OFGEM gives green light to energy hikes

Energy hikes are inevitable, as the industry continues to pull the wool over all our eyes

Back when wholesale prices were higher, the energy regulator OFGEM argued that energy companies were making zero profit. Recently it estimated they're making about £60 profit per household. Somehow those figures, especially the first one, are hard to believe, especially considering the almost unbroken rise in energy company profits over the years.

How OFGEM comes to these estimates we don't know, but it's not through the openness of suppliers. Suppliers keep their wholesale-purchasing and retail-pricing policies strictly secret.

Yet it's hard to see how its estimates can be true when you look at the figures that we do have available (other than company profits, I mean).

Get ready for some maths

Retail-price rises for most of the past ten years have very closely matched wholesale-price rises. However, since wholesale-price increases have been by far the biggest increases to suppliers' costs, retail prices should have gone up by somewhat less. I'll try to explain why.

Let's say a supplier receives £1m in one year from all its customers. Let's say it pays £300,000 in rent, staff, lighting, heating and so on, and £500,000 for wholesale energy. Therefore it's had total costs of £800,000 and made a profit of £200,000, or 20%. (Those percentages might not be too far wrong; OFGEM analysis found that wholesale prices plus profits make up nearly 75% of our bills.)

The following year wholesale prices rise 20%, costing the suppliers £600,000. However, other costs rise just 3% to £309,000. The total costs are now £909,000 – up 14%. But, rather than raising prices 14% to maintain its 20% profits, it raises them 20% – the wholesale increase. Thus, the energy company boosts its profit margin to 24%.

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That's a very simplified example ignoring such things as taxes, more wholesale movements, other commercial activities, and some price controls, but it's the inevitable result of letting these companies increase the prices we pay directly in line with rapidly rising wholesale prices.

Cynically, energy suppliers don't do the same when wholesale prices fall, as I wrote about in Big energy price hikes to come. Wholesale gas prices fell by 70%, but energy companies were very slow to give us any of that back in reductions.

Now it has been reported that energy prices are up around 30% this year, although they've just been recovering lost ground. That's not stopping the energy companies from increasing margins further. You may have missed it, but EDF put its standard prices up this month. This is the first mass increase of prices since the beginning of 2009, according to my own database. It's just 1.2% more, but considering it did little to give anything back to customers after wholesale gas prices plunged, it's very one-sided.

Where's the regulator?

OFGEM has never criticised all this, as far as I've seen. OFGEM's active influence to put downward pressure on prices appears to be very minimal; it usually says the industry's not being anti-competitive or says nothing at all.

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Now, OFGEM is not saying nothing - in fact it's actually giving the green light to increasing prices.  OFGEM estimates that infrastructure costs will be £200bn in the next ten years, with £32bn of that coming under OFGEM's jurisdiction and the rest the government's. To put this into context, the industry is worth just £43bn.

This new bill equates to about £8,000 per household. Even the £32bn equates to more than £1,000 extra, yet OFGEM tells me the cost to consumers might work out around just £6 per year. It'll be interesting to see if the energy companies will really swallow its profits to cover the rest – or perhaps OFGEM is expecting the taxpayer to cover it.

If these costs are necessary for the country then customers should pay for them, but we can be sure that a large part of these investments will result in benefits for the businesses in terms of knowledge, better market position, and increasing profits worldwide. That part of the costs should not be added to our bills, but paid for from existing profits.

It's nice to be asked

OFGEM has just announced what it calls the greatest overhaul to energy regulation in 20 years, which rewards companies that push these infrastructural changes. In other words, the companies pushing these new, expensive projects the most will get the most help to being profitable.

Its plan (called RIIO – pronounced Rio – by the way) to change regulation to include incentivising much-needed investment seems laudable and appropriate, but it remains to be seen if doing so won't involve even greater profits for suppliers.

You have to be sceptical for example about its claims to give consumers “a bigger voice in what they want network companies to deliver”. A spokesperson told me that suppliers would have to include consumers in their business plans. This won't mean we'll be able to tell them how large a profit margin they should aim for, or whether they should go nuclear or wind.  What it means is we can tell them if we want them to focus on such things like more reliable service or faster reconnections, but these are things most of us have no problems with.

OFGEM also said we could perhaps ask for better standards of service or more small-scale renewables, but how is OFGEM going to measure that? How little can the suppliers do to get away with this consumer 'consultation'?

I sound pretty sceptical today, but after years of revealing the many tricks that even energy commentators and my colleagues don't spot, such as here, that can be no surprise.

I'd like to see OFGEM providing more information on how it makes its estimates and more openness from the whole industry.

But I don't think customers will have to wait very long before we see more rises, and at more than 1.2%.

More: You're making the same mistake again | Big energy price hikes to come

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