Defeating Inflation with 9 solutions without raising interest rates

Inflation, for many this year has been a devasting ordeal. You can ask if it was predictable and for many it was. The solution however, has been far less predictable, with the most common solution to 'break the back of inflation by hiking interest rates'. What we will explore in this article is how else we can tackle inflation meaningfully.

Where did it come from?

When you ask the question, how did we get to todays inflation two answers present themselves, the first is Covid-19 and the second is the war in Ukraine. Whilst this is true, the fundamental cause is far more simpler, it is demand and supply. Unfortunately, this simple explanation results in complicated solutions.

You see, what actually caused inflation was a growing use of products that are in short supply. As countries populations grow and as the capital of a country grows, its desire for luxury goods increases. Be that excess food, or warm homes, or bright lights. Small simple things that make the world of difference in life. We were told the world has risen out of poverty, even if the long term trend is a population of older people. Taken together, this means more people using energy, more people eating and more demand for all manner of products.

The other problem is less availability. We have been told in the last 50 years 90% of life on earth has gone extinct because of humanity. That countries like the UK have less than 30% of the forests it had 400 years ago and oddly in the past 100 years city populations have in many places stayed even and in others grown massively. The result has been a concentration of products with a lack of space for them and to deliver them.

So the cause of inflation, is not enough to go around. During C-19 the collapse of the 'just in time model' of stores (i.e. products arrive at the store just in time to be sold) meant short term demand for products rose. As salaries grew due to an available worker shortage, this led to greater orders. The company's, wishing to grow product sales at high prices, with less products, decided to use shrinkage (reduce packaging and product but charge more). This action has not been boycotted and instead scapegoated by high tax and inflation. Still, had they not shrunk the packages and products, the supplies may well have dwindled further. So there is some value in this greedy behaviour.

It is unlikely this behaviour will be reversed without serious competition to encourage it.

Some other crisis's of time further increased the problems, from: unnatural weather, to illness outbreaks and trade wars. After many tumultuous years, this led to the biggest shock of the 'just in time model', which was the Ukraine war. This instantly, with only a few months warning, took significant portions of staple products from the market leading to knock on effects in other markets. High energy, higher costs to make and ship, higher tax so less products faced with steep demand.

It is important to note the inflation arose from a high demand with a lowered supply. The solution of interest rates does not necessarily solve this problem, except psychologically. For example, if high energy is creating inflation how does increasing the cost to borrow money lead to lower prices? It does not, but what it does do is creates another cost at home for houses or businesses on a mortgages or loans to deal with, which may lead to them cutting excess spending on heating (which uses 50% of home energy) and to cut down on driving (lowering oil and diesel use) or excess personnel (a few percentage points) in turn leading to lower demand for this energy. The lowering demand makes it cheaper for farmers and fertilizers who can then buy the energy cheap, fertilizers cheap and increase domestic produce leading to lower food costs. Similarly, lower food costs increasing domestic supply lead to lower foreign demands which leads to lower shipping costs etc.

Yet, buried in this approach are some dilemma's, what do you do about people who make money from high interest rates? They will not have to cut demand as they now have more money. What about those who do not have mortgages or loans, they will not necessarily cut energy or food consumption?

So you might say these actions will inflict the most pain on young millenials or home owners. It will not have too much of an impact on those in social housing who will be waiting for demand to reduce as they have no money to save anyway. Nor will it make much of a difference to those well off as they could shrug off the high costs.

Paying for the solution

Before I go into the details of the solution, let us look at how the current costs for people are determined. The largest causes of inflation have taken root in food and energy products, with these knock on costs affecting business operations in other fields. (i.e. higher energy bill might mean higher costs in hospitals so less staff).

Due to that, we can surmise a higher cost means more money made from taxing it. It is from these costs we find the solution to funding the energy crisis.

The average energy bill breaks down like this: 1) wholesale cost, 2) network costs and 3) government obligations, 4)operating costs, 5) VAT, 6)other direct costs and 7)pre-tax margin aka profits.

When we see the UK Gas price at 10pw therm etc. this is the wholesale price. The war in Ukraine impacts directly on the supply of energy so affects this price. So does the weather, supply, refineries and a host of other elements. (30%)

Network accounts for transmission (7-10%), i.e. the cost to repair, build and maintain systems. It also includes distribution (12-15%) i.e. costs to operate the system, peak or offpeak hours. The cost to balance the system (3%) to ensure consistent flow. Transmission losses (1-3%). Assistant distribution costs (>1%) the cost to send energy to hard to reach places. Total - 25-33% bill

Government Obligations (hidden taxes), renewable obligation (15-20%) i.e. companys were meant to invest in renewable and use these contributions to fund it, the obligation was discontinued but they are still charging the amount. The Feed-in-Tarriff designed to encourage small scale renewable generators (6%). Contracts for difference, designed to replace the renewable contribution they add (8%) to the bill. Capacity mechanism (2%) designed to encourage renewable energy supply. Climate Change Levy (7-8%) to encourage businesses to reduce energy usage. - Total 45% of the bill are these stealth taxes

Other direct costs include meter instillation, maintenance, administering data, smart meters.

The operating costs and profits before tax are self explanatory, these are the costs to run the business and the companys own charge for the product.

VAT which is set at 5%.

Now according to Ovo Energy, this breakdown is a little different. The above percentage breakdown was based on an Ofgem report from 2020 using 2016 figures. According to an Ovo Energy report using 2019 figures it breaks down as:

1. Wholesale cost 33%,
2. Network cost 22%,
3. Obligations 22%,
4. Operating costs 17%,
5. Direct costs 1.5%,
6. VAT 5% and;
7. Supplier profits 3%.

I cannot find available average figures, even from Ofgem, explaining the breakdown of these costs for 2020, 2021 and 2022 so it is impossible to know which elements have risen and what that money has been spent on. If energy companies have made record profits in the tens of billions of a couple of percentage points, then they must have hundreds of billions to spend on energy infrastructure and obligations - it just does not add up.

The problem with the breakdown

Assuming Wholesale Prices increased from the war, only them and the VAT should have increased in price. So that means the cost of energy assuming Wholesale prices doubled or quadrupled then the costs should not have risen as they have.

Lets say the normal price for an energy bill is 10p, then energy is 3p and VAT is 0.5p, if energy went to 12p and VAT 4p then the other costs could stay the same. Meaning energy costs should be more like 22.5p they should not be around 33p. Energy company's have increased prices by 50% for no other reason then to fund expansion and increase profits. It seems quite unrealistic they locked in August prices at the height and have not locked in current December prices for 2023 (which are only double 2019 rates and the same as November 2021).

How the UK can reduce Inflation of energy

There are some different possibilities. These can be linked to the above costs or be outside of them. Starting with the above costs some solutions present themselves:

1. Create a public sector energy supplier. Something I want keep abundantly clear, is whilst VAT is paid to the government they do not receive the 22% of obligations money (if they do, this has not been told to citizens) which the company is expected to reinvest. If, instead, these proceeds were taken from the energy company, then the government could fund wholesale projects to install renewable energy capacity directly into homes, governments sites and more. A move which would also reduce overall costs and network costs.

As long as obligation costs are spent on company expansion, network costs will remain high as no company has any interest in the most convenient energy sources, which will be on the homes of people.

2. If the Government is determined to keep private companies they could take the obligation costs for themselves. Then redirect the money in grants to worthwhile projects, this would enable investment in localised infrastructure projects. As it stands, there is a lack of transparency on what precisely this near 25% of the energy bill is spent on.

To take a jab at the 'token' 'energy tax', given the tax on profits is 35% after expenses, on profits of 3% of the bill, it is ridiculous. 3% of 35% after expenses will never be recovered, energy company's can easily reduce obligations to zero. What the government should do is go after the obligation cost before expenses, otherwise it's pointless. 10-20-35%-80% of 3% post expenses is meaningless. A company can just use the losses from 2020 and 2021 or buy a company with high losses and offset those against its 'profits' so that they have zero tax to pay.

To repeat, the 'windfall tax' is political not practical. It can be 5% and VAT charged at 10% that will likely make more as it is before expenses.

3. Have Ofgem order energy suppliers to provide transparent bills which breakdown the energy bill costs. At the moment, customers are given the 'full' cost and it is just assumed the reason for that is the Ukraine war. This is opaque and enables questionable pricing activities.

If a company provided a real breakdown of the price charged to the consumer. i.e. wholesale price, network costs, so on (as broken down above) then we would have a better idea of whether they are taking advantage of consumers. Call it a failure of a system which has not looked into energy company's costings for too long.

If there was real auditing, real transparency and real accountability, then customers might pick company's which invest say more infrastructure then profits.

As an example, the national grid has been building a lot of underground energy lines recently - these may well be coming out of peoples high energy bills. So, until those pipes are finished costs may well be much higher. Consumers have a right to know what their money is being spent on given they are subsidizing it through higher costs and government tax allocations.

4. Another option is to drop the tax's and direct energy company's to stop charging for the obligation costs. This would immediately lead to costs dropping 33% for consumers, rob the country of its stealth tax profits but also mean it does not need to spend on hundreds of subsidies to energy bill payers. That is assuming energy company's do not increase profits or another area to keep prices inflated. With these stealth taxes removed the energy crisis would be averted in the short term.

5. Now lets assume nothing changes, there's no public sector energy supplier. No creation of targeted investment. No transparent bills leading to public boycotts or reduced taxing's. The next possible solution is to reduce restrictions on the creation or recommissioning of refineries - at the moment ship refineries are entering the UK sea which will help to convert LNG into gas for usage. No matter how much is drawn from the sea, or land, or shipped over, if it cannot be refined it cannot be used.

At the moment LNG ships are circling Spain unable to offload LNG (Liquid Natural Gas) because there is nowhere to store it or refine it. On the mainland that is changing as LNG refineries come on line.

6. Now, assuming all these solutions are not possible another presents itself. Taking the subsidies on over 25 million UK homes energy bills - this is expected to cost 89 billion to 140 billion. Likely, this is because most of this money will be spent on the larger inefficient homes. The average person is likely to see their own energy bill decline by a few hundred pounds, this accounts for about 10% of the costs but for the owners of much much bigger properties they will likely see the lion share of this price cap as they save thousands.

