Analysis: Why UK energy bills are soaring to record highs – and how to cut them

§ How high are household energy bills going to get?

In October, the cap on domestic energy bills is due to reach new highs of more than £3,500, according to the latest forecasts from various financial services and consultancy firms.

Investec forecasts the cap will increase from its current level of £1,971 per year for the average household to £3,523 on 1 October, an increase of 79%. Cornwall Insights suggests £3,582. (Update, 26/08/2022: Ofgem has announced the energy price cap will increase to £3,549 per year for dual fuel for an average household from 1 October.)

The cap is expected to increase again on 1 January and then even further on 1 April, although forecasts beyond this year remain subject to significant uncertainty.

On 4 August, Investec forecast an increase in the cap to £4,210 on 1 January. By 9 August, Cornwall Insights was forecasting £4,266 for January and £4,426 from 1 April. Yet by 10 August Auxilione was putting the January price cap at £4,467 and its forecast for April reached £5,038.

If this forecast proves accurate, then bills will have risen from £1,138 per year for the average household in summer 2021 to over £5,000 per year in April 2023, more than a four-fold increase in just 18 months. (See: Why are energy bills rising so much?)

To put this in historical context, Carbon Brief analysed government data on household energy spending over the past half century and found, after adjusting for inflation, that this winter’s bills will be truly unprecedented, in figures going back more than half a century.

The current crisis is so acute that the average family will face “dual-fuel” gas and electricity bills nearly three times higher than anything they have experienced since 1970.

The red line in the chart below shows dual-fuel bills for the average household since 1970, with the figures adjusted for inflation and shown in current prices. (The pale pink line adds the costs of solid and liquid fuels, in other words the coal and oil that once saw more widespread use for heating.)

Notably, the chart shows household energy bills had been relatively stable for the past half-century, with a dip in the early 2000s and a bump from 2004 into the early 2010s.

(According to a 2011 “factsheet” from energy regulator Ofgem: “Higher gas prices have been the main driver of increasing energy bills over the last eight years [since 2003].”)

That bump in the 2010s marked the last major outbreak of UK media and political interest in energy bills. A now-infamous 2013 Sun frontpage reported then-prime minister David Cameron’s answer to rising costs: to “get rid of the green crap” – meaning cut climate policies.

The climate policy rollbacks that followed have left energy bills billions of pounds higher than they would have been, if energy efficiency and renewable investment had continued, Carbon Brief found in January. (For an updated estimate see: What could be done to reduce bills?).

Looking at energy costs as a share of overall consumer spending, this winter will also see unprecedented pressure on household finances. Assuming the latest forecasts are accurate, heat and power would peak at 11% of household spending, with vehicle fuel costing another 3%.

The share of household spending going towards gas and electricity since 1970 is shown by the red line on the chart below, with the pink line including other heating fuels. The blue line represents overall household expenditure on energy, including domestic energy and vehicle fuels.

The early 2023 peak is particularly striking. The 13% of average household expenditure going towards energy and fuel would far exceed the levels seen in the early 2010s – when high oil prices pushed up the cost of motoring – and would even eclipse the 1970s oil price shocks.

Moreover, the averages across households and seasons conceal even greater pressures on the poorest families – particularly during the winter months when energy use is higher – as well as on homes that are poorly insulated (See: What could be done to reduce bills?)

More than 18m households – nearly two-thirds of the UK – will be in fuel poverty by January 2023, according to updated figures shared with Carbon Brief by researchers at the University of York. This compares with less than a fifth in 2019 and less than two-fifths today.

The research shows that more than a fifth of households will be spending at least 25% of their net income on energy bills. It also finds fuel poverty increasing sharply along a north-south divide.

Collectively, the UK’s households face a £129bn hike in their energy costs by next spring (5.4% of GDP, red bar below), taking spending on power, heat and fuel to £193bn (8.1%). This total is comfortably larger than the combined UK budgets for defence (£49bn) and education (£103bn). It is also nearly as large as the UK’s annual health budget (£217bn).

Since households have historically accounted for around half of national energy spending, the overall costs for the economy as a whole are likely to reach in the region of 16% of GDP.

This is far outside the historical “stable range” of national energy expenditure identified in a 2018 research paper from University College London, covering more than 30 countries since 1970.

It finds long-run national energy expenditures have tended to be around 8% of GDP, with periods of higher spending causing shifts in technology, behaviour and economic structure until the relationship between economic activity and GDP is brought back towards that stable range.

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§ Why are energy bills rising so much?

Energy bills are rising as a result of rocketing gas prices, which have increased 11-fold since 2019.

