Big energy price hikes to come

Wholesale gas prices are up 80% in half a year, but it's not as bad as it seems!

Deciding when to switch energy tariff isn't as straightforward as it seems. Contrary to popular opinion, it doesn't usually make sense to wait for other suppliers to drop prices after one of them makes a move. Energy suppliers appear to use such popular misconceptions – spread by many of my not-cynical-enough colleagues in the world of journalism – to create strategies that increase profits at the consumers' expense.

I predict another misconception

Data from Energyhelpline shows wholesale gas is up about 80% over about half a year. It seems logical that retail prices must also rise soon, but taking one figure and considering nothing else is what has led to poor energy-switching guidance from many analysts and journalists. (Read You're making the same mistake again for an example.)

To pre-empt my colleagues, let's take a closer look.

The history

Two years ago, the regulator OFGEM avoided a scathing public backlash from its main clients – the energy suppliers – when it used and interpreted data in a way that's favourable to them, and refused to come down hard over prices. I'm not saying it deliberately favoured energy suppliers, as it could easily have been caution or carelessness, but it amounts to the same thing either way.

In 2008, the regulator produced data which, to me if not to OFGEM, shows clearly that there is, at least at times, anti-competitive supplier pricing.*

The data stretches eight-and-a-half years, ending in July 2008. It shows that suppliers have usually raised retail electricity and gas prices very closely in line with wholesale prices. Sometimes, but not always, retail-price rises have lagged a few months to a year, but the correlation is strong.

The pattern breaks

However, the closely intertwined pattern broke at one point – very dramatically. This is when wholesale gas and electricity prices collapsed rapidly from around June 2006 through part of 2007. At this time, retail prices just ticked a little downwards. That's presumably why energy suppliers boasted massively-increased profits, because they used sharply falling wholesale prices to increase their margins.

There's a twist

Wholesale prices then bounced back up. From around April 2007, wholesale prices rose quickly, but retail prices didn't go up with them. They stayed flat. This could be because the energy suppliers couldn't risk ripping us off any more, which would risk precipitating stronger price regulation.

Around the end of 2007, wholesale prices got close to their June 2006 peak and continued to rise. At this point the long-term pattern resumed, whereby retail prices moved again with wholesale prices. The suppliers were (presumably) satisfied with their 18-month bonanza thanks to the temporarily crushed wholesale prices.

It's happening again

According to data from Ilex Energy and a House of Commons paper, a similar thing occurred pre-2000. Now it's happening again.

Data from Energyhelpline shows wholesale gas prices reached massive heights by autumn 2008. Retail prices closely matched the moves, as usual. Then the global economy collapsed, taking wholesale prices with them. Gas prices went down as much as 70% at one point and have spent most of the past 16 months at least 50% below the 2008 peak. During this time, retail prices have fallen maybe 20%. It's the same pattern: a big plummet in wholesale prices but no corresponding fall in retail prices.

Now wholesale prices have gone up 80% in about a half year. The hacks are preparing to write their scare stories.

But let's not panic

It requires a little bit of maths to explain how an 80% rise in wholesale prices doesn't necessarily mean we face big rises in our bills.

In autumn 2008 an amount of wholesale gas cost £100. The price fell 70% to £30 at the end of 2009. Now, a rise of 80% takes the price to just £54 (because 80% of £30 is £24). That's still a long way off the £100 peak. Hence, if the previous patterns repeat, wholesale prices need to go up a lot further before retail prices are likely to start rising again.

Taking into account the roughly 20% fall in retail prices that suppliers have grudgingly granted us, I estimate that gas prices need to rise another 40% or so before we should see retail prices rise significantly.

However...

I've been looking here at average retail prices. If I was an energy supplier, I would remove the cheapest tariffs sooner. This boosts profits from customers who like to shop around without incurring the wrath (such as it is) of OFGEM, which has complained about the difference in prices between the cheapest tariffs and standard tariffs. Several cheap deals – some fixed – have disappeared already, and existing customers have been moved off the cheapest tariffs. There are still cheap tariffs available, but fewer of them.

Related goal

Lower your household bills

How to cut your energy, insurance, phone, broadband, water and TV bills, lower your council tax and save thousands of pounds a year!

Do this goal

What's more, energy companies could raise prices sooner, because they're being allowed to make greater profits in order to fund major improvements to infrastructure.

On the flipside, just because energy prices have risen in the past six months, it doesn't mean they'll continue to do so over the next 6-24 months. It could go either way, just like the global economy. We do face big energy price rises, but not necessarily soon.

Tips

I reckon that there's no rush to switch now unless you haven't done so for more than a year, which means you can get a cheaper deal today than you did then. I would always urge people who've never swapped since living at their current residence to do so, because suppliers automatically put new occupants on expensive tariffs.

I think you should switch sometime between now and the beginning of winter – but no later – for reasons I've explained previously, e.g. last September in Now is the best time to switch energy prices.

More from Neil and lovemoney.com

Compare gas and electricity through lovemoney.com.

Read how to Earn interest from your energy supplier.

Read about Exit penalties in gas and electricity tariffs.

*If you want to see the data for yourself, look at Chart 1 from page 175 of the report. I'm looking at the one year-ahead wholesale gas and electricity prices (suppliers typically buy in advance) versus average retail prices from the Big 6 suppliers. Let me know whether you agree with me or OFGEM in the Comments section.