Vincent Cable: The way to tackle fuel poverty

There are demands for a windfall tax on the big energy companies. But this largely misses the point

The recent announcements by British Gas and the French electricity utility EDF, that they plan to increase gas and electricity prices by a third and a fifth respectively, have major, and worrying, implications for those on the edge of fuel poverty. This comes on top of industry-wide increases at the start of the year. Even in the balmy heat of midsummer, people are understandably worrying about their energy bills.

Average bills now sit well above the psychological barrier of £1000 per year. This in turn raises the question of whether the Government's target of eradicating fuel poverty by 2016 is any longer credible, or even meaningful. There are currently 2.5 million households so defined.

As domestic energy prices have shot up, so too have the questions about whether they are a fair representation any more of the actual cost of supplying domestic energy. Indeed, the current vogue for many who want to tackle the problems of fuel poverty is to point to the major energy producers as a source of economic "rent", which can be used to cushion the impact on consumers. Many people feel instinctively that there is something wrong when companies – such as BP this week – are reporting exceptionally high profits at a time when people are struggling to afford their energy and fuel bills.

There are demands for a windfall tax. But this largely misses the point. The headline profits usually relate to global operations, of which only a modest part is in the UK. Even if there were a large UK-based windfall tax, the same logic would apply to wheat farmers, who have also benefited from rising world prices. What is more, all these arguments for a windfall tax ignore the inconvenient truth that North Sea producers already face a windfall tax.

I appreciate that this argument offers no solace to those facing soaring household energy bills. There is, however, a separate argument about the electricity and gas companies. These companies benefit from a windfall received from phase two of the Emissions Trading Scheme. During phase two of the scheme, the vast majority of permits to produce carbon dioxide have been given away free, and energy companies can decide to trade rather than use these permits.

The energy regulator Ofgem has calculated that the collective windfall of energy producers from the introduction of free ETS permits amounts to £9bn over the whole of phase two (five years). At least some of this money is fair game: there is a difference between profits made because of increasing demand and profits made because of a government giveaway.

Indeed, the Government (and the industry) has now accepted this argument in principle, and will auction permits in the future in a way that their scarcity value accrues to government rather than to the industry.

The industry argues that the current arrangements were entered into in good faith and that they should not be taxed retrospectively. But it is not unreasonable to expect it to shoulder more responsibility.

Indeed, there are other arguments for taking a tough approach. The competitive market which once existed in electricity generation has largely disappeared, with six major vertically-integrated companies dominating it. Moreover, the claim that consumers can shop around for good bargains is undermined by analysis from the University of East Anglia, which shows that a third of switchers actually make themselves worse off, and half of customers never switch. Overall, there is a strong case for a Competition Commission referral.

In the absence of such a – necessarily long – inquiry, various actions should be insisted upon, under the watchful eye of the energy regulator, to ensure that costs are not passed on to consumers.

The first is to improve energy efficiency. According to the Local Government Association, at least 12 million houses are currently inadequately insulated, costing households around £200 in lost energy. Some companies, under the Carbon Emission Reductions Target, already have a rolling programme to insulate people's homes, but this needs to be scaled up hugely. A 10-year rolling programme of £500m could ensure that not only are all British homes adequately insulated, but that household carbon emissions are reduced by a fifth.

Secondly, the most vulnerable customers face disproportionately high bills from pre-payment meters. Ironically, despite the claims to offer a "social tariff", major energy companies charge a negative social tariff. According to recent research commissioned for Energywatch, those on pre-payment meters can pay up to £142 more than people on direct debits on their combined gas and electricity bills. With around a quarter of poorer fuel customers on pre-payment meters, this has to be a priority.

Rolling out social tariffs to ensure that the 2.25 million people on pre-payment meters are not unfairly penalised would cost the energy companies in the region of £275m a year. Given the level of their ETS windfall, this does not seem an unreasonable obligation.

Finally, through the introduction of smart meters, which display consumption costs, Energywatch has shown energy usage can be reduced by between 3 and 15 per cent through changes in behaviour. With a 5 per cent reduction translating into a bill reduction of around £35, this can also help reduce fuel poverty. What is more, the introduction of smart meters that can be read remotely could also significantly benefit the energy companies.

The energy companies have so far led something of a charmed life, with a windfall from the ETC and a regulator who is reluctant to enforce the full rigours of competition rules. They would be well advised to be generous to their customers. Otherwise they may find themselves subject to enforced generosity.

The writer is Treasury spokesman for the Liberal Democrats