The UK is particularly exposed to high gas prices, because 85% of households use gas boilers to heat their homes and around 40% of electricity is generated in gas-fired power stations. (In France and Germany, fewer than 50% of homes are heated with gas boilers.)

Moreover, the electricity market operates in a way that means the price of power is almost always set by the price of gas. (A government consultation on how to reform this system explains that the market arrangements “had largely been designed for a fossil fuel-based electricity system”.)

This means UK wholesale electricity prices (red line in the chart below) are largely driven by wholesale gas prices (blue line): There is a 98% correlation between the two.

As with the chart of energy bills since 1970 (see: How high are household energy bills going to get?) this chart confirms that gas prices – and therefore electricity prices and energy bills – have been relatively stable over the past 15 years, in comparison to their stratospheric levels over the past twelve months.

In total, Carbon Brief analysis reveals that sky-high gas prices are behind 96% of the increase in household energy bills expected to take place between summer 2021 and spring 2023.

Another 3% is due to the collapse of multiple energy suppliers last winter. The cost of managing the customers of these failed businesses is being passed on to households via their bills.

(The National Audit Office estimates this will add £94 per household to annual bills, some £2.7bn overall. This excludes the cost bailing out major supplier Bulb, which could reportedly reach £2bn.)

The chart below illustrates the dominant role of wholesale energy costs (black bars) in driving higher household energy bills. In comparison, green levies and policy costs (red) have fallen since last year. The temporary cost impact of supplier failure is included in the blue bars labelled “other”.

Green levies currently make up less than 5% of energy bills under the summer 2022 price cap and this figure will fall further to less than 3% on 1 October. The roughly £95 per household per year of green levies pays subsidies for older renewable energy projects.

Another 3% of bills today – £57 per household – goes towards social policy objectives. This money pays for the “warm home discount” that helps poorer pensioners with their bills, as well as the “energy company obligation”, which aims to tackle fuel poverty by insulating homes.

In total, green levies and social policy costs make up 8% of bills today, a total of £153. This amount is expected to remain unchanged for the next few price cap periods but will make up a declining share of bills – less than 5% from October – as wholesale prices dominate the total.

Levies are largely paid via electricity bills, artificially increasing the cost of electricity relative to gas. Green levies make up 9% of electricity bills today, with social policy costs adding another 3%. This 12% share is down 23% in summer 2021. In contrast, levies make up just 3% of gas bills.

The “contracts for difference” (CfDs) that give guaranteed prices to new renewable energy schemes are currently costing the average household just 28p per year.

They will turn negative and start reducing consumer energy costs from October. The design of the contracts means projects pay money back to consumers when electricity prices are very high.

The current portfolio of roughly 18 gigawatts (GW) of CfD projects – mainly offshore wind – will be cutting average bills by around £11 per year under the October cap.

As wholesale gas prices are rising and the portfolio is expanding, this saving will increase to around £18 in January, according to Auxilione’s detailed forecasts shared with Carbon Brief.

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§ What could be done to reduce bills?

There are a range of options to reduce bills in the short, medium and long term. These include direct payments to struggling households, boiler adjustments, behavioural changes and home improvements to reduce the amount of energy needed to stay warm.

Given the latest CfD projects were four times cheaper than current gas prices, expanding renewable energy capacity is also a way to cut bills in the medium term. Similarly, solar panels, electric vehicles and even heat pumps can cut bills, albeit they come with high upfront costs.

The government has already announced a series of measures to ease the cost of living crisis, including a package of support specifically aimed at energy bills.

(The Resolution Foundation says the net impact of government interventions is relatively broad, offering similar support across the range of incomes rather than targeting those most in need.)

Government says its 5p per litre reduction in fuel duty is worth £2.4bn and its package of energy bill grants, payments via council tax, benefits-related support and other measures is worth £15bn.

This includes £400 for all households, £150 for those in Council Tax bands A-D and up to £650 for those on means-tested benefits, a total of up to £1,200 for some families. There is separate support for those with disabilities and for pensioners on low incomes.

These figures can be compared with the analysis above showing households face a £129bn hike in their overall energy costs, with energy bills rising by £4,100 for the average household.

The chart below compares these figures with current government support and proposals from the candidates to be the UK’s next prime minister, as well as from the opposition Liberal Democrats and the Labour Party.

Proposals by foreign secretary Liz Truss to temporarily “suspend” green levies would only take £4bn off household bills, while former chancellor Rishi Sunak’s pledge to take VAT off bills would be equivalent to £5bn under the October cap or £6bn in January.

Truss’s pledge to reverse the increase in National Insurance contributions would cost £13bn. Half would go to employers and only 15% of the rest would go to the poorer half of the population.

Sunak’s pledge to cut income tax would cost £19bn but would only be brought in at some unknown point in the future when inflation is under control, so is not included in the chart. He has also indicated he would offer an extra £5bn of extra household support, the Times reports.

The Liberal Democrat leader Ed Davey has suggested a £36bn “energy furlough scheme” that he says would “cancel” the £1,400 increase in bills in October.

The Labour opposition has announced £29bn to “freeze” bills for six months from October. Carbon Brief analysis confirms that this amount would cover the increase expected under the October and January caps. However, the analysis suggests extending the freeze for a year would increase the cost to around £73bn (3.1% of GDP).

As already noted, the widely-quoted price cap for the average home applies to usage of 2,900 kilowatt hours (kWh) of electricity and 12,000kWh of gas per year. This conceals wide variation between different household types and locations.

The least efficient “F” or “G” rated homes face bills as much as £2,000 higher than those rated “C” or above, Carbon Brief analysis shows. If the cap for average households hits £5,277, an average “C” rated home would pay £4,494 whereas an average “F” rated property would pay £6,585.

These dramatic differences illustrate the potential impact of better insulation, which can cut gas bills by a fifth. Moreover, they highlight the lost opportunity from government cuts to energy efficiency policies in the wake of David Cameron’s “green crap” moment.

Updated Carbon Brief analysis shows that energy bills would have been £9.5bn lower under the October price cap and £13bn lower in January, if successive Conservative-led governments had not rolled back climate policies over the past decade. (See Carbon Brief’s January article for methodology.)

The savings would have been equivalent to £168 per household in October and £220 in January.

These savings would have come from additional cheap renewable capacity (blue bars), more efficient homes (yellow) and new homes being built to zero-carbon standards (red).

Whereas insulation takes time and money to install, there are immediate savings to be had from adjusting the settings on the combi boilers that heat most homes.

Carbon Brief estimates that reducing the boiler “flow temperature” and turning off hot water “pre-heating” could save households more than £300 under the January cap, taking up to £5bn off UK bills overall and cutting carbon dioxide (CO2) emissions by nearly 6m tonnes.

Analysis from Cornwall Insight says an increase in European investments in renewables in response to the current energy crisis “has resulted in lower price projections in GB” in the medium term. Plans to resurrect fracking for shale gas in the UK will not reduce energy bills.

Analysis from the Tony Blair Institute for Global Change, published in April, shows the options to tackle bills in terms of their speed, impact and public support, shown in the table below.

A number of commentators, most prominently Conservative peer Lord David Frost, have argued – contrary to all the evidence – that the cause of the current energy crisis is the UK’s net-zero target.

In reality, the UK’s rapid deployment of renewables has reduced our reliance on costly fossil fuels.

To put this argument in perspective, Carbon Brief calculated the cost of extra gas that the UK would have needed to buy, if it did not already get a third of its electricity from renewables.

The chart below shows this cost broken down by year, with renewables having helped the UK avoid the need to buy nearly £12.5bn of gas in 2022 to date, more than in any other year.

The analysis shows that in 2021, the UK would have needed to buy another 253 terawatt hours (TWh) of gas, which would have raised annual demand for the fuel by 30%. For context, the UK imported 36TWh of gas from Russia in 2021.

In 2022 to date, the UK would have needed to buy an extra 164TWh of gas at a time when European countries are rushing to end their use of Russian exports.

Update 15/08/2022: The article was updated to with analysis of Labour’s £29bn six-month “freeze”.

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§ Methodology

Carbon Brief’s estimates of energy bills since 1970 are based on figures from BEIS, adjusted for inflation using the Treasury “deflator” and allocated per household based on figures for population, household size and the number of households in the UK from the Office for National Statistics.

Where necessary, for example on the number of households, figures have been projected into the future based on a continuation of existing trends. Current-year and future consumer spending are estimated based on the latest March 2022 forecast from the Office for Budget Responsibility.

Consumer spending levels in the face of the intensifying cost of living crisis is highly uncertain. It is also the denominator in the figures on energy’s share of consumer spending overall.

Future household dual-fuel (electricity and gas) energy bills are the latest forecasts from Investec Securities, Cornwall Insights and Auxilione, and are current at time of publication.

Current-year and future spending on vehicle fuels is estimated based on UK vehicle mileage and pump prices, on the assumption that Brent crude oil prices – and therefore pump prices – remain at similar levels to today. Oil prices are currently subject to even larger than usual uncertainty.

Household spending on solid and liquid fuels (predominantly oil for heating) is assumed to have risen in line with the increase in transport fuel spending.

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