Energy Price Freeze

Energy Price Freeze

Energy Price Freeze Vs Energy Price Hold:

You say “Freeze”, I say “Hold”, you say “No Increase”, I say “Subject to Wholesale Markets maintaining their current horizontal trajectory, in which case all bets are off anyway”.

Not quite “Potayto, Potahto; Tomayto, Tomahto” but you get the drift.

If we contemplate what would actually be necessary for energy prices to be held at their current price point or lower, then we need to look at all elements of our household energy bills and not just Wholesale Prices, Profits and ECO/Warm Homes Discount. The sector by sector account below highlights the cost of electricity with reference to elements under a supplier’s control; the elements under discussion in the latest government proposals to “Hold” prices until 2015; and those elements that both sides of the house seem keen to pretend both don’t exist and don’t change.

Figure 1: British Gas Illustration from PR Release 2013

It is here that I feel there has been severely inadequate focus from the regulator, the media and indeed the companies themselves. All the focus has been on the absolute number of profit (£49 in the illustration above) but as any simple analysis of a P&L spreadsheet will tell you the means by which that profit number is arrived at are a function of both turnover and costs. Lumped into operating costs (£104 in this case) are:

  1. The salaries and pensions of the thousands of people employed in the industry by the Big Six. Can these costs be rationalised by offshoring jobs, becoming more efficient, consolidating offices? The recent announcement by npower of a massive consolidation exercise culminating in the closure of whole sites, the redundancy of 1,460 staff and the outsourcing of a further 540 would seem to suggest that they can. That evidence can also be seen in the competitiveness of the smaller suppliers who are not carrying dead wood and significant pensions’ burdens. I bet that nearly 1,500 people losing their jobs wasn’t part of the political master plan of either party when they set about beating the Big 6 with a very large stick though!
  2. The property costs of offices, locations (and posh boardrooms), many of which are relics from mergers and acquisitions over the last 15 years, which in most other industries would have been a core part of the efficiency gains to be had from such mergers. Whilst Npower (see above) are addressing this it will be interesting to see whether the other suppliers follow suit.
  3. The costs of hedging or managing the market risk. The thing with hedging is that suppliers seem to want to chuck this bit into the generic “Wholesale market prices” pot; pretending that they have no say over how well or badly they manage these costs. Well this is blatantly untrue. If an efficient market allows for good and bad trading to result in higher or lower wholesale market costs for a supplier then this should materially affect the overall price the consumer has to pay in a “competitive” market. However because consumers don’t punish bad trading by switching; this inefficient market finds its price being set by the poorest performer. If your trading division does a brilliant job; why would you drop your prices massively when you know it won’t attract any new customers anyway? Rather set your prices marginally below those of the poorest performers and capture all that trading benefit as profit rather than price reductions for consumers. One of the many dichotomies in the energy markets is how consumers claim to be extremely price sensitive and yet when push comes to shove they turn out to be extremely price inelastic.
  4. Systems costs and general costs for doing business. These incorporate the fairly heavy IT costs needed to construct, manage and deliver billing services to 5 million plus people as well as other associated costs for doing business in this industry such as credit insurance and regulatory compliance. Compliance in the energy industry is extremely onerous, credit in the energy industry is costly because of the difficulties in stopping a non-paying customer from taking your products; and the IT systems have been going through years of integration and pain as a result of the merging or scrapping of legacy systems from the disparate bits of business that coalesced around the Big 6 brands. There is probably a level of inefficiency and temporary-to-permanent “fixes” that have built up over the years which would horrify any close examination. It is fair to say that “No-one would wish to start from here” were they to look at how to build an efficient energy industry and its component parts!

If some headway could be made in eliminating the bloated costs of operation attendant to these businesses then we could concentrate on the absolute profit number. As it is, the number we see bears little or no relation to the number we should see in an efficient market. Surely a supplier which made the same or more profit (£49) at a greater margin (8% instead of 5% for arguments sake); yet managed to reduce their impact on the costs from £153 to £110 would be welcomed? Sadly not I fear. The media and the naysayers with an agenda would simply focus on the 8% and accuse the businesses of profiteering and redouble their efforts to push profits flat or negative. Which rather begs the question; why become efficient then? Who knows; maybe the shouting minority will get their way and then we will get to compare how efficient a nationalised industry with no competition truly is. There is an answer to be had here if we are prepared to dig it out; but I am fairly certain nationalisation isn’t it.

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At the time of writing SSE, British Gas, Npower, Scottish Power had all raised their prices by between 8% – 11%. (…)

Rise of Energy Bills:

Infographic Energy Prices Rise

*This figure is an annual saving, based on a dual fuel energy switch on the 19/07/2013, from a British Standard tariff (payment: cash / cheque) and a EDF Standard tariff (payment: cash / cheque) to a dual fuel online variable tariff (payment: Direct Debit). We used a London postcode and the average UK consumptions: 16,500 kWh/year for gas and 3,300 kWh/year for electricity.