The energy price debate

Politicians and consumer groups are up in arms about the latest gas price rises. But is Britain’s energy overly expensive? Matthew Partridge investigates.

Why is energy back in the headlines?

The pledge was highlighted again last week when power firm SSE raised prices by 8.2%, following on from large price rises last year. But it's unlikely to be the last company to do so.

So, it's the energy companies' fault?

According to SSE, one tax alone, the carbon price floor, which charges power plants and other industrial firms a minimum rate of £16 per tonne of carbon dioxide emitted, will cost consumers £709m a year by 2015.

Another factor is that wholesale energy prices what energy companies pay to power plants have also risen sharply.

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The wholesale market is heavily influenced by trends in the global energy market, which are beyond the control of individual utility groups. Energy minister Ed Davey also points out that money has gone into upgrading the power network.

What are these other green' taxes?

Power companies also have to pay money (feed-in tariffs) to people who generate power from renewables in their homes.

While the government theoretically sets a total cap on the cost of these regulations (called the Levy Control Framework LCF), the Financial Times believes they are set to rise significantly, reaching £7.6bn a year by 2020.

The only policy the government is thinking about scrapping or reducing is the Energy Company Obligation, which is outside the LCF.

But this obligation, which forces energy firms to support low and middle-income households who want to improve energy efficiency by insulating their home, costs only £1.3bn a year and is seen as helping to lower bills in the long run.

Is our energy really that expensive?

However, the Department for Energy and Climate Change (from which their figures are taken) notes that when you exclude direct taxes on energy, domestic gas prices are "14.3% above the EU15 and G7 median", while electricity is slightly above average.

Also, data from Eurostat suggests that if you compare us with the entire European Union, we're somewhere in the middle of the range.

What about supply concerns?

Regulator Ofgem has repeatedly warned that unless we sharply increase the amount of energy we produce in the next few years, the risk of blackouts could rise rapidly in the near future.

National Grid, which runs the overall power network, warned recently that, due to a dramatic decline in the number of coal-fired power plants, the gap between available capacity and demand was "wafer-thin" and expected to fall to a six-year low during this upcoming winter.

That could result in it being forced to request that mothballed plants be restarted in order to prevent blackouts, though this would only be a stop-gap measure.

Could price caps work?

While it might be possible to keep plants running in the short run, it would lead to these companies either leaving the industry, or cutting back on investment.

Even supporters of Miliband's scheme concede this could become a problem, with the Institute for Public Policy Research think-tank admitting that the "freeze could affect the ability of energy companies to raise cheap capital and invest in new energy supplies".

Indeed, immediately after the proposal was floated in September, the shares of the energy companies plunged by around 5%, wiping billions off their value.

How the average bill breaks down

According to the latest statistics, the average customer pays £755 for gas and £600 for electricity, for a combined cost of £1,355. Of this, the energy company has to pay a wholesale price of £585, VAT and other taxes of £540, and operating costs of £130.

The net margin, the difference after the costs of buying electricity, paying taxes and operating costs are taking into account, is only about £100 (roughly 7.7%).

Interestingly, margins have gone down from two years ago, when they were just under 10% (£125 out of £1,280). This suggests that companies, far from just passing costs on to consumers, are already trying to absorb price rises by cutting their level of profits.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri