Rishi Sunak thrown a fiscal lifeline by falling energy costs

rishi sunak - Stefan Rousseau/Pool via REUTERS
rishi sunak – Stefan Rousseau/Pool via REUTERS

Setting out his priorities in his first major speech as Prime Minister, Rishi Sunak acknowledged on Wednesday that while the “New Year should be a time of optimism and excitement.. many of you look ahead to 2023 with apprehension.”

With Britain gripped by a plethora of crises ranging from inflation to a faltering NHS, there wasn’t much for Rishi Sunak to celebrate this Christmas.

Yet the Prime Minister has been handed an unexpected gift in recent days: the unseasonably mild weather we’ve been having.

It may not sound like much of a boon, but it is having a dramatic effect on gas prices – and that in turn could ease financial pressure on both households and the Government. The falling cost of gas may also stop price rises, helping the Prime Minister meet his goal of halving inflation this year.

On Wednesday, the European benchmark price for natural gas dipped below €70 per megawatt hour, down from August’s high of €339 and the lowest it has been since mid-February, before Russia’s invasion of Ukraine.

The backdrop is unusually balmy weather: after a mild end to December, Met Office forecasters are currently predicting a reasonably mild January.

Temperatures in London usually range between 2 and 8 degrees celsius at this time of year, according to the Met Office, but clocked in at between 8 and 14 degrees on Wednesday, with a similar outlook expected for much of the next week.

Although there is a possibility of a colder period in the middle of the month, even nighttime temperatures have been warmer than the minimum forecast daytime temperatures recently.

The drop in wholesale gas prices should mean households pay less than feared for their heating in the second half of 2023. A typical family’s energy bill is now forecast to be £500 less than previous predictions this summer.

Just as crucially for Sunak, lower prices should also spare the Treasury from forking out billions of pounds in subsidies, giving the PM and Chancellor Jeremy Hunt more breathing room as they attempt to repair Britain’s battered finances.

“There could be some good news for Mr Hunt,” says Carl Emmerson from the Institute for Fiscal Studies.

“At the time of the Autumn Statement, there was next to no headroom against their desire to have debt falling. Things could be a bit better than it looked like at the time.”

The weather is down to sheer luck and could of course change. However, there are other more sustainable factors at work.

Prices have also been driven lower by an influx of liquified natural gas (LNG) to Europe, thanks to sagging demand from Covid-struck China. A successful drive to fill gas storage tanks across the Continent has also eased pressure.

Strong power generation from renewable sources, such as wind and solar, in the UK has reduced demand for gas as well. “Zero carbon” sources including nuclear met a record 87.6pc of Britain’s electricity needs on Wednesday.

Falling gas prices reduce the fiscal burden on the Government because of the energy price guarantee, which was first introduced by Sunak’s predecessor Liz Truss.

Under the scheme, the Government is on the hook for a portion of consumer gas and electricity bills above a certain threshold.

It means a typical household won’t pay more than the annual equivalent of £2,500 for energy this winter, with the figure set to rise to £3,000 in April as the support becomes less generous.

By the second half of this year, analysts predict the scheme may not even be necessary.

That’s because the energy price cap – a separate limit on what suppliers can charge that is determined by wholesale prices – is on course to undershoot the price guarantee.

Based on today’s wholesale gas prices, Martin Young, an energy analyst at Investec, says the price cap is likely to be £2,640 in July before rising to £2,700 in October.

He estimates the more favourable conditions will mean the Treasury spends £3bn on the price guarantee in the 2023/24 financial year, a saving of £7bn compared to mid-December when market prices would have put the figure at closer to £10bn.

“It is definitely some kind of relief,” he adds.

Separate predictions for the price cap published by consultants at Cornwall Insight on Wednesday were in a similar ballpark to Investec, at £2,800 for July and £2,835 for October.

Samuel Tombs, an economist at Pantheon Macroeconomics, also believes the price guarantee will likely not cost the Government anything from the second half of this year, freeing up cash for other uses.

“They could use the money to support households in other ways – such as by reducing the guarantee back to £2,500, or by increasing the personal allowance for income tax,” he adds.

However, before then, there will be some short term pain for households and the Exchequer. Between April and June, both Investec and Cornwall Insight believe the price cap will hover around £3,500, requiring the Government to continue subsidising bills.

Lower gas prices are also likely to slow down the pace of inflation somewhat. James Smith, a market economist at ING, believes it could shave off around half a percentage point from price rises. It may also indirectly lower inflation by allowing businesses to raise prices less.

Slowing inflation puts less upward pressure on interest rates and the Government stands to benefit from rates rising less than markets anticipated in November, making debt cheaper to service.

Pantheon Macroeconomics predicts interest payments will be about £10bn lower than the OBR’s forecast for 2023/24 and £30bn below its forecast for five years’ time.

All this means some of the spending cuts announced in the Chancellor’s Autumn Statement may “never need to see the light of day,” according to Paul Dales, chief UK economist at Capital Economics.

Despite the rosier outlook, however, experts say Sunak should hold off on celebrating for now.

As Young points out: “The big caveat in all this is that prices could go back up again.”

Specifically, the July price cap will be based on a period of market observation from February 20 to May 18.

Between now and the end of that period, much could still go wrong.

Tony Jordan, co-founder of energy consultancy Auxilione, says it would only take another cold snap, a spike in demand for LNG from a recovering China, or some other unforeseen disruption to throw a spanner in the works.

What’s more, the push to refill Europe’s gas storage tanks in time for next winter will be even harder this year because it will have to be done without supplies from Russia.

“We are in uncharted territory, as we have been for this past year,” Jordan says. “We’ve never had to live without Russian gas, we’ve never had to have such a big reliance on LNG.

“Right now, it’s all looking very good. But if we get a cold snap in January or February and we have to deplete European gas storage, then obviously we’ve got a big amount of gas to put back in through the summer.”

At the moment, however, the sun gods are smiling on Britain and its allies. For Sunak, it gives some of that much needed optimism he has been looking for.

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