Written evidence submitted by Energy Intensive Users Group (EPM0015)

Response from the Energy Intensive Users Group to the Business, Energy and Industrial Strategy Committee Inquiry into Energy Pricing and the Future of the Energy Market

Introduction

1. The EIUG represents the UK’s Energy Intensive Industries (EIIs) including manufacturers of steel, chemicals, fertilisers, paper, glass, cement, lime, ceramics and industrial gases. EIUG members produce materials which are essential inputs to UK manufacturing supply chains, including materials that support climate solutions in the energy, transport, construction, agriculture and household sectors. They add an annual contribution of £29bn GVA to the UK economy and support 210,000 jobs directly and 800,000 jobs indirectly around the country.

2. These foundation industries are both energy and trade intensive – remaining located & continuing to invest in the UK and competing globally requires secure, internationally competitive energy supplies and freedom to export without tariff barriers. However, inward investment, growth and competitiveness have been hampered for years by UK energy costs higher than those of international competitors. In some cases, investment, economic activity & jobs have relocated abroad, leading to a subsequent increase in imports.

UK Industrial Energy Prices- the Current Situation

3. A report published by Ofgem in July 2021[1] showed that GB industrial electricity prices are higher than in other European countries. These higher GB prices are a result of the compound effect of higher wholesale costs, greater GB policy costs, and a network cost distribution model that disadvanatges UK Energy Intensive Industries (EIIs).

4. Across Europe, and in the UK, gas prices have risen rapidly throughout 2021 due to increased global gas demand as economies recover from the pandemic, and supply constraints driven by Russia. This in turn has impacted electricity prices due to greater use of gas as the marginal generation fuel in the UK and because at the same time wind generation has been low. Due to the UK market, policy and energy mix dynamics, the price increases are considerably higher in the UK than elsewhere. This was confirmed in a report published by UK Steel in November 2021[2] which highlighted that not only are prices in the UK higher, but the gap between the UK and other European countries has widened.

5. In 2021 gas prices rose as high as 451p/therm and are now over 4.5 times what they were at the start of 2021. This is an unprecedented and extraordinary rise in prices. In April 2021, UK wholesale electricity prices rose to £47/MWh (compared to just £30/MWh the year before), before soaring above £100/MWh in August.  September saw UK wholesale prices and price volatility explode to levels not seen for decades, with hourly prices peaking at £2,500/MWh. Even more worryingly, the monthly average UK wholesale price reached £260/MWh – more than double French & German averages of £110/MWh. It is also clear that for electricity, the impact is long term with the average three year price from October 2021 expected to be £208, this is a 342% increase on the previous 5 year average price of £47/MWh price up to April 2021.

6. On top of this wholesale price difference, the ongoing policy cost disparity has also increased. Confirming the conclusion by Ofgem, the report by UK Steel found that the overall delivered price gap compared to the EU rocketed to £109.30MWh in September (taking exemption and partial compensation schemes into account, which are not universally available to all UK EIIs). Whilst, at the time of writing, gas and electricity price volatility has stabilised to some degree, overall the prices remain extraordinarily high.  As the winter progresses, it is expected that the UK will continue to experience high and frequent spikes in energy prices.

7. While domestic consumers have been widely protected from short term movement in the energy markets by the domestic price cap, industrial consumers have not been afforded the same facility. Given the importance of affordable energy to EIIs, many would have hedged at least some of their energy consumption. However, hedged contracts are starting to unwind and now all EIIs are facing the full force of the price increases as they purchase energy for the year(s) ahead and the extraordinary prices levels and price risks are being locked into contracts.

Energy Price Impact on Energy Intensive Industries

8. For EIIs, energy costs are a large proportion of their operating costs and therefore higher prices in the UK compared to other competing nations can quickly render UK plants and products uncompetitive in international markets. The rise in gas prices in September 2021 caused UK fertiliser sites to switch off, interrupted production at some sites and impacted the profits of all. It also put considerable inflationary pressures down the supply chain. EIUG has had feedback that when EIIs try to pass increased costs down the supply chain customers start looking for alternatives, whether its alternative products, often sourced overseas, or alternative suppliers based overseas that can now produce the same products more cheaply and export them to the UK.

9. Unless the situation is remedied or contingency measures put in place, there is a risk of further production disruption and ultimately long-term erosion to the competitiveness and investment attractiveness of our vital foundation industries. 

10. As businesses struggle to pass through cost increases of this scale to downstream consumers and hedged energy positions unwind, a growing number of businesses are pausing or minimising production and bringing forward annual maintenance to reduce energy consumption temporarily.

11. High energy prices jeopardise longer term decarbonisation investments. Decarbonisation of the UK electricity grid has been hugely successful, but the subsidies used to achieve this have come at a high cost to consumers, more so for industrial consumers. Now the UK enjoys low carbon but very expensive electricity as the current and legacy subsidies continue to be paid. According to the 2021 Ofgem report1, policy costs resulting from Contracts for Difference, Feed-in Tariffs, the Renewables Obligation and the Capacity Market make up around 22% of total industrial electricity costs after any EII exemption has been applied (note that EIIs that do not receive these exemptions face even higher costs). This compares to just 10% in Germany, 7% in the Netherlands and around 4% in France.

12. Electrification is a key decarbonisation option for some industries but high industrial electricity prices act as a barrier to such investments due to the short term competitiveness impact. High electricity prices will also impact the commercial production of electrolytic hydrogen and sectoral decarbonisation options for those using gas that might consider switching. It also acts as a barrier to the deployment of carbon capture systems which will also require a large increase in electricity consumption at the sites where CCUS is fitted.

