Why is Britain facing gas supply problems and what does it mean for household bills?

Households are facing big rises in the cost of powering their homes thanks to an unprecedented spike in energy costs, while a number of energy firms are expected to go out of business this year.

Amid warnings of the lights going out this winter, Kwasi Kwarteng, the business secretary, has urged people not to worry, stating that the UK’s energy supplies are secure and the failure of some energy firms is “no cause for alarm”.

But how credible is that claim? What is behind the huge price rises? Why are UK supplies so low and what does it mean for consumers?

How severe are current gas supply issues?

Global gas prices have risen 250 per cent since the start of the year, partly due to the rapid reopening of economies as vaccines have helped to control the Covid pandemic. Prices shot up 70 per cent in August alone.

The amount of gas in storage in northwest Europe is at a record low, according to a research note from Goldman Sachs.

Typically, supplies are built up during the summer when demand is low so that there is enough gas stored up for the winter when demand is high.

It is feared that prices will rise further as demand continues to increase but supply does not. A harsh winter would deepen current problems.

The government points out that, while the UK is to some extent beholden to global market prices for gas, some 40 per cent of the country’s supply come from the North Sea with around another 30 per cent coming through an agreement with Norway.

Why are there problems with gas supply?

Surging demand as economies have rebounded from Covid-19 has combined with a cold winter which left stocks lower. This has been compounded by very low winds over the summer, meaning less renewable energy and more demand for gas. Wind is an important part of the UK’s energy mix.

Meanwhile, Russia’s Gazprom has also been supplying less gas to Europe than normal. The company says this is due to production problems and Russia’s own increased need for gas. Sceptics allege that the Kremlin is exerting its power over the EU, which has yet to grant approval for the Nord Stream 2 pipeline which would allow more gas to be transported from Russia to Europe.

There have also been unexpected outages at four UK nuclear sites and a fire at an interconnector that links the Britain to energy supplies from mainland Europe.

Adding to this array of problems is the fact that the UK has much lower levels of gas stored than many other European countries, largely because storage capacity has been depleted in recent years. It is also more reliant on gas, which is used to heat the large majority of homes, and to generate around 40 per cent of electricity.

What impact might gas supply problems have?

It is not widely expected that gas will “run out”, though if prices jump further, some industries will see their costs increase so far that their business becomes unviable.

Cost increases will inevitably feed through into prices of goods for consumers and have further knock-on effects.

The first to be hit have been fertiliser manufacturers who stopped production last week, potentially further increasing costs for farmers.

European governments have indicated that they will ensure that households are protected from price rises but that could mean problems for industry.

“From an industrial perspective the risk that we cannot ignore is that the price rises so high that it chokes off activity and the economic recovery,” says Ole Hansen, head of commodity strategy at Saxo Bank.

“We could get to a point of rationing energy, and politicians don’t want people freezing in their homes so the other option is for industry to shut down.

Energy-intensive industries would be the first to be impacted, Hansen said, pointing to nitrogen fertiliser companies that suspended production last week.

“Chemicals production uses a lot of energy, so does cement, and you already cannot get cement for love nor money.”

Construction firms are currently reeling from a global shortage of building materials that has caused work to stop on some projects.

While supply problems are affecting Europe and the US, the UK is “desperately vulnerable” to price fluctuations because, unlike many other countries, the vast majority of homes are heated with gas, Hansen added.

Henri Patricot,oil and gas equity research analyst at UBS, says there is “no prospect” of a significant increase in supply of gas from Russia by the end of the year. “Any stabilisation of prices would have to come through destruction of demand,” he said.

Higher prices give the Bank of England a dilemma too. It will be reluctant to raise interest rates when the economy is struggling but at the same time will be concerned about spiraling inflation.

A rate rise would mean higher costs for businesses and mortgage borrowers.

How are food supplies being impacted?

Iceland managing director Richard Walker has warned that food supply shortages could happen in the “coming days and weeks” because of a shortage of CO2.

The gas is a by-product of making fertiliser, an industry which has partially shut down due to rising costs. CO2 is used to stun pigs before slaughter so they can be killed humanely.

Trade body leaders have called on the government to “urgently ensure adequate supplies” of the gas to keep production going.

If disruption to fertiliser supplies continues it will further increase costs for farmers, putting upward pressure on food prices.

What does it mean for energy bills?

Energy bills are likely to go up for most households but not necessarily immediately; that will depend on the tariff that people are on. Variable deals can be increased at short notice, others can only go up after the current deal expires.

All consumers are protected by the energy price cap which sets a maximum level that firms can charge.

The hypothetical average home using a typical amount of energy will pay no more than £1,277 a year from 1 October – a 12 per cent jump on the previous level. Prepayment meter customers, who are more likely to be vulnerable, will see a £153 jump to £1,309 a year.

Analysts at HSBC estimate that consumers will face a further 15 per cent jump in prices in April next year when the cap is reviewed again.

Why are energy suppliers going out of business?

Several energy companies have been unable to absorb rising prices and have either become insolvent or are about to.

The price cap, as well as fixed-rate tariff deals, mean that they cannot immediately pass on higher costs to customers and are now making losses.

While companies often hedge their exposure to price fluctuations, many are thought to have only partially covered themselves.

The number of energy companies in the UK has risen in recent years. Deregulation was designed to increase competition and break up what has been labelled a “cosy oligopoly” of big companies dominating the supply of energy. Critics of the changes say they have allowed badly run companies to enter the market before going bust and leaving the rest of the industry to pick up the tab.

Customers of firms that go out of business are switched to other companies and their supply of energy is not impacted. However, that mechanism has not been tested at large scale yet.

Will this cause further damage to energy supply?

No, it should not have a direct impact on the supply of energy. Most suppliers are primarily retail companies that bill consumers and provide customer service, they aren’t involved in the extraction and distribution of gas.

Ed Miliband, the shadow energy secretary, said it was important not to “alarmist” about the prospect

Will taxpayers have to bail out energy companies?

The government ruled providing public funds to save firms in financial trouble. Kwasi Kwarteng said the public would not have to pay for the “poor practices of a minority of companies”. However, it is possible that the government will have to provide support to businesses who take on customers of other failed suppliers.