The battle to pay for £170bn energy bills freeze

The sums involved in suspending power costs are vast, but the options to fund it are limited, write Tim Wallace and Rachel Millard

Liz Truss did not use to be a fan of dishing out cash. The Prime Minister began her campaign for the top job by stating her goal is “lowering the tax burden, not giving out handouts”.

But circumstance has forced her hand. Almost unimaginable forecasts of inflation rising to 20pc or more are seen as a key factor in this.

The sums involved are vast. The anticipated cost to the Exchequer of freezing bills for households and businesses could come to anything up to £170bn over two years, more than double the cost of the furlough scheme unleashed in the pandemic.

This is particularly painful after the heavy spending of the past two years. After borrowing more than £300bn in 2020-21 and almost £150bn last financial year, how can the Government pay for an energy bailout now? Here are the four main options.

Higher energy bills in the future

Every option begins with the Government borrowing more. The public sector spends more than it brings in, so extra debt is a given.

The difficulty is in deciding what to do with it next. One possibility is higher energy bills.

This was Rishi Sunak’s idea when he initially proposed giving households a discount on this winter’s bills, to be recouped by higher charges spread over future years.

However, as the former chancellor discovered, it only works if energy prices come down in future. As costs kept mounting, it became clear the repayments would come at a time of even higher prices and so risked making the problem worse, not better.

Higher taxes

The usual way of getting extra cash for the Government involves raiding the funds of businesses or workers one way or another. Given the universal nature of some of the support expected to be on offer, this would feel rather like robbing Peter to pay Paul.

Truss has already pledged to reverse Sunak’s National Insurance rate increase and to cancel the planned leap in corporation tax, as well as pledging to cut VAT and green levies, so raising other taxes would be unlikely.

‘Placing obligations on companies to trade gas at a predetermined price is not workable’

‘You fund it in the way you fund wars – with long-term borrowing’

Make the energy companies pay

One possibility is ramping up the windfall tax on the energy industry, which Boris Johnson initially resisted but then about-turned on in May with a 25pc levy on the oil and gas industry.

But the Truss-backing economist Julian Jessop disapproves, on the basis that repeated “one off ” windfall taxes risk dangerously undermining stability and certainty in the energy sector.

The Government is also talking to electricity generators about voluntarily moving more of them on to fixed-price contracts. Under the so-called contracts for difference, generators are guaranteed a fixed price of electricity, backed by a levy on consumer bills. If the wholesale price is higher than the guaranteed price, they have to pay back the difference.

It would not directly help pay down the debt incurred to cover the support package, but it would aim to lower bills.

Westminster sources indicate Truss sees her proposals not as a handout, but a stopgap to tide households and businesses over while they wait for supply side reforms to take effect and bring bills to a more reasonable level.

Other reforms include potentially lifting the ban on onshore fracking – put in place in 2019 because of concerns over earthquake risk.

There are also an estimated 15bn barrels of oil equivalent left to be extracted from Britain’s North Sea, with the country’s annual consumption at 1bn barrels. The US Energy Information Administration said that the UK produced 934,000 barrels of oil per day and 1.1 trillion cubic feet of natural gas last year.

Allowing rapid development of new rigs could significantly increase the £3.1bn of tax paid by the industry last year, but would not come close to paying for Truss’s proposed giveaway.

So far the Government has not made any steps towards directly capping the wholesale price at which producers can sell gas, but the past few months have shown drastic solutions are never completely off the table.

Will Webster, policy manager at Offshore Energies UK, the trade body, cautions “against any sweeping measures which could disrupt reliable supplies and prevent the efficient functioning of the sector”. He adds: “Placing obligations on companies to trade gas at a pre-determined price is not workable in international markets – of which the UK is a part.”

Permanent debt

Given the problems with making anyone pay, this may be the most likely outcome. Jessop sees it as “a cost of war”. He says: “You fund it in the way you fund wars – long-term borrowing.”

This does not mean the measure is cost-free, however.

The Government is already heavily indebted to the tune of almost

£2.5 trillion, and rising inflation and interest rates are pushing up the cost of servicing this mountain.

Financial markets now charge the Government more than 3pc on 10-year bonds, the highest rate since the start of 2014. Paul Dales, at Capital Economics, says “most of it is coming through expectations that if fiscal policy is looser, monetary policy will have to be tighter, so interest rates will have to go higher”.

He estimates that when the interest rate on government bonds rises by one percentage point, the cost builds gradually over time as more bonds are issued, from an extra £0.6bn of interest payments in the first year to £6bn in the fifth year.

On the other hand, Capital Economics predicts a freeze would lower the inflationary peak to 11pc in October, rather than the 14.5pc in January it had previously predicted.

As one quarter of the Government’s debt is linked to retail prices, that element of the debt servicing bill could fall by about £17.5bn compared to prior projections. That comes nowhere close to covering the cost of the freeze, but at least softens the blow a touch.

Such are the fortunes of war.