Higher interest rates could add £29bn to household energy bills, according to analysis by Resolution Foundation.
Because of this, the foundation called for a four-fold increase to investment in Britain’s power sector over the next decade, to move towards decarbonising the economy.
The ‘Electric Dreams’ report considered how to fund the major power sector upgrade needed to cope with rising demand for electricity in a decarbonising economy.
By 2040, Britain’s homes will consume 45% more electricity than in 2025, while road transport electricity demand will increase 13-fold, as heat pumps and Electric Vehicles (EVs) become commonplace.
The costs, ultimately paid via household energy bills, of providing more renewable energy have fallen sharply over the past decade.
For example, the cost of offshore wind contracts has fallen from £164 per megawatt hour in 2014, to just £51 in the 2022 renewable energy auction.
This, coupled with forecasts made when interest rates were at historic lows, have led many to say this investment surge can be delivered alongside consumer savings.
Resolution Foundation noted that in a low interest rate world, energy spending on homes and cars could fall by between 1% and 2% of household income by 2050, compared to pre-pandemic levels, offering real terms savings of between £250 and £1,000 a year.
However, historically low interest rates can no longer be banked on, and that the cost of financing energy investment if today’s higher rates environment continues would be considerably more expensive, adding £29bn a year to household energy bills in 2050.
For example, borrowing costs of 9% rather than 5% would increase the cost of the same offshore wind project by 31%, while households would see their future energy spending increase by an average of £400 in 2050, rather than decrease.
The poorest fifth could see their total energy spending rise by £700 per year – or 3.6% as a share of income.
Richer households would be less affected as the higher cost of domestic energy bills would be offset by savings from EV ownership, and their energy spending would rise by just 0.3%.
The foundation said Government should plan for how it would deal with this higher interest rate environment.
The report set out three key areas to focus on: pushing down on prices, price protection for low-to-middle income households, and balancing the financing of investment between household bills and the state.
The report said there should be a renewed focus on keeping prices low when delivering new investment.
In the short-term, this would mean not overpaying for contracts today, but also making up lost ground on building the cheapest technologies – such as onshore wind – and preventing local politics around pylons and substations leading to higher cost alternatives.
Second, the Government could mitigate against the risk of vulnerable households facing higher bills by introducing a social tariff for lower income families, protecting poorer households who are high energy users in particular.
Third, although publicly funding the entire power sector investment is not feasible, key aspects – such as modernising the grid – could be if the pressure of funding it all through energy bills becomes too great.
The costs of tax, rather than energy bill, financed investment would be more evenly spread across the income distribution, rather than falling more heavily on poorer households.
Jonathan Marshall, senior economist at the Resolution Foundation, said: “Britain needs to massively increase its electricity supply, and ensure it can be efficiently moved around the country, as we move towards a decarbonised economy of renewable energy, heat pumps and EVs.
“This will require tens of billions of pounds worth of investment each year – more over the next 15 years than insulating homes or buying electric cars.
“Cleaner energy could be cheaper energy, if interest rates return to the low levels seen during the 2010s.
“But we can’t count on that being the case. If interest rates stay high, energy costs will rise rather than fall in the years ahead.
“So now is the time for planning on how we deliver the energy investment surge while protecting lower income households, with a greater focus on price reduction in contracts, price protection for vulnerable households, and rethinking the role of the state as an investor.”
