An energy price freeze is a very bad idea

The confirmation of the huge jump in the Ofgem cap on domestic energy bills in October, and forecasts of even worse to come, have fuelled more calls for prices to be frozen at current levels. This is not a completely daft idea, but it is not a good one either.

There is no shortage of suggestions for how to solve the energy crisis. Labour has proposed a six-month bills freeze, financed by higher taxes on energy producers, the redirection of the £400 energy discount, and assumed (but largely mythical) savings on the debt interest bill due to lower RPI inflation.

An alternative, being promoted by the energy suppliers, is to freeze bills for up to two years, with any shortfall covered by a ‘deficit fund’. The money here would be provided by government-guaranteed loans from commercial banks, paid back over a long period (perhaps ten to 15 years) from a surcharge on customer bills.

This would be preferable to Labour’s proposal (and no doubt has some fans in the Treasury), partly because it could be self-financing. However, this would mean that consumers end up paying higher bills long into the future and, if done via a fixed surcharge, the burden would fall disproportionately on lower users of energy, who tend to be poorer.

But regardless of how it would be financed, there are four powerful arguments against any freeze on prices.

First, market forces need to be allowed to work. Global supply and demand are out of balance, and higher prices are part of the solution to this. This is not just free-market ‘headbanging’. Price controls have almost always backfired, throughout history. This includes Venezuela’s attempts to fix food prices, and the rent controls which London’s mayor continues to back in the face of all the evidence.

Second, not everyone actually needs additional support to cover all of the increase in their energy bills. Some could meet at least part of the cost from their own resources, including higher nominal incomes. Indeed, the household sector as a whole has built up substantial savings during the pandemic: the Office for National Statistics has estimated that forced savings amount to over £140 billion, or around 10 per cent of annual household disposable income.

Third, more than half the benefit of a freeze on energy bills would go to households on above-average incomes (making it a very expensive solution). Poorer families spend proportionately more of their budgets on domestic energy bills, but less in absolute terms.

This is also one reason why comparisons with the furlough scheme are potentially misleading. Unlike an energy price freeze, the furlough scheme was targeted and capped at 80 per cent of average wages.

Fourth, the cost-of-living crisis has spread well beyond energy prices anyway, including to food and other essentials. Cash transfers and tax cuts would give households more flexibility to respond to pressures elsewhere in their budgets, including those households who (for whatever reason) do not have large energy bills to begin with.

A broader package of tax cuts should help here too. Even if not directly focused on tackling the energy crisis, cuts in personal and corporate taxes would boost the economy more generally, supporting consumer and business confidence. Among other things, this will protect jobs and investment, and make households more comfortable about dipping into their pandemic savings.

In short, any plan to freeze prices would certainly be popular and have some underlying appeal: it would keep household bills down in a way that is easy to understand, and which should leave no one behind.

This means that it should not be ruled out completely, especially if prices continue to soar. One least bad option might be to cap prices at the new (higher) October level. That would at least reassure people that bills would not rise any further, while being a lot cheaper than cancelling the October increase altogether.

But it would still be premature to change tack, based on just a short period of soaring gas prices in wholesale markets. Instead, the focus should remain on targeted support for lower-income households and the most vulnerable businesses. The government should not be in the business of fixing prices, whether for food, rents – or energy.