Energy prices in the UK are still below the level that prompted widespread government fuel subsidies in 2022 and 2023 at the start of the Ukraine war.
But there’s little sign that the war in Iran will end soon, and prices could easily rise further. As policymakers consider ways to shield consumers from the increase, the challenge is not simply to cushion the blow. It’s to do this in a way that preserves incentives, protects the most vulnerable and avoids repeating costly mistakes.
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Chancellor Rachel Reeves’s plan to help only “those who need it the most” is a significant improvement on the broad-based schemes of the previous energy crisis.
The desire to keep inflation and interest rates as low as possible also suggests policymakers are aware that a fiscal bailout would risk fueling inflation and lead to a self-defeating cycle of rising interest rates.
If an energy bailout is required, then it should be targeted and temporary, although the scheduled fuel duty increase in September seems unlikely to take effect.
Why broad energy subsidies aren’t a solution
Calls to protect consumers from higher energy prices are well intentioned and politically popular. But they reflect a fundamental misunderstanding of the price signal and how markets operate.
Energy prices have risen because supply has been squeezed. Higher prices provide an incentive for consumers to use less energy and for producers to supply more.
Broad energy subsidies distort these signals and can lead to over consumption of what has become a scarcer resource.
In extreme cases, suppressing prices during a genuine supply shortage—which may happen if the Strait of Hormuz remains effectively closed—can even lead to rationing.
That’s a much less economically efficient way of distributing resources.
What’s more, broad energy subsidies tend to be regressive. Richer households tend to use more energy and therefore benefit the most from these subsidies.
Broad energy subsidies are also fiscally expensive. During the last energy crisis, the government spent around 75 billion pounds supporting households and businesses.
The current tighter fiscal position and surge in gilt yields, which are now at 4.9% compared with 1% to 2% during the last crisis, make it much more difficult to fund a large bailout.
Admittedly, a one-off support package this year would make little difference to headroom in 2030. That would also be true for a temporary postponement of the five-pence increase in fuel duty scheduled for September.
But the combination of higher inflation, weaker employment and surging gilt yields means the chancellor has probably already lost between and third and half of her headroom. Markets would be highly sensitive to any significant bailout measures.
A large support package would also risk turning the rapid series of rate hikes currently priced in by financial markets into reality.
While it might limit the impact on household incomes, demand and the unemployment rate, it would also make second-order effects more likely as firms passed on cost increases.
Those interest rate hikes would then offset much of the bailout’s benefit, resulting in a higher deficit and debt for little economic improvement. Indeed, our modeling suggests that a bailout of 0.5% of gross domestic product could prompt an additional 25 basis points in rate hikes.
Targeted support strikes the right balance
The case for government intervention is clear. Without support, energy price shocks can impose welfare losses equivalent to around 6% of household income on average, according to the Institute for Fiscal Studies, with poorer households bearing more of the brunt as they spend more of their income on necessities like energy.
But the key lesson from the 2022–23 crisis is that the way support is delivered matters as much as whether it’s delivered at all.
Targeted support should be focused on low-income households, those with additional needs and temporary support for energy-intensive small businesses that may otherwise go out of business.
Means-tested transfers, social tariffs or enhanced support through existing welfare mechanisms can provide meaningful relief where it is needed most and at a fraction of the cost of universal schemes.
Such an approach is not only more equitable, but also fiscally sustainable at a time when public finances are under pressure.
The same principle applies to businesses. Energy-intensive firms and small businesses operating on thin margins are particularly vulnerable to price shocks.
The priority should be temporary and targeted support, such as time-limited grants or government-backed loans, aimed at preserving viable firms through a period of elevated costs.
What should be avoided is any attempt to shield businesses permanently from higher energy prices. Doing so would weaken incentives to improve efficiency, adapt production processes or invest in less energy-intensive technologies.
A long-term solution
Along with short-term support, there is a clear need for longer-term reform. The UK remains heavily exposed to global gas prices, which continue to play a significant role in setting electricity costs.
Reducing this exposure should be a policy priority. That means accelerating investment in renewables and nuclear power, improving energy efficiency across the housing stock and reforming electricity market pricing so that cheaper sources of generation are better reflected in consumer bills.
For now, energy prices are not yet at the level where a bailout is needed. The government has some time with the energy price cap not scheduled to rise until July. But if a bailout is required, it should be guided by three principles:
- Target support to those who need it most.
- Preserve the role of prices in driving behavior.
- Reduce long-term dependence on volatile fossil fuel markets.
Striking this balance is not easy, but it’s essential.
The alternative—blanket subsidies that mask the true cost of energy—may offer short-term, politically popular relief, but at the expense of long-term resilience. In an era of repeated energy shocks, the UK cannot afford to get this wrong.
