Are energy companies making excess profits?
Labour leader Ed Miliband claimed last week that energy companies have been “overcharging” their customers for years. He’s not the first to say it, and the industry furiously deny the accusation. But the complexity of the market makes the truth hard to disentangle.
So who’s right – and why is the question such a tough nut to crack?
Rising bills, contested claims
Brits pay some of the lowest gas and electricity prices in Europe. But that seems largely irrelevant to how people feel about their energy bills. As household budgets become more strained, bills have risen by at least ten per cent in the last three years, and polling consistently shows consumers are worried.
Image - Screen Shot 2013-10-04 At 15.03.53 (note)
European gas and electricity price rankings – source: Ofgem
Meanwhile, the ‘big six’ energy companies who make up most of the market recently made a series of announcements of profit increases of up to 40 per cent. So you can understand why polling shows about half the population blame power company profits for their rising bills.
Unsurprisingly the energy companies disagree, blaming rising wholesale energy prices and increasing green subsidies for price hikes.
The challenge is that the details of the energy market are pretty complicated, making it difficult for anyone to work out how energy company profits interact with rising bills – see recent evidence given to Parliament on the subject.
To try and unpack this issue, here are some general principles we’ve been able to work out.
1. Different bits of the energy industry make different amounts of profit
Angela Knight, chief executive of industry group Energy UK, says profits for energy companies average at about five percent.
This figure refers to the amount of money companies make by selling energy to consumers, after interest and tax have been deducted. But energy companies also make money by generating, selling and trading energy – sometimes even selling energy to themselves. For example, British Gas is owned by Centrica, and buys gas and electricity off its parent wholesale.
Some of these other parts of the businesses make significantly more profit. In a recent report into the issue, the Energy and Climate Change (ECC) Committee concluded that although energy companies made just over three per cent profit in supplying energy to consumers in 2011, they made 24.4 per cent profit through energy generation:
Image - Screen Shot 2013-10-04 At 15.06.24 (note)
Ofgem data, cited by the ECC Committee, July 2013
Overall, that means a 7.6 percent profit in 2011, before interest and tax are deducted.
Energy UK disputes the figure of 7.6 percent, because it doesn’t take interest and taxes into account.
It says energy company profits are less than for most supermarkets. Tesco’s operating profit margin – a pre-tax measure – averaged 5.6 percent over the last five years. It’s post-tax profits in August 2013 were about 3.5 percent. Someone who knows more about profit reporting will be able to tell us whether these figures can be compared with power company profits.
2. You need to make money to invest money
Energy companies defend their profits by arguing that they have to supply investment in new power lines and forms of energy generation.
The government says £110 billion of private sector investment is needed to to construct new power plants and upgrade the UK’s electricity networks over the next eight years – £75 billion for constructing new generation capacity and £35 billion for upgrading the network grid.
Although the UK’s ageing infrastructure needs to be upgraded whatever happens, a significant part of the £110 billion cost is created by the need to shift to renewable sources of energy – and the industry says it needs high profits in order to deliver on that.
Labour has countered by arguing that while energy company profits have been going up the last few years, renewable energy investment has been falling – and only about half of renewable energy investment is coming from the ‘big six’ anyway.
Figures from Bloomberg New Energy Finance (BNEF) appear to show total investment in renewable energy falling slightly over the last few years. This is, in part, because there was a particularly large amount of investment in 2009, the year the London Array offshore wind farm was agreed:
Image - Chart 1 (1) (1) (note)
Renewable energy investment in the UK, 2004 – 2013. ‘Asset finance’ refers to renewable energy projects of more than one megawatt (1MW). Small-scale refers to projects of less than 1MW – nearly all solar power. Source: figures provided by BNEF.
Renewable energy investment has fallen in 2013, reportedly in response to policy uncertainty created by the passage of the energy bill – but it doesn’t seem fair to blame the energy companies for that.
Labour is right that a lot of significant portion of recent investment has been in small-scale renewables, rather than big projects. Over the last few years government subsidies supported an expansion of domestic solar power – which didn’t come from the big six energy companies.
So there seems to be some justification for the argument that the companies making the big profits don’t account for the majority of investment in renewable power – although this doesn’t tell us anything about the wider point of who is investing in fossil fuels, nuclear or other infrastructure.
3. The market isn’t transparent
Working out how much money energy companies are making is a complicated business. Five of the ‘big six’ are active overseas – EDF for example is 85 percent owned by the French government. When they make profit announcements, the companies take into account profits they have made outside the UK.
Secondly, companies buy energy ahead of time – using so-called ‘ hedging strategies‘ to manage the rapidly fluctuating prices of electricity and gas. Suppliers buy energy in separate, private deals, so it’s difficult to know how much they are paying for it. And without that, it’s difficult to work out the maths behind profit calculations.
Richard Hall from consumer rights group Consumer Futures tells Carbon Brief:
“Whilst we can see the price of a particular product [wholesale electricity or gas], we don’t know what hedging strategies the companies are using. We can have a stab but we don’t actually know. So every year there’s a sort of Punch and Judy show between us, Ofgem and the power suppliers, trying to work out what’s going on”.
We need to know more
There is one common theme running through commentary on this issue. Everyone – from energy regulator Ofgem to the Energy and Climate Change Committee – seems to agree more transparency is needed in the market.
Until that’s achieved, it is extremely difficult to work out whether or not energy companies are making excess profits. Figures used in the public debate – for example percentage figures for the amount of profit energy companies make, or the profit announcements energy companies make – are difficult to interrogate, for many of the reasons outlined above.
At a time of rising living costs and increasing energy bills, it’s little wonder that Ed Miliband’s proposal to impose a temporary freeze on energy bills while the government “reset[s] the market” has ‘ hit a nerve‘ with voters. Energy companies dispute the widespread belief that excess profits are to blame – but unless the industry comes up with a better way of proving otherwise, they’re probably going to have problems countering it.