Energy efficiency is the best way to help the squeezed middle with bills

Liz Truss and Jacob Rees-Mogg hurriedly introduced measures to protect households from higher energy prices from the 1st October 2022. These measures left the state paying well over a third of household energy bills. Interventions were needed to protect poor and vulnerable households, but in a climate emergency it was a mistake to make energy cheaper for everyone, regardless of income and situation. Much better to target specific support at those in fuel poverty, and the ‘squeezed middle’.

Fairly obviously, if energy prices rise, households think more carefully about how they use energy – and how much. The higher prices rise, the harder they think about how they can reduce energy use. This applies equally to short-term decisions about how high to set the thermostat or how long to spend in the shower, and long-term decisions about whether to install extra insulation or a new heating system.

We examined ‘price elasticity of demand’ (how much demand changes in response to a given change in energy prices) for gas in the UK a few years ago, but our results were inconclusive: varying depending on the period of scrutiny, even when demand was adjusted for milder or colder winters.

Research by UCL, published by the old Department of Energy and Climate Change in 2016, cited estimates of UK price elasticity of demand for gas from -0.1 to -0.28 [2]. This means that for every 10% rise in the price of electricity, demand falls by between 1% and 2.8%. (In economics-speak, gas demand is ‘inelastic’ because demand falls less than the increase in energy prices.) The research also suggested that price elasticity of demand is around 25% higher for low-income households (with household income below £15,000 a year) than for high-income households (earning more than £150,000 a year). i.e. low income households cut their energy use more than better off households when prices rise.

This research further indicated, based on NEED [3] that high-income households also use two-fifths more gas than low-income households, on average. Also that gas use by wealthy households has not reduced nearly as much as poorer households since 2005. (9% average reduction for the wealthy, compared to a 33% reduction among poorer households.)

It is critical to understand that reduced demand in response to price rises has quite different meanings and consequences for rich and poor. For those already in or near fuel poverty, it can put at risk both health and well-being – creating anxiety and impossible choices about whether to heat or eat. For the rich, higher costs and reduced demand may not impinge on quality of life whatsoever.

UCL’s research also indicated that around 40% in the actual reduction in gas use in UK homes from 2005 to 2014 could be explained by rising gas prices.

A more recent study of the elasticity of demand for electricity in the UK, using data from 1975 to 2018, found that the long-run price elasticity of demand was -0.607 [1]. This means that for every 10% rise in the price of electricity, demand is expected to fall by 6.07%. It is still ‘inelastic’, but less so than previous estimates – perhaps because a longer timeframe was included, which allowed time for households to invest in energy efficiency measures as well as short-term measures like adjusting boiler settings.

Eye-watering estimates of higher bills for everyone are nonsense

What this means is that the petrifying estimates of higher bills circulating in the press when Ofgem first published the October price caps – indicating a doubling of gas bills and an 83% rise in electricity bills (even when both were already at record highs) – were bunk. (Even accepting that past elasticities were based on much smaller changes in energy prices than we have witnessed this year.)

Table 1: Energy price changes in 2022

Gas Elec
April 2022 prices 7.39 28.43 p/kWh
October 2022 prices 14.80 52.05 p/kWh
Government Price Guarantee 10.3 34 p/kWh

If we take Ofgem’s ‘Typical’ gas consumption figure of 12,000 kWh a year (which our modelling work for BEIS and the Scottish Government suggests is about right for a typical three-bedroom semi-D in England or a mid-terrace in Scotland), then annual bills would have been £1,768 before the October price rises. Using the crude and flawed methods in the press, this would rise to £3,390 a year after the October price rises (see Table 2 below).

However, this ignores elasticity of demand, and the fact that many households would take action to reduce their energy use. Allowing for the latest figure of -0.602, the post-rise bills are actually £1,594 (see Table 3 below) – accepting that it will take time for households to fully adjust to higher energy prices and where necessary invest to improve energy efficiency. This is also an average across all households, and not every household will be able to take action to reduce bills (see below).  This level of bills is actually 15% lower than the annual cost of energy for the same typical household under the Government’s Price Guarantee. The difference is that instead of the savings coming as a subsidy from taxes and the national debt, in this scenario it comes from reduced demand, meaning lower energy use and carbon emissions – which is what we should be aiming for in a climate crisis.

These figures almost certainly overstate the impact on demand of such large increases in energy prices – in particular because they rely on continued energy efficiency improvements in homes, and these almost certainly become more complicated and expensive as successive energy efficiency measures are implemented. We must not overlook the fact that they also entail sacrifices – lower internal temperatures, shorter showers, possibly not heating rooms that are seldom used, and so on.

Even using the lowest published estimate of elasticity of demand (-0.1, very likely reflecting only short-term changes), post-rise bills are £3,078 – still significantly lower than the crude estimates published in the press.

Table 2: Simple model assuming no change in demand

Annual bills for Ofgem ‘Typical Consumption’ Gas Elec Total bill
April 2022 prices £886.68 £881.41 £1,768.09
October 2022 prices (no elasticity) £1,776.44 £1,613.48 £3,389.92
Government Price Guarantee (no elasticity) £1,236.00 £1,054.00 £2,290.00

Table 3: Allowing for price elasticity of demand

Annual bills for Ofgem ‘Typical Consumption’ Gas Elec Total bill
April 2022 prices £886.68 £881.41 £1,768.09
October 2022 prices (adjusted for -0.607 elasticity) £694.40 £800.03 £1,494.43
October 2022 prices (adjusted for -0.1 elasticity) £1,598.18 £1,479.47 £3,077.65

What about vulnerable groups?

To return to our theme of contrasting impacts between rich and poor, households where people have health conditions that could be worsened by low indoor temperatures, and/or households that already have very low indoor temperatures (because fuel poverty means they were already struggling to afford to heat their homes, even before the price rises) must be protected from price rises, so they are not put in danger by their efforts to keep bills down. Humidity, damp and mould can all become problems if people turn off their heating and/or they do not ventilate their homes sufficiently, and these too can put people’s health at risk.

This is where the state should intervene, so that anyone who cannot afford to heat at least one room of their home to 20C should get an energy subsidy that means higher energy prices do not force them into sacrifices that could jeopardise their health. (Estimates in the press of 40% of households being in fuel poverty without Government intervention are based on heating all rooms, and achieving 21C in the living room and about 19C in other rooms. We think it is time to revisit this definition of fuel poverty.)

The way the current Energy Price Guarantee is structured fails to do this. It is based around Ofgem’s ‘Typical Domestic Consumption Values’, which are meant to reflect typical energy use in UK homes. These assume households will use 12,000kWh a year of gas for space and water heating, and 3,100 kWh a year of electricity for lights and appliances. (There are different figures for homes with electric heating.)

The problem comes because the poorest, most vulnerable households are not typical. Roughly 4 million people (perhaps 1.5 million households) with chronic health conditions are unable to work [4], so they stay at home for most of the day – requiring more heating in winter, and more electricity use than a typical household. They may need more hot water for washing, which also increases energy use and bills. Many households living in fuel poverty have poorly-insulated homes with inefficient or expensive heating systems. They may also live in private rented accommodation, which as well as being inefficient, is also impossible for them to change to make it more energy efficient – because even if they got the landlord’s permission, they may not stay in the home long enough to reap the savings benefit they have created.

In reality the £2,500 supposed ‘cap’ does not apply to these households. They might easily use 20,000kWh a year of gas, and 6,000kWh a year of electricity in a ‘typical’ three-bedroomed semi-detached house. Under the Energy Price Guarantee, this would leave such households paying £4,100 a year. This would rise to £4,700 a year when the Guarantee is removed in April – excluding any future changes to Ofgem’s price caps, or further Government support.

The Energy-Bill Support Scheme

Alongside the Energy Price Guarantee, the Truss Government also introduced the Energy-Bill Support Scheme, which is a flat £400 payment to all households with an electricity meter, paid in six monthly instalments of £66. This is a very blunt instrument. For ‘typical’ households using exactly the 12,000 kWh of gas and 3,100 kWh of electricity, it will substantially close the gap of £522 between annual bills before the October 2022 energy price rises and current prices, shaped by the Price Guarantee.

However, £400 more than covers any change in running costs for small flats or very energy-efficient homes – resulting in a profit for households in small flats and efficient homes – yet is quite inadequate to cover vulnerable households in larger dwellings whose bills could rise much more than £400. (£916 a year in the case of the vulnerable household discussed above which uses 20,000kWh of gas and 6,000kWh of electricity a year.)

We accept that benefits need to be as simple as possible, and minimise administrative costs, but this flat-rate scheme penalises households that need financial support the most.

What could we do instead?

The Energy-Bill Support Scheme will cost around £11.2 bn this winter [5]. The Energy Price Guarantee will cost around £18.3 bn through to April next year [6]. This makes a net total of roughly £29 bn – just over £1000 for every household in the UK. This is taxpayers’ money that will be lost forever: there is no long-term benefit to households or Government beyond the immediate relief of taking the sting out of very high energy prices. Let’s contrast this with investing most of this money in energy efficiency improvements to homes: loft and wall insulation, better controls and better boilers. These are long-lasting investments that would benefit households (and ultimately Government too – by helping to address the root cause of very high energy prices: demand for energy that currently outstrips supply). Energy bills in this scenario would be lower not just for this winter, but every winter – perhaps for the next 30 years.

For the sake of argument, let’s imagine that 20% of households were already struggling to pay energy bills before the October price rises. Let us also imagine that 20% of households have incomes high enough that they do not need to worry about energy bills (and also have money they could invest in energy efficiency improvements to their homes that would allow them to reduce bills, with sufficient incentive from higher energy prices). The remaining 60% of households are the ‘squeezed middle’: households that are just about able to cover their monthly outgoings from their incomes, and who may even have small amounts of savings.

The squeezed middle will certainly feel the effect of higher energy prices – if not now, while the Energy Price Guarantee is in place, then certainly when this is removed next April. They will have to make changes to their lifestyle – and in many cases sacrifices – to accommodate higher energy bills.

These three groups need different forms of support. The 20% of fuel-poor households need state support to ensure they can pay energy bills and they are comfortable. The system should be more discriminating and fairer than the current crude instruments, but we have time to work this out properly between now and April. Let us assume that costs are similar to the cost of current support, so 20% x £29 bn = £5.8 bn to the end of April. This leaves around £23 bn to spend on energy efficiency improvements elsewhere.

Our stance is that this money should be shared between fuel poor households and the 60% of squeezed middle households – so that they have the opportunity to invest in their homes and achieve long-term savings in energy use and bills. £23 bn is enough money to pay to insulate ALL 9.5 million homes that currently have less than 150mm of loft insulation and ALL 3.9 million homes with cavity walls that are currently un-insulated and ‘easy’ to treat [7, 8], and still leave £14.4bn over to upgrade inefficient boilers, install advanced heating controls, and begin to insulate the 7.3 million UK homes with un-insulated solid walls.

(This would, incidentally, result in a huge injection of money into small companies that are largely responsible for insulating homes and heating systems. This is a far bigger ‘pro-growth’ intervention than throwing away government energy subsidies that are lost forever on international energy markets. Whether the UK currently has enough tradespeople to carry out this work is a legitimate question, and one we will return to another time.)

This might also be a time to introduce incentives for moving demand for electricity to periods of low demand – when it costs less to generate power, and when carbon emissions per unit of electricity are lower. ‘Time of use’ tariffs mean that you pay more for a kWh of electricity when demand is highest (usually from 4-7pm), so households have a reason to delay running their washing machines and dishwashers, and perhaps charging their electric vehicles, until outside the peak period. Octopus Energy have run a successful trial of demand shifting recently – other suppliers should take note. [9]

This would be good for power generation, and also for distribution networks, which face the most challenging capacity constraints during peak periods.

Now the Truss regime is over it is time to start again on the crisis caused by the global energy shortage. We have until April next year to get it right.

[1] E Pellini (2021) Estimating income and price elasticities of residential electricity demand with Autometrics. Energy Economics, 101, 105411

[2] Department of Energy and Climate Change (2016) Gas price elasticities: the impact of gas prices on domestic consumption – a discussion of available evidence. London: DECC.

[3] NEED is the National Energy Efficiency Data Framework, which pools detailed energy use data from many different sources, with the objective of improving understanding of energy use in homes and organisations.

[4] A Powell (2021) Disabled People in Employment. House of Commons Library Briefing Paper.

[5] £400 x 28m eligible households = £11.2bn

[6] Current subsidy on gas and electricity x Ofgem Typical Domestic Consumption Values (minus 20% due to elasticity of demand), assuming 80% of gas and 60% of electricity is used in winter x 28 million UK households.

[7] Loft insulation: 9.5m homes with less than 150mm x average costs £500/dwelling = £4.75bn. CWI: 3.9m un-insulated easy-to-treat cavity walls x average costs £1000/dwelling = £3.9bn

[8] BEIS (2021) Household Energy Efficiency detailed release: Great Britain Data to December 2020. London: BEIS