The UK Energy Crisis: What’s Happening?

On Thursday 3 February, the UK government energy regulator OFGEM revised the UK domestic energy price cap, increasing the limit by 693 GBP – a 54% rise – for 22 million customers. This article will look at the underlying causes of the price rise, and evaluate some of the impacts both to consumers and wider markets.

Amid a global cost of living crisis, energy prices are on a sustained rise. The UK is worse off than many for reasons both domestic and commercial.

Since December 2021 gas prices in the UK have been well over 300p/Therm, after hitting a record 450p/Therm the same month. Whilst winter weather naturally pushes up demand, the anomalous prices have also been driven by various supply side pressures.

Natural gas supplies held across Europe going into the 2021-22 winter were exceptionally low, thanks to an unusually cold spring. Think tank Bruegel found that in December 2021, Europe wide gas storage levels were at a low not usually seen until late January – significantly lower than the same time in any of the previous five years, around 690 TWh. In addition to this, the UK has some of the lowest levels of gas storage in Europe – enough to cover 4-5 winter days of demand.

Pipeline flows into Europe from the East, particularly Russia, have been diminished over recent months. In addition, the worsening military situation along the Ukraine-Russian border has stoked fears that Russia could cut off the East-West gas pipelines to Europe, pushing the price of futures up into Q4 in 2022 across European markets.

It is worth noting that whilst a large amount of the UK’s gas comes directly from the North Sea (not Russia or continental Europe) the general price mechanism affecting the market has still pushed up prices.

Another large contributing factor to the increased energy prices is the growing issues with electricity supply. French nuclear facilities’ capacity has been reduced over the last few years. A growing number of reactors have been shut for maintenance, and capacity has been reduced since 2019. In fact, according to the French electricity grid operator RTE, the country has been a net importer of electricity since Q4 2021.

The strength of wind around Europe also fell by up to 15% in certain areas in 2021, meaning much less power in the grid for export to the UK from the continent. On the 6 September 2021, only 2.5% of the UK’s electricity came from wind, as opposed to almost 20% on average in 2021. This has meant an increased reliance on more expensive energy sources, which has further pushed up prices.

This rapid increase in energy prices has led to many UK based energy companies going bust, as they are unable to absorb the cost difference between market price and domestic cap. 4.3 million UK customers, from 29 bankrupt companies, have been switched to new energy providers. Manufacturers and service provider’s costs of production have gone through the roof as well, passing on price rises to consumers and exacerbating inflationary pressure.

In an attempt to curb this pressure on average households, Chancellor Rishi Sunak has stated that the government will “directly help people manage” their rising costs. From April, there will be a 200 GBP energy-bill discount for all homes, which will be fully repaid by 2027. There will also be a 150 GBP council tax rebate for most. It has also been suggested that the UK could increase its liquified natural gas inflows from the current level of 9% of total energy imports, with supply from the east offering to fill some of the slack.

It is worth noting that these discounts come amid a 1.25% increase in payroll tax, and a doubling of interest rates from 0.25 to 0.5%. This will also have the unfortunate impact of increasing borrowing costs for those who become reliant on credit card debt to pay their energy bills. In addition, the measures taken are focused on the short term, and with UK natural gas futures remaining high into Q4 of 2022, the longer-term risk remains to be seen.  Bloomberg has warned that if unchecked, this rise in energy prices could lead to 10% of the UK being dragged into ‘energy poverty’ – meaning they spend over 10% of their income on energy and heating.

Overall, a mix of supply and demand factors have led to rampant energy price increases of the last three quarters. This, in turn, has contributed to immense pressure on domestic households and businesses, already under stress thanks to a cost-of-living crisis.

Analyst: Otto Rutter

Sector Head: Edward Raftery

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