Climate change and green taxes: the statistics of energy bills

Features

  • Author: Dr John Fry
  • Date: 02 Jan 2014
  • Copyright: Image appears courtesy of iStock Photo.

Climate change is an important issue affecting the future of all humanity. However, if you can’t afford enough to eat or to heat your home, and this is happening in the here and now, it would be difficult to argue that the debate about the standard of living is not also of a similar magnitude of importance.

To counter man-made climate change a series of government measures labelled “green taxes” have been introduced to encourage the expansion of low-carbon power, subsidise home insulation and tackle fuel poverty by reducing energy consumption or by providing a Warm Home Discount (WHD) for eligible low-income households.

thumbnail image: Climate change and green taxes: the statistics of energy bills

Popular folklore holds that politicians like “kissing babies”. Against the backdrop of the UK Government’s Climate Programme, which started in November 2000, for many years politicians have held a similar desire to show their “green credentials”. However, it appears that the “green worm” may have turned and may now be about to bite! Energy bills have been high on the political agenda of late. In recent months both Prime Minister David Cameron and Labour Leader Ed Miliband have seemingly sought to blame each other for green taxes added to energy bills allegedly increasing the financial burden faced by millions of ordinary people at a time when the standard of living is becoming more and more squeezed.

There are thus two main questions of interest.

1. How much do green taxes add to energy bills?
2. What are the likely long-term effects of government policies and green taxes upon energy bills?

Current estimates from the Department of Energy and Climate Change (DECC) are that energy and climate change policies make up around 9% of the average household energy bill [1]. However, this is potentially much more serious than it sounds. Since 2010 gas and electric prices have increased by around 18% and 9% in real terms and by around 41% and 20% since 2007 [1]. Further, it is important to realise that real-term price rises will appear even more dramatic when viewed on a purely nominal scale. Rises in the cost of the price of living have dwarfed the scale of even recent house-price rises [2]. This means that any effects that green taxes have will be further exacerbated if, as for many people, wages have not kept pace with inflation.

Global energy prices are expected to continue to keep rising. However, irrespective of this fact, it is anticipated that government policies will have the counter-intuitive effect of actually leading to reduced household energy bills. This is because government measures are intended to deliver increased energy efficiency savings.

There are several ways in which government policy may directly lead to some reductions in energy demands. Firstly, this may be brought about by an increase in the use of loft, cavity wall or solid wall insulation through supplier obligations. Secondly, households may be able to benefit from efficiency improvements if they sign up to a Green Deal [1]. In particular, the Energy Company Obligation (ECO) requires energy companies to support households in improving the energy efficiency of their homes. Product policies are also expected to deliver significant house-hold savings e.g. through more efficient TVs and set-top boxes. In a similar vein building regulations requiring the introduction of newer and more energy-efficient boilers may also lead to savings.

A central tenet of government policy is to enable more informed consumers to make energy-saving decisions themselves through better billing and via the use of Smart Meters. Under the better billing policy energy suppliers are required to include on bills and statements comparisons between current energy usage and usage in previous periods. Smart Meters are intended to provide both real-time information about energy consumption and will eventually bring to an end the practice of estimated billing. In addition to the above small-scale feed-in tariffs also allow customers to earn money from their own small-scale electricity generation.

So it appears that the ideal scenario of an army of well-informed domestic electricity consumers increasingly de-coupled from the ravages of global energy markets is probably precisely that - a pipe dream. Historically rising energy prices have coincided with a decrease in demand and this relationship seems to remain stable over time. Interestingly, the statistical relationship between electricity prices and demand does not seem to have changed despite the increased emphasis on energy efficiency in recent years. This suggests that government and policy makers need to be realistic when setting energy-reduction targets.

Rising wholesale energy and network costs probably mean that energy bills will continue to increase. This is almost certainly beyond the control of any government. If we were to try to judge the effectiveness of government policy we might ask if there is any macroscopic evidence to suggest that consumers are, as government policy intends, able to alter their consumption patterns as electricity prices change.

Graphical evidence presented in [1] suggests that domestic consumption of electricity has decreased as inflation-adjusted electricity prices increase. Using data available from the DECC website, Figure 1 shows a plot of quarterly domestic electricity consumption over time (left panel) and an inflation-adjusted domestic electricity price index (right panel).

Now, energy statistics and energy consumption provide interesting statistical challenges in their own right. Looking at Figure 1, energy consumption is both volatile highly seasonal in nature but it does seem that, as expected, generally consumption decreases as prices rise and vice versa. A Granger causality test (results not reported) shows that quarterly electricity price fluctuations do have some predictive capability for electricity consumption beyond that simply contained in lagged values of electricity consumption over the past year. Hence, domestic electricity consumers do appear able to moderate their electricity consumption based on the price of electricity - at least to some extent. However, using the method of [3] to test for breakpoints we found no evidence that this relationship changes over time. So it appears that the ideal scenario of an army of well-informed domestic electricity consumers increasingly de-coupled from the ravages of global energy markets is probably precisely that - a pipe dream. Historically rising energy prices have coincided with a decrease in demand and this relationship seems to remain stable over time. Interestingly, the statistical relationship between electricity prices and demand does not seem to have changed despite the increased emphasis on energy efficiency in recent years. This suggests that government and policy makers need to be realistic when setting energy-reduction targets.

Figure 1. Left panel: Quarterly Domestic Electricity Consumption. Right panel: Quarterly Domestic Electricity Price Index. Source DECC Energy Trends Statistics.

Whilst the seriousness of climate change must be acknowledged the effects of previously in-vogue green policies are non-trivial and are now starting to be felt. It is estimated that green taxes add around 9% to domestic energy bills. Amid concerns over a decreasing standard of living means this is hugely important and energy bills will likely remain at the centre of the political debate for some time to come.

Global energy marekts are beyond the control of governments. At least in part government policy seeks to enable better informed consumers to moderate their own consumption. Evidence suggests that domestic energy prices Granger-cause domestic electricity consumption. Thus, it would appear that, to some extent at least, consumers can track prices and moderate their behaviour accordingly.

Price is probably the single biggest issue governing current energy consumption. Government clearly faces conflicting aims in this regard. There is a need to both reduce energy consumption, brought about by the threat of climate change, and the need to look after today’s poorest citizens. In terms of measuring “success” if government policy works individual consumers ought to be able to use electricity prices to make informed decisions about their electricity consumption in subsequent periods. Thus, if government policy works current electricity prices should directly affect future electricity consumption. Any dramatic changes in the relationship between prices and consumption may therefore provide an early warning that government policy is not working and that further action on fuel poverty is required.

References

[1] DECC, 2013. Estimated impacts of energy and climate change policies on energy prices and bills.
https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/172923/130326_-_Price_and_Bill_Impacts_Report_Final.pdf
[2] Fry, J. M, 2013. Is there really a new bubble in UK house prices? Statistics Views Website, Wiley http://www.statisticsviews.com/details/feature/5528141/Is-there-really-a-new-bubble-in-UK-house-prices.html  
[3] Zeileis, A., Kleiber, C., Krӓmer, W., Hornik. K. (2003) Testing and dating of structural changes in practice. Computational Statistics and Data Analysis, 44, 109-123.

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