So the subsidy scheme you could say is a way to save the rich at the expense if slightly reducing the costs of the poor before increasing costs for everyone. It might be hoped during the subsidy period energy company's will invest wisely but given the lack of transparency on investments and the big energy dividends this year...well...

7. Lets say rather then throw money away in such a pointless endeavour because it is. A staged investment in renewable energy could be implemented. It takes an average of 90 days to install solar panels on roofs, whereas it takes 5 days to install heat pumps, efficient boilers cost approximately ￡1000 (rather then the heat pump subsidy of ￡5000). Wind turbines take 2 months to install and cost 8million for 6 million kilowatts per year/1500 homes energy, however, since efficiency is about 30% at its worse, lets say it is enough to power 500 homes.

Then if the entire 89 billion was spent on building and installing wind turbines at the lowest efficiency, they could build 11125 wind turbines or generate enough energy to power 5,562,500 homes completely (if these wind turbines had 10% more efficiency thats another 1 million homes) or 20% off home energy cost demands. Equally, if the same money was spent on solar panels which cost an average of ￡10,000 per home, then 8,900,000 homes would see the cost of their energy halve or more, as the average solar set up generates 4000 kw a year or the cost of the average small home. This in turn would lower demand on the entire system both for network costs and energy costs.

With 20-35% of demand taken out of the market, energy costs will go down drastically. As it is, the price cap only serves the purpose of enriching energy company's, making money disappear and does nothing to reduce long term costs.

8. Now, the government may take the view installing energy saving products for free into a person's home will lead to a loss of VAT permanently of 5%, this is true. In reality, the country will get back this money and more as the savings could be diverted to buying products or improving the home or to lower growing government expenses.

The government could install these products and set a flat fee of ￡500-800.00 per year to cover the cost of the panels. That way, the country might recover 8 billion a year which could be spent on further energy products and within a year or more the country will become an energy exporter assuming this is combined with the efforts of current energy suppliers.

As for wind turbines, these could have a collective tax on people in the area. I suspect those in the area will accept this cost as it will bring down energy costs for them.

How we can turn the Energy Crisis into the Energy Export Opportunity

9. What the energy crisis has done, is provide the country with more profits in the form of the VAT. At the same time it has led to increased costs for all parts of the government from the civil service to infrastructure as energy is linked to many costs.

Given the government is diverting money from elsewhere to fund its spending spree on 'saving people's' energy, this money is better spent on improving energy efficiency within the organs of government healthcare such as: hospitals, health clinics and others. This would have a triple benefit of reducing NHS costs, reducing civil service costs and if done to a large extent, even generate profits for these areas.

With these cost savings they can reduce costs on the system and ensure the lights will not go off in public services. The next focus can then be on solar energy in the South, wind energy in the North (where there is more space), river energy in the upstream Thames and boiler improvements in homes.

The cost of the most efficient boilers on the market are around ￡1200, a fraction of the cost to install heat pumps (about 20% of the heat pump subsidy/grant). These could be targeted for old homes boilers to lower costs there as this has the largest impact on market demand for heating in homes.

All in all, the best approach for this country is to focus on its treasures. Its health service, make the buildings more energy efficient, make them energy generating - many, such as the mental health hospitals have large grounds where these hospitals could power themselves completely with one or two wind turbines and solar panels.

Money spent on people, sadly, disappears for good. Money spent on funding energy companies encourages higher prices but money spent on investments retained by the government can have a real impact in the areas they are based.

Summary of Solutions

In summary, the country can be saved in many ways. Public institutions can be set up like the Norwegian Equinox energy company which can receive funding to build up renewable energy and infrastructure in the most deprived areas. This energy can be provided to social housing as they need the lower costs and it would also mean the government does not need to cover these energy costs for energy companies.

Alternatively, the government can take the obligation costs away from the companies and decide for themselves how it is allocated, thus, ensuring the best investments are selected.

Another possibility is to redivert the subsidies into either adding technology to homes and areas or investing in items that reduce the energy consumption of UK homes and buildings. Doing this reduces the demand within the UK which does impact the global price, it also impacts the prices of the individuals within the UK.

Finally, these activities can either be funded through current taxes, or made on conditional timed taxes on homes accepting the options to add the technology. The trouble with enabling this technology to be added through mortgages is that the ones who benefit will be the banks not the country as they can add a lot of interest to the house through the costs.

Many home owners are likely to accept the trade off to add panels and turbines in exchange for a reduced yearly energy bill. This would also create real jobs in the market, as all this technology will need to have maintenance and service in future.

In conclusion, the current treasury budget plan does not offer any lasting solutions to the UK, let alone for energy security. Currently, the UK pays 8 billion or more on interest payments to service its debts. With these kinds of changes to the UK system the UK would be able to start paying these debts in a year or mores time.

This article is not supported by any political party, I would be happy to provide paid consultation on similar solutions if asked. I just do not see these suggestions being advanced and so feel a need to write an article raising the possibility.