24 Jan 2022
By Dr David Deller
Over the past few months there has been intense discussion of a coming 'cost of living crisis'. A key element is the expected sharp rise in energy bills in April, when Ofgem must revise the energy price cap to reflect a sharply higher gas price in wholesale markets. This blog provides a historical perspective to address the question: how serious will the expected squeeze on energy affordability be?
Deller and Waddams Price (2018) provide the background context with a carefully constructed time series of the share of total household expenditure devoted to energy over the period 1992-2014. It would be a significant task to extend this time series with a similar degree of rigour. Nevertheless, if we set aside issues like payment methods and household types, publicly available data enable one to answer the above question in broad terms. The following chart plots the ratio of average household expenditure on all non-motoring fuels1 divided by median equivalised household disposable income2 in the UK between 1977 and 2019/20.3 The aim is to provide a simple measure of domestic energy spending relative to typical household income.
This chart indicates that the proportion of household income devoted to energy expenditure was much higher in the late 1970s and early 1980s than it has been since the early 2000s. Even when energy costs last hit the headlines in the early 2010s, the proportion of income devoted to energy was only as high as it was in the early 1990s.
So where might households find themselves later this year? If we assume incomes increase in line with the Office of Budget Responsibility’s nominal GDP forecasts, median equivalised household disposable income in 2022-23 would reach £32,304. The average household expenditure on all non-motoring fuels was £1,284 in 2019-20. If this increased to £2,000 it would imply a ratio of 6.2% in the chart. This would be higher than the 2013 peak of 5.6% and would have last been higher in 1988. However, domestic energy expenditure would have to exceed £3,000 for the ratio to exceed the all-time high of 9.3% in 1985. Based on current predictions of the revised energy price cap, it seems plausible that energy affordability will reach a position similar to that in the late 1980s and, as such, could be more challenging than when energy prices last dominated the headlines in 2013. If 2013 is a guide, considerable political pressure around high energy prices is likely and households at the bottom of the income distribution with tight budgets will see considerable pressure on their living standards compared to the past few years.
This budget challenge for low-income households is likely to be all the more severe as the jump in energy (un)affordability is going to occur in the space of a single year rather than being a gradual, but sustained, increase as occurred in the decade up to 2013. Also, while we can say that energy affordability was worse 40 years ago this is likely to be scant consolation for those households that already struggle to afford to heat their homes.
Lastly, one thing to remember about the chart and other discussions of likely energy bills is that the precise definition of the metrics used can vary. First, the chart above includes fuels beyond electricity and gas, such as heating oils and coal. Second, common projections of energy bills generally assume households consume both electricity and gas and may hold energy consumption fixed. In the face of large price increases, households are likely to reduce their energy consumption to some extent. Hence, there is a degree of uncertainty in how energy bill projections will convert into the average energy expenditures recorded in the Living Costs and Food Survey on which our data are based. However, these are points of detail rather than something affecting the qualitative conclusion that high energy bills are likely to be a source of significant concern for many households in the coming year.
Notes on data sources:
1. See the government’s statistical dataset ‘Annual domestic energy bills’, specifically, ‘Average expenditure each week on fuel per consuming household in the UK (QEP 2.6.2).
2. See Table 1 of the 2020 edition of the ONS dataset ‘The effects of taxes and benefits on household income, disposable income estimate. Equivalisation controls for variation in the size of households, while disposable income is income after direct taxes are deducted and benefits are added.
3. Note this is the ratio of two average values, the average of the ratio of the underlying variables is likely to be different.