Soaring energy prices in the UK are squeezing many businesses, with “household names” reportedly only days away from going bust. Energy-intensive sectors like steel, paper, glass and fertilisers are leading calls for government support to subsidise operations.
Meanwhile, the British Chambers of Commerce is warning that thousands of smaller businesses may not survive the winter, with the energy price crunch coming on top of labour shortages, supply-chain problems and other rising prices.
The government is reportedly in internal conflict over how to respond. Boris Johnson and Business Secretary Kwasi Kwarteng appear to be more keen to offer support, while the Treasury has been more reluctant. It comes only several weeks ahead of Chancellor Rishi Sunak’s autumn budget, which is being trailed as a set of tough measures to get the public finances in order after the pandemic.
The latest reports suggest that the government will nevertheless offer some support, but perhaps only for major energy-intensive firms on the verge of going out of business, and only then as loans not grants. So to what extent should the government support companies when the price of resources changes?
The case for not doing much
The starting point in a market economy is that businesses are free to choose which markets to enter and the business models they use. They do this at their own risk, and they profit if they are successful. That’s the nature of enterprise.
It’s also worth pointing out that the rising energy prices in the UK refer to the “spot” markets, meaning buying and selling a commodity like natural gas or coal for immediate use. The alternative is to enter into longer-term supply contracts that fix prices into the future. Many bigger businesses enter into such contracts, typically paying a premium for price certainty over months or years. Therefore, headline “spot” prices don’t necessarily reflect the average price being paid by companies.
As for those businesses who are buying energy at “spot” prices, a good analogy is the UK’s small energy retailers. Many of them have been victims of the rising market, having relied on making money from buying energy in the “spot” market and selling it at a higher price to consumers. They are going out of business because they didn’t anticipate the risk of rising prices, which has been a strategic failure on their part.
I would argue that the same is true of businesses in other sectors who are struggling with the high energy prices. Many financial instruments are available that can be used to “hedge” against the risk of price fluctuations. Industries such as airlines do this all the time. Even smaller businesses should be able to get fixed tariffs from suppliers for up to three years.
Such risk-reductions expire after a given period, so they don’t protect a business if energy prices permanently shift upwards, but do give them time to adjust. If it is felt that these tariffs have not been available at sufficiently competitive prices, there might of course be an argument for the government to make that a requirement of energy retailers in future.
Another dimension to this is climate change, particularly as the UK prepares to host the UN’s COP26 climate conference in November. The current price shock is in part a signal about the need to develop strategies for a low-carbon economy. Businesses should already have been trying to make themselves more energy efficient. Any government intervention is arguably subsidising their failure or inability to do so.
We are seeing a similar situation playing out in China, where I am based. A combination of a strong economic recovery post-COVID, rising coal prices, and tougher carbon emissions targets have led to power cuts, at least temporarily. With many factories cutting back their operations or shutting down, the government has ended up loosening its restrictions on importing and mining coal, even offering financial support to coal miners to ramp up operations.
The exceptions
But if these are reasons for not giving businesses support, there are times when it does make sense for government to intervene. There is a strong case where a situation is likely to cause significant disruption to either the wider economy or society. Examples might be where vulnerable consumers would be hurt or where multiple businesses might end up failing because a struggling customer is defaulting on their debt.
A recent example of what I would consider a justified bailout was the government’s decision in September to financially support fertiliser-maker CF Industries. This was after the company announced it would be shutting two UK plants in response to rising energy prices. The plants produce carbon dioxide as a by-product for industries like food and nuclear power, so the knock-on effects of the closures were likely to be considerable.
Another example is where bigger energy retailers have taken over the customers from retailers who have failed. The government is compensating the bigger retailers for the cost of maintaining supply to these customers via an industry levy, and this is justified to maintain confidence in energy supply as a whole and to avoid major disruption to businesses. Others might argue that a windfall tax on, say, gas producers might be a better option.
In short, it is not the role of a government to protect businesses from the consequences of their own strategic shortcomings. Governments do need to intervene occasionally when the alternative is significant disruption, but the UK should not stretch its support beyond this basic test. Generally speaking, businesses should be aware of the risks of rising prices and have systems in place to avoid bearing the brunt.