Rising costs or corporate greed? Exploring retail and wholesale energy price data
Politicians have been queuing up in recent weeks to interrogate the UK’s big six energy companies after a spate of bill hikes. Last week, energy bosses faced a group of MPs to justify their companies’ profits, while the government announced the 18th energy market investigation since 2001. And today, the Labour leader renewed his assault on the sector, saying the recent price hikes were down to a “broken market” and corporate greed.
Companies regularly justify swelling household bills by claiming they have to account for rising wholesale energy costs. But a number of politicians and newspapers have disagreed. They point to data suggesting wholesale costs have increased by 1.6 per cent on average this year, while bills have increased by nearly 10 per cent, and have accused the companies of making excess profits.
Digging into the data suggests the relationship between costs and profits isn’t as simple that criticism implies, however.
Wholesale versus retail prices
Working out how much profit energy companies are making requires untangling how much it costs them to supply energy.
Energy companies say the money from household bills has to cover a lot of costs, with a bit of profit for the big six’s shareholders on top. In particular, the big six say they spend a lot of money buying gas and electricity to supply the UK’s 26 million households.
That outlay is known as the wholesale cost of energy. The energy companies argue that if the wholesale price goes up, a household’s bill – also called the retail price – needs to increase, too.
There is a range of other costs involved in getting energy from power plant to plug or stove top, as well. Wholesale costs get a lot of attention, however, because they account for such a large chunk of a household’s bill – around 46 per cent according to market regulator, Ofgem.
In response to critics, energy companies say Ofgem’s current wholesale data doesn’t reflect what they pay for energy. So what’s really going on?
Wholesale price data
If companies can get fuel more cheaply than their competitors it gives them a big competitive advantage, so they tend to resist sharing exactly how they go about buying wholesale energy. That makes getting hold of precise wholesale price data tricky.
A good source of energy cost data is Ofgem’s Supply Market Indicators (SMI), which it updates every week. Through the SMI, Ofgem tracks how much it costs energy companies to deliver energy – including wholesale costs.
Image - OFGEM SMI graph (note)
Source: Ofgem’s Supply Market Indicators
The blue chunk on the graph above shows how much Ofgem estimates companies pay for wholesale energy at particular times. As you can see, the blue line rises slightly over the last 12 months – showing the wholesale cost rising by 1.6 per cent over the course of the year.
While this does give some indication of how wholesale costs are changing, there are some problems with using this as an indicator of rising wholesale costs.
For instance, there isn’t really one wholesale price, or one wholesale market.
Energy companies buy wholesale gas and electricity to supply their customers in advance – anywhere from a couple of years or a few months ahead, to the day before its needed. Companies aim to get a secure supply as cheaply as possible by buying different amounts from various markets – a strategy known as hedging.
Ofgem’s data is based on an artificial hedging strategy – based on what the companies have told it they do. It isn’t a real price, but a modelled one – meaning the big six are likely to all have different wholesale costs from Ofgem’s estimate depending on how they hedge.
And Ofgem’s wholesale cost estimate isn’t for the energy coming into people’s homes now, but for energy that will be supplied in 12 months time. In other words, Ofgem’s ‘October 2013’ wholesale cost of £610 doesn’t mean that’s how much British Gas, SSE, or any of the other big six paid to supply a household’s energy this month – it’s how much they could expect to pay for energy to supply people’s homes in October 2014 if they buy it today.
Ofgem’s estimates may bear little or no relation to how much suppliers actually paid for the energy being supplied to households today (as Ofgem points out).
The regulator says market data for the past year – in contrast to its modelled figures – shows the wholesale price of gas for use this winter is 8 per cent higher than the price of gas for use last winter, while the price of electricity for use this winter is 13 per cent higher than last year. That’s much closer to the retail price hikes over the last couple of years.
So Ofgem’s SMI figures aren’t a particularly good source for understanding what’s driving the recent household bill increase.
Retail price data
Working out how much a household’s energy bill will increase when prices change is equally complex.
The big six energy companies have raised retail prices for an average dual fuel bill by between six and 11 per cent over the last two years, as this table shows:
Image - Price hike table (note)
Source: Table by Carbon Brief from energy company press release data
The headline-hitting price hikes are expressed in terms of an ‘average’ household bill (which uses 13,500 kilowatt hours of gas and 3,200 kilowatt hours of electricity a year). But the price increase ultimately affects households differently depending on what tariff they’re on, how they pay for their energy, and how much energy they use.
So not every household will feel the same effect of a retail price hike – regardless of how the wholesale price changes.
The generation game
And analysing how much energy companies make while supplying households is only one part of a bigger project.
All of the big six generate power as well as supplying it – known as vertical integration. This allows them to sell each other energy on the wholesale market, as well as selling some of it to themselves.
This potentially means that while a wholesale cost increase might dent their supply profit margins, it could boost generation profits. Unmuddling the two parts of the businesses is notoriously difficult, leading Miliband to today call for the supply and generation parts of the energy companies to be more obviously separated from each other.
Were that to happen, it could lead to better (and hopefully easier) energy company scrutiny.