13. Government proposals to rebalance policy costs from electricity onto gas will also add to the erosion of gas intensive industry competitiveness, particularly as new tariffs are expected imminently.

14. Carbon costs have also significantly increased, most sharply in the UK scheme where UK Emissions Trading System prices have been higher than in the EU scheme since August 2021, and where UK businesses still face the unilateral cost of Carbon Price Support (CPS) that is passed on in energy bills, while other major competing economies still have negligible carbon costs. The CPS was introduced to raise the carbon price when it was very low with the aim of accelerating the closure of coal fired power generation. The carbon price is no longer low (it is currently well over £80/tCO2) and coal fired power generation is declining quickly. The CPS has fulfilled its purpose and now is just an unnecessary cost that EIIs are having to bear, that competitors overseas don’t face.

15. The UK Government has twice had the opportunity to contain volatile UK ETS carbon prices when the Cost Containment Mechanism (CCM) was triggered, but has actively chosen to take no action, leaving UK industry to continue operating at a competitive disadvantage to our European neighbours. The Government claims that the UK CCM has been deliberately designed in its early stages to be more reactive than its European equivalent, but they have refused to use the tool they created to specifically address this concern. Furthermore, now that the threshold for CCM triggering has been raised, the intervention opportunities are likely to be fewer.

16. The lack of action to rebalance UK industrial energy costs with those of competitors overseas and the unwillingness to use policy tools designed to mitigate unreasonably high costs, suggests that the UK Government has little interest in keeping a competitive industrial foundation in the UK.

Action Needed

17. The EIUG has clearly set out to Government the short and long term measures that are required to address the shorfalls in the energy market and its implications for EII consumers. The measures seek to enable a competitive industrial base that underpins the UK economy, contributing GVA and jobs often in areas targeted for levelling up. These measures are set out below.

18. Short term measures:

1. Introduce Winter Cost Containment Measures on gas, electricity and carbon prices to ensure that those most exposed to these costs can continue to operate during winter spike episodes such as those experienced in winter 21/22.
2. Cease immediately uncompetitive policy ‘on-costs’ such as ‘Carbon Price Support’ (CPS).
3. Require immediate action by Ofgem to reduce EII network costs. Ofgem must replicate the network tariff discounts recognised in its own analysis and that are offered to competitor industries in the EU by their Governments/network regulators. This will help to bring UK network costs for EIIs more in line with those faced by European competitors.
4. Modify the Gas Emergency Measures. The Government and Ofgem must outline steps to ensure that sufficient gas is available and that the ‘priority site’ value threshold is reduced from £50 million to £1 million to make sure that many more kilns and furnaces can be safely shutdown without sustaining serious damage in the event of an emergency or sudden supply disruption.
5. Ensure the £1bn+ Supplier of Last Resort (SoLR) Costs and use of public funds associated with Bulb, are not allocated to EIIs. Unlike the domestic sector, there isn’t a price cap for EIIs and many are already bearing increased energy costs on any energy not hedged, and those with hedged contracts are facing substantial increases as their contracts end. It is unfair to attribute SoLR (and Bulb) costs, eminating from failures of domestic suppliers resulting from the domestic price cap, onto an industry sector that was not the cause of the failure. A ‘gas code modification’ has been proposed to enable SoLR costs to be recovered from the market that they are attributed to, which should ensure the costs are not borne by EIIs, and EIUG understand that this has very recently been approved by Ofgem.

19. Long term measures:
1. Provide full relief for historic legacy costs for renewables: a 100% exemption from Contracts for Difference, Feed-in Tariffs, and the Renewables Obligation costs for all EII sectors, including those not currently in receipt of relief. The current exemption does not cover all businesses within eligible sectors. This creates intra-sector distortions and leaves some EIIs exposed to these high costs. The scheme must be expanded.
2. Full relief from indirect carbon prices (ETS and CPS) for all EII sectors, including those not currently in receipt of relief: the test for relief eligibility was carried out using EU data and an EU derived test. BEIS consulted on modifications to this relief system in 2021 but no response to the call for evidence has been forthcoming. The current compensation scheme was extended for a year and is now due to end in March 2022. This is less than 3 months away and yet industry has no idea whether compensation will continue, at what level or for what sectors.
3. Don’t rebalance oncosts from electricity to gas: provide an EII exemption from Green Gas Levy and other forthcoming policy costs aimed at decarbonising gas supply until low carbon cost- competitive alternatives are available to industry.

The Energy Retail Market

20. Competition in the retail energy market is vital for keeping down costs for all consumers. The current crisis has decimated energy suppliers which in turn impacts competition within the energy retail market. The future energy retail market must learn from the collapse of energy supply companies over the last few months, and the supply sector must be rebuilt to be more economically sustainable and competitive. Closer collaboration between the retail market, consumers of all types, the regulator and the Government will be needed to ensure a secure and afforable supply of energy, increased innovation and the delivery of net zero at an accelerated pace.

21. More must also be done to protect all consumers from high energy costs. This is currently hampered as the existing enabling tools principally focus on domestic consumer affordability, rather than also considering the affordability and competitiveness of UK businesses and particularly the EIIs at the start of UK value-chains. The regulatory framework must be updated to ensure that the vulnerable and fuel poor protected, and the decarbonisation of UK EIIs and downstream businesses are facilitated whilst their international competitiveness is maintained. The EIUG is still awaiting a Government consultation on a Strategy and Policy Statement for Ofgem where it is anticipated that the guidance from the Government to the regulator will direct Ofgem to treat all consumer groups equally and remove the domestic consumer bias currently instutionalised within the regulator.

January 2022