Are energy firms profiteering?

The ‘big six’ energy firms faced a summit with the government this week to account for their high prices. Are they justified? Simon Wilson reports.

Are the energy firms ripping us off?

The energy regulator certainly thinks so. Last week, Ofgem in effect accused the big six' energy suppliers (EDF, E.ON, Scottish and Southern Energy, RWE npower, Scottish Power and British Gas) of rampant profiteering and collusion. It published figures showing that the profit per dual-fuel customer has leapt more than eightfold from £15 to £125 a year within just a few months. "When consumers face energy bills at around £1,345 [a year], they must have complete confidence that this price is set by companies operating in a fully competitive market," said Ofgem chief executive Alistair Buchanan. "At the moment this is not the case."

What do the energy companies say?

They claim Ofgem is using dodgy data to mislead customers. According to British Gas MD Phil Bentley, Ofgem's "methodology is flawed, excluding, as it does, the discounts we give our customers and the benefits they receive from fixed price contracts as well as understating our commodity costs". Bentley says that Ofgem deliberately overstated industry profits in 2010 by 100% compared with the regulator's own analysis of audited company accounts. British Gas's own current estimate of its profit margin per dual-fuel household is just £24. Meanwhile, the boss of RWE npower, Volker Beckers, says his firm makes just £1.50 on each £100 spent, and made a loss per average customer between 2004 and 2009 "simply not figures associated with an industry that is profiteering or uncompetitive".

Are the industry's claims credible?

RWE also says it has invested more than £1bn in each of the last three years into new, more energy-efficient infrastructure, and has paid getting on for another £1bn back to shareholders in the form of dividends. So it doesn't exactly look like a loss-making business. Overall, the combined profits of the big six over the last five years total an estimated £30bn (according to Energy and Environmental Management magazine), of which £8bn was given to investors as dividends. Nevertheless, RWE and the rest of the big six look pretty confident of their position when it comes to standing up to the regulator and government. Last month, EDF, E.ON and RWE called the government's bluff, saying they would prefer Ofgem simply to refer them to the Competition Commission rather than dish out constant warnings. This week's "summit" between big six bosses and Chris Huhne also attended by the prime minister looked rather more like a government PR stunt than a serious attempt to hold the energy companies to account.

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What happened?

The big six (which account for 80% of energy generated in Britain and more than 95% of the energy supplied to customers) agreed to make minor concessions, such as giving customers more information about competitors. Oddly, just a few weeks after giving a combative party conference speech in which he laid into the energy companies, the energy secretary Chris Huhne struck a notably conciliatory tone and defended the need for businesses to make profits (they are "not the Salvation Army", he noted). The bottom line is that the government (and Ofgem) face a delicate balancing act. They need to ensure a fair deal for consumers, but they can't afford to beat up the industry so much that the energy companies and their shareholders fail to come up with the tens of billions (£100bn over the next ten years, according to energy sector academic Robert Gross) needed mostly for new power stations to bring Britain's energy industry up to date and avoid a supply crunch.

But why are prices so high?

First, energy companies have been pushing through massive price rises in anticipation of a 40% jump in forward wholesale prices. They are also shoring up their balance sheets ahead of much-needed infrastructural investment, which (they argue) they have already begun. While they are guilty of upping prices when the wholesale price of oil and gas rises, but failing to bring them down by as much (or at all) when they fall, that doesn't necessarily mean they are "profiteering". Part of the problem is that the energy market is marked by a high degree of vertical integration (the big companies generate electricity, sell it on their trading arms and then sell it on again to their customer-facing divisions), making it easy for firms to mask their true earnings.

Are there any other reasons?

Britain is reliant on a global gas market that doesn't work very well. These days we get about a third of our electricity from burning gas. But North Sea gas is running out, and prices are high in Europe because they are linked to oil prices. Until shale gas proves itself a game-changer in Britain, as it has in America, we can all expect to continue paying more to keep warm. And that's no matter how often the government urges us to save a few quid by switching providers.

Is wind power to blame for high prices?

The cost of investing in expensive wind power to bring carbon emissions down is a factor in high energy prices. But it's a marginal one, says Robert Gross, amounting to about £50 per household per year. Figures cited by Energy and Environmental Management magazine suggest about two-thirds (63%) of the retail price is due to the wholesale price of fuel. Environmental costs account for about 10% of electricity prices and 4% of gas prices. Of those costs only about a fifth is due to new carbon-target-related initiatives.

Simon Wilson’s first career was in book publishing, as an economics editor at Routledge, and as a publisher of non-fiction at Random House, specialising in popular business and management books. While there, he published, a bestselling classic of the early days of e-commerce, and The Money or Your Life: Reuniting Work and Joy, an inspirational book that helped inspire its publisher towards a post-corporate, portfolio life.   

Since 2001, he has been a writer for MoneyWeek, a financial copywriter, and a long-time contributing editor at The Week. Simon also works as an actor and corporate trainer; current and past clients include investment banks, the Bank of England, the UK government, several Magic Circle law firms and all of the Big Four accountancy firms. He has a degree in languages (German and Spanish) and social and political sciences from the University of Cambridge.