer-term outlook, investors can seek exposure to companies at the leading edge of constructing renewable energy capacity. Conducting metals are required to decarbonise so mining companies are another way of capturing the transition to renewables electricity. As the shift away from fossil fuels intensifies and the focus on decarbonisation reaches fever pitch, a more agile, broader investment approach might just be the solution to bridge that gap.
Naeem Siddique, Investment Research Manager
Katie Poulson, Client Engagement & Marketing Manager
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