The Big Lie About the ‘Big 6′

Posted by Ben Pile on October 16, 2011
Oct 162011

In spite of their having campaigned tirelessly over the last few decades for more expensive and less efficient forms of energy production — ‘sustainable energy’ — many of a greenish hue are getting heated up about about UK energy market regulator OFGEM’s latest report. The Left Foot Forward blog reports,

Outrage at 733 per cent rise in energy companies’ profits
There was anger today at the news this morning that energy companies’profits had soared eight-fold from £15 to £125 per customer per year.Friends of the Earth said it was “outrageous” the energy fat cats were raking in the profits while people face “rocketing” bills and “shiver in cold homes”.

As discussed here recently, it’s just a bit rich that FoE are complaining about rising energy prices. Few organisations have done more to make using energy more difficult for poorer people in the UK than FoE.

Rising bills and increasing levels of ‘fuel poverty’ have embarrassed the UK government. And perhaps for the first time, the UK public is finding itself exposed to the realities of climate change policies. In other words, climate change policies just got political. They are now part of people’s daily lives, exactly as the green NGOs wanted. Now everybody has to think before they turn their lights and heating on. Everybody is now forced to think of ways to cut their fuel consumption. And as a consequence, Quangos, NGOs, government departments, and their ministers past and present are trying to distance themselves from those consequences, by pretending to champion the interests of the consumer. “It wasn’t us”, they scream.

The Guardian reported last month that,

The Labour party is to put the UK’s big six energy companies “on notice”, pledging that the next Labour government will break up their “stranglehold” of the market in order to tackle soaring bills.

Labour will pledge to break up the existing market which allows the major energy companies to both generate and sell energy to households, which the party argues fails to minimise prices and prevents new companies entering the market.

Earlier in the year, the same paper quoted Chris Huhne,

As concern grows that the other five major energy companies are preparing to follow Scottish Power and announce big rises within weeks, the energy secretary, Chris Huhne, told the Observer that consumers should not accept the increases “lying down” but “hurt” their supplier by finding cheaper alternatives.

“Consumers don’t have to take price increases lying down,” he said. “If an energy company hits you with a price increase, you can hit them back where it hurts – by shopping around and voting with your feet.”

But come the conference party season, Huhne had a new target.

Price rises were the energy companies’ fault. And then they were the consumer’s fault. But they weren’t the fault of the Secretary of State for Energy and Climate Change, DECC, the coalition government or the previous government/s,  oh no.

Now the quango seemingly charged with being the ‘energy consumer watchdog’ OFGEM, has entered the debate to attempt to give substance to the claims about the energy companies’ dubious selling practices. The press release announcing its intervention said,

After extensive analysis, Ofgem has decided to progress its preferred model for the reform of the retail energy market. It has also published today its latest report on prices which shows that the average dual fuel bill now stands at £1,345 and, following recent price rises, estimated suppliers’ margins have peaked at around £125 per year, but are likely to fall back next year. This report on prices does nothing to alter Ofgem’s findings in March that competition is being stifled by a combination of tariff complexity, poor supplier behaviour and lack of transparency and that radical change is needed. [...] In December further decisions on proposals on liquidity to break the stranglehold of the Big Six in the wholesale electricity market

Spurious claims are made about the conduct of energy companies. They’re making excessive profits. They’re misleading consumers. They’re ripping people off. See this interview with Adam Scorer from quango Consumer Focus, for instance.

But who is really doing the misleading and ripping off here? A closer look at the OFGEM (another quango) report reveals a far less straightforward picture.

Between 2004 and 2009, it seems that energy companies were not making a profit (if margin is assumed to be profit) at all. There followed two years of profitability, which can barely be described as excessive. In fact, the margin between Aug 2009 and June 2011 looks modest. By June this year, the margin was just £15. The apparently shocking rise of 733% is extraordinary, only when we forget that the margin represented by 100% (£15) is so low. Moreover, the margin reported by OFGEM this quarter is unusually high — an anomaly, in fact. It makes no more sense to talk about the margin rising over just one quarter in this way than it does to talk about climate change by comparing minimum winter temperatures with maximum summer temperatures, as is discussed shortly. It should be treated with some care before it is used as evidence that the energy companies are ripping us off. After all, the idea that they have been ripping us off simply isn’t demonstrated by the curves on the graphs representing their profits. I asked OFGEM for the figures, and how they were derived. They said they couldn’t tell me. It’s ‘commercially sensitive’ data.

OFGEM produce this report quarterly. Take a peek at the headline from the June report, then, and it seems that it’s much harder to portray energy companies as evil b*stards.

We estimate net margin on supplying a typical, standard tariff, dual fuel customer to be approximately £15 per customer for the year from June 2011. This is a significant reduction on the net margin indicator published in March. The main driver of reduced net margins is the increase in wholesale gas and electricity prices. Gas prices, in particular, have had a strong upward shift in the last six months, owing to global events. This means that the price for next Winter‟s gas is around 30% higher than the price for last Winter’s gas. Other factors have also had an effect on suppliers’ margins, and these are explained in the report. The £15 net margin figure is not affected by the recent price increase announced by one of the Big 6 energy supply companies, as this price increase is not effective until August. This will cause the average dual fuel customer bill in our analysis to rise from that date by about £15.

In other words, in June, energy companies would have seen that their profits were going to go negative again. Perhaps this explains the apparently shocking 733% rise in the margin. Faced with the very likely possibility that wholesale prices would rise considerably, the suppliers had to anticipate the market price — which was both high and volatile. Looking at the June report for winter gas prices shows the problem.

Between October 2010 and April 2011, gas prices for winter 2011-12 increased by a third. The apparently huge increase in profits may merely reflect the fact that prices are high, volatile, and the energy companies’ need to anticipate prices.

To make the point more clearly, here are the October to October year increases given by the latest OFGEM report.

(Sharp-eyed readers will observe that there’s an error in the calculation of gross margin for October 2011.)

The first thing to note is that the October ’10 to October ’11 increase is lower than the June ’11 to October ’11 increase, in both absolute terms, and proportionally. It’s a 300% increase, rather than a 733% increase. Still an increase, but hardly as shocking. Second, the increase in the margin represents just over a third of the total increase. The shocking increase in margin was produced by taking a anomalous relative low from a corrective, anomalous high.

Now, let’s assume that the ‘right’ amount of margin for a duel fuel energy company is £50, and then that the current October price was caused by increases in wholesale costs, and the other actual rises.

So in the real world, wholesale prices increased Oct-Oct from £490 to £605 or by 23%. In our imagined scenario, prices rose from £490 to £685, or by 40%. In other words, the energy company would have to anticipate a rise in prices, and the hypothetical energy company estimated a rise of 40%, against the reality of 23%. Is that so unreasonable, given that we have seen prices increase in the order of 33% in just half a year, and that energy companies were barely making a profit at all back in March?

I don’t believe that it is is. And there are many problems with the vilification of energy companies. Why take the June 2011 margin £15 as the starting point to show the increasing profits of energy companies? Why not choose October 2007, when the margin was -£55?

The reasons for this vilification are obvious, and discussed above. Those individuals and organisations need a scape goat. Now let’s consider their solution: breaking the putative monopoly that the ‘big six’ energy providers have on the market. Says OFGEM:

Today’s consultation is the first of four waves of reform:
* In November detailed proposals to reform the energy market to help the businesses sector
* In December further decisions on proposals on liquidity to break the stranglehold of the Big Six in the wholesale electricity market
* In the New Year the findings of an independent report into making energy company accounts more transparent.

Ofgem’s Chief Executive Alistair Buchