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Analysis Governments must act before energy prices break consumers' backs

Economist Victor Duggan looks at rising energy prices and possible ways consumers can be helped.

LAST UPDATE | 6 Sep 2022

WHOLESALE GAS PRICES are off the charts in Europe, leading to surging costs to light and heat our homes. Urgent policy action is needed, both in Brussels and in Dublin, if we are to avoid social chaos this Winter.

Recent murmurings from leaders in both cities suggest they appreciate the urgency, and that help is on the way. EU energy ministers hold an emergency meeting this Thursday to discuss while preparations continue ahead of Ireland’s budget day on 27 September. Consumers need a break before energy prices break their backs.

Even before the latest round of price rises, a record 29% of Irish families were already facing energy poverty. That number is now nearing half and rising. For people already forced to tighten their belts, calls to turn down the heating or wear another jumper aren’t likely to land well. Indeed, steps can be taken to conserve energy but there are limits to what is reasonable in the short term.

How did it come to this?

It’s all about gas. Russia was the source of 45% of EU gas imports in 2021. But, retaliation for Europe’s support of Ukraine in repelling Russian invaders has seen these supplies reduced to a trickle, causing prices to skyrocket.

About a third of households have gas heating, but this rises to more than two-thirds in Dublin and three-quarters in Dún Laoghaire-Rathdown (oil heating is far more common outside Dublin). Wholesale price increases are being passed on to consumers by providers.

When it comes to electricity, things are a little more complicated. Although the use of renewables has massively increased over the past decade, they still only account for around a third of power generation. While they were traditionally expensive, technological advances have seen costs collapse (of solar panels and windmills, for example). Even before the recent surge in fossil fuel prices, renewables were already competitive price-wise. However, most of the investment in renewables is up-front, while running costs are minimal.

On the contrary, running costs for oil or gas-fired power plants obviously depend on volatile market prices for these fuels. Unfortunately, gas still accounts for the majority (57.1% in 2020) of our power generation and it currently costs ten times more than what it cost for most of the past decade. Worse, the wholesale price of electricity in Ireland is calculated as if gas is the only source because of something called the System Marginal Price (SMP).

Wind and sunshine might be free but, as we well know, they can’t be relied on. Since it is difficult to store electricity, it means we need a power supply on hand that can be dialled up and down to meet fluctuating demand. In Ireland, and in most European countries, gas-fired generation fulfils this role. This is the price that determines the SMP, which is passed on in turn to consumers.

Since the Kinsale gas field stopped pumping in 2020, the Corrib field is the only major domestic source, accounting for about a third of our needs, and even it is expected to be depleted in a few years. More than half of our gas is currently imported from the UK, which in turn imports most of its gas from Norway. With gas supplies to Europe from Russia having slowed to a trickle, and in danger of stopping completely, demand (and the price) for Norway’s gas has gone up.

Since Ireland is at the end of the pipeline, we are essentially at the mercy of European markets for our supply. Until mid-2021, the benchmark European gas price (Dutch TTF) had never been above €30 per megawatt/hour (MWh), typically averaging significantly less. On 26 August, it peaked at nearly €340, before easing back to around €210 by close of business on 2 September following EU signals that intervention was imminent and news that the bloc had achieved its 80% gas storage target ahead of schedule.

But, even if those wholesale prices ease somewhat further in the coming weeks, the prospect that they will retreat to more normal levels any time soon seems remote.

Indeed, if Europe has to wean itself off piped Russian gas completely, or even just meaningfully diversify its supply, it will mean a long-term increase in the share of more expensive Liquified Natural Gas (LNG) in imports. So, sky-high prices look baked in this Winter while the era of cheap gas could be over for good. This will eventually feed through to even higher prices for other goods and services since almost everything depends on energy as an input.

What is to be done?

Today’s heresy can quickly become tomorrow’s orthodoxy. Britain’s Conservative government ruled out a windfall tax on energy companies in the Spring, before their Summer U-turn. Italy, Greece, Spain, Romania and Belgium are following a similar path.

There have been calls for a similar tax in Ireland, and the Department of Finance is understood to be examining it ahead of the budget. Back in 2007, the government demonstrated its flexibility in how it taxed windfall energy profits by adjusting the licensing arrangements for the Corrib gas field. The time has come to do so again.

The idea is to impose a one-off charge on energy providers on profits generated through no extra effort of their own. For example, renewable energy companies are set for a massive windfall this year because they benefit from the high SMP determined by the gas price, even though they have not experienced a meaningful increase in input costs themselves.

Because this windfall will not be permanent, taxing it is unlikely to impact on long-term investment plans. Yes, it needs to be carefully designed, but it is more than possible. It would also send a signal that the burden is being fairly shared between producers and consumers. Letting businesses make out like bandits on the backs of consumers isn’t a good look.

A question of Truss

In the wake of Brexit, Anglo-Irish relations have hit a generational low. Things are unlikely to improve when Liz Truss becomes Britain’s new Prime Minister today. The Northern Ireland protocol hasn’t gone away, you know.

Should she play hardball, effective control of Irish gas imports is a significant point of leverage. Behind the scenes, diplomatic efforts are hopefully already underway to ensure this not even on the table.

At EU level, there have been calls to reform how the SMP is calculated to break the link between gas and electricity prices, as has already been done in Spain and Portugal, and to allow for local price signals. As we moved further along the transition path away from fossil fuel to renewable power generation, such a move was inevitable.

Current dysfunction in European gas markets has just increased the degree of urgency. One would hope Ireland’s position in these discussions will be supportive of EU-wide reform, and that they are ready to act at national level if there is not meaningful EU agreement.

A temporary price cap is another possibility. Again looking to the UK, they introduced an energy price cap in 2019 to set the maximum amount that energy companies can charge to consumers. They then review the cap every three (previously six) months.

Alternative price cap arrangements have been put in place in France, Spain and Portugal. Ireland could introduce such a cap (€/MWh and standing charge) on a once-off basis this Winter, announced on budget day and covering say the coming October-March period. This would provide certainty to consumers and put a lid on inflation.

If retail energy prices can’t be contained, then the Irish government needs to bail out consumers after the fact. This has already happened partially with the introduction of the universal €200 electricity credit and adjustments to VAT and the fuel allowance earlier this year.

Further such measures can be expected in the 2023 budget, with debate surrounding both the extent to which consumers should be compensated and the extent to which such supports should be targeted to those most in need. Another option is suspending the Public Service Obligation (PSO; currently €51.60 per annum on electricity bills) levy through the Winter, in line with EU Commission recommendations. Reduced rate (from 13.5% to 9%) VAT on energy bills should be extended for a further six months from end-October. Postponing the scheduled €7.50 per tonne increase in the carbon tax until energy markets normalize could give further relief.

People are already facing the steepest fall in living standards since 2009, maybe since the 1980’s. If the policy response in the face of this emergency is insufficient, the political risk is not just to government’s polling numbers, but of widespread social unrest.

For a start, it could put at risk the high degree of solidarity Irish people have shown to Ukraine thus far. It could also undermine continued acceptance of measures to tackle climate change if those are perceived to be pouring salt in the wound.

The previously unthinkable may need to become thinkable, and implemented rapidly.

Victor Duggan is an economist.

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