Energy prices are still below the level that prompted widespread government support in 2022 and 2023. However, there’s little sign of the Iran crisis ending and prices could easily rise further. While the desire to shield consumers is obvious, the challenge for policymakers 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 past costly mistakes.

Chancellor Rachel Reeves’s plan to help only “those who need it the most” is therefore 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 fuelling inflation and lead to a self-defeating cycle of rising interest rates. If an energy price bailout is required, then it should be targeted and temporary − although the scheduled increase in fuel duty in September does look unlikely to go ahead.

Why broad energy subsidies aren’t a solution

Calls to protect everyone from higher energy prices are well intentioned and politically popular. However, they reflect a fundamental misunderstanding of the price signal and how markets operate. Energy prices have risen because supply has been squeezed. Higher prices here 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 − as we may soon be facing if the Strait of Hormuz remains 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 £75bn supporting households and businesses. The current tighter fiscal position and surge in gilt yields, which are now at 4.9% vs 1−2% 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 5p increase in fuel duty scheduled for September. However, the combination of higher inflation, weaker employment and surging gilt yields means the Chancellor has probably already lost between a third and a half of her headroom. Markets would therefore 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 make second-round effects more likely too as firms would be better able to pass 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 modelling suggests a bailout of 0.5% of GDP could prompt an additional 25bps rate hike.

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 IFS, with larger impacts on poorer households as they spend more of their income on necessities like energy.

However, the key lesson from the 2022–23 crisis is that it’s how support is delivered that 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. Here, 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 to the energy crisis

Alongside short-term support, there is also a clear need for longer-term reform. The UK remains heavily exposed to global gas prices, which continue to play a key role in setting electricity costs. Reducing this exposure should be a central 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:

1. Target support to those who need it most.
2. Preserve the role of prices in driving behaviour.
3. 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.

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