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There is nothing good about the energy shock stemming from the closure of the Strait of Hormuz. Higher prices for fuel, gas and electricity are needed to reduce demand to the point it balances lower global energy supply. So far, the world has papered over cracks by depleting well-stocked inventories, but this policy is strictly time-limited.
When energy prices rise, consumers suffer and the calls for governments to do something become irresistible. Many countries are already ignoring multilateral organisations’ appeal for energy subsidies to be temporary and targeted and instead simply lowering petrol and diesel taxes.
In the words of Canadian Prime Minister Mark Carney, middle powers are taking the sign out of the window and looking after their own. But even with a relentless focus on their populations, net energy importers can do better than introduce blanket road-fuel subsidies.
For a net energy-importing country such as the UK, there is no escaping the fact that the war makes everyone worse off. The best ministers can do is to distribute losses as fairly as possible. Borrowing a little more might be sensible to smooth adjustment, but it simply delays the inevitable bills.
In terms of energy support, the burden of higher gas and electricity prices falls on those with low incomes. This should be the focus of policy rather than road fuels, where spending is spread much more widely.
So long as governments have levelled with their public that losses are inevitable, they can look at some positives. So far, the energy shock is far smaller than that of 2022, so state support can also be much more modest. Research also shows that in 2022 UK households were far better at finding substitutes for energy than was expected, which also limits the pain — so long as they face the right incentives to reduce consumption.
This suggests the following four policy objectives. First, there should be no blanket price subsidies that destroy incentives to conserve energy. Second, support should target low-income households with high consumption of energy. Third, support should be felt not just in people’s incomes but in lower costs that reduce measured inflation, lowering knock-on increases in the cost of index-linked debt and the risk that price rises become persistent. Fourth, it should seek to minimise the cost to other taxpayers. Efficiency matters.
The Resolution Foundation has proposed a social energy tariff targeting low-income households with high energy use. This gets the targeting right, but would not lower measured inflation, creates a cliff edge for households that marginally fail to qualify and would exacerbate a perception that people on benefits get favourable treatment.
The good news is that government can do better. It can offer a combination of some limited and temporary means-tested social security increases this winter to target low-income households. In addition, it can introduce a version of Germany’s 2023 gas and electricity price break, which was a universal discount on energy bills based on past consumption levels. This preserved incentives to conserve energy because it maintained the market price of gas and electricity — and lowered inflation as it was a universal discount.
Finally, the UK and other governments should consider whether a temporary solidarity tax would distribute losses better between current taxpayers and those in the future.
The parameters of the subsidies and taxes can all be calibrated to match the degree of pain as the crisis unfolds and winter in Europe approaches. With luck, none of this is needed at all. But there is no excuse this time for countries to reach for expensive, blunt tools. A geopolitical energy crisis happened as recently as 2022-23. For the public to trust their governments, policy must reflect lessons learnt.
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