Why are British household energy bills so high?

The typical household energy bill in Britain is forecast to soar to £4,420 next April, more than three times the level it was at the start of 2022, stoking calls for increased state support for families facing energy poverty.

But why has Britain’s energy price cap, which dictates a maximum that suppliers can charge the vast majority of the country’s households, climbed so high and how does it compare with what families pay in other countries in Europe?

The options facing the incoming prime minister — due to be chosen by members of the ruling Conservative party in early September — are already becoming an issue in the leadership campaign.

Why are bills so high?

Energy bills have started to rise sharply as gas prices shot higher in the past 12 months, driven primarily by Russia’s squeeze on supplies to Europe.

Wholesale gas prices have now reached about 10 times the level they averaged last decade after Russia’s supply curbs intensified following the invasion of Ukraine, with Moscow and the west engaging in economic warfare.

While Britain imported only a small percentage of its gas from Russia prior to the war, it is connected by pipeline to the wider European market, which relied on Russia for as much as 40 per cent of its supplies. This means prices paid by British suppliers still track those in the rest of Europe relatively closely.

British bill payers, however, are more exposed than their continental peers because the vast majority of homes are heated with gas, and about 40 per cent of electricity is generated by gas-fired power stations — a higher proportion than most European countries.

The collapse of dozens of small retail energy suppliers as the gas price rose has also added about £100 to bills. Analysts have pointed out that the tweak by regulator Ofgem to its methodology for calculating the energy price cap has inflated bills further by allowing suppliers to claw back more of the cost of hedging the price of the gas they have to buy in advance and at a faster rate.

How do bills compare with the rest of Europe?

The situation varies quite dramatically and depends a lot on the degree of state intervention. Some governments on the rest of the continent have gone further than the British government in taking steps to shield consumers.

Direct comparisons are difficult but the typical Italian household is forecast to spend around £2,300 annually at present, compared to a current British price cap of £1,971. A July estimate for households in Germany put the average bill at £2,759.

France is something of an outlier with president Emmanuel Macron moving to shield consumers almost entirely from soaring prices. After raising gas and electricity bills marginally last year, they have since been largely capped, beyond a 4 per cent rise in household electricity costs. The French state, which owns 84 per cent of energy provider EDF, will nationalise the utility fully as it absorbs the costs.

The UK has so far announced a £15bn package that will shave £400 off most household bills, with more going to poorer and more vulnerable families. But this was based on expectations of the price cap reaching £2,800 in October, far below the latest projections for the autumn of £3,582.

Why have a price cap that doesn’t cap prices?

Despite its name, the price cap was not designed to prevent bills rising when it was introduced in 2019; it was meant to prevent suppliers from earning excessive profit margins on consumers less willing or less able to shop around when old fixed-price deals expired.

But as wholesale costs have soared, suppliers have largely withdrawn fixed-term deals. About 86 per cent of Britain’s 27.8mn households have now defaulted on to tariffs governed by the price cap.

Ofgem, the regulator, announced last week it would review the cap once every three months rather than six months. While that would mean bills falling more quickly if wholesale prices dropped, it also means customers being hit by higher energy costs more rapidly for the foreseeable future unless Russia opens the gas taps soon.

Cornwall Insight, the consultancy that put out the latest £4,420 forecast for next spring, has suggested doing away with the cap altogether, adding: “If it is not controlling consumer prices, and is damaging suppliers’ business models, we must wonder if it is fit for purpose.”

What are the options for lowering bills?

Pressure is mounting on ministers from a range of different interest groups to provide additional help. Poverty campaigners are concerned the poorest households face a choice between “eating and heating” this winter when energy usage peaks. And economists worry that middle-income households will severely cut back their discretionary spending, thereby pitching the UK into a deeper recession than forecast.

Liz Truss, who is favourite to become the next prime minister, has maintained she would rather cut taxes than provide more “‘handouts”, even as her allies cautioned that additional support has not been ruled out. She has previously said she would suspend “green” levies on energy bills — meant to help fund investment in low-carbon generation and upgrade housing stock.

Rishi Sunak, the other leadership candidate and former chancellor, has previously said he would cut VAT on energy bills. This week he promised to expand the £15bn package of support on the cost of power he announced in May, but has so far not given any details.

The candidates’ costed promises — to suspend “green” levies or cut VAT on bills — would save less than £200 per household.

Sir Ed Davey, leader of the Liberal Democrats and a former energy minister, has proposed freezing the price cap at its current level, with the government absorbing the £36bn he estimates that would cost.

Davey has suggested expanding a windfall tax on energy companies and using higher VAT receipts to help pay for it. But his estimate of a £36bn cost to the taxpayer could end up being too low, with forward gas prices stubbornly high into 2023.

Over the longer term, business secretary Kwasi Kwarteng has proposed breaking the link between gas and electricity prices as more renewables such as wind and solar are added to the grid, a move that Ofgem has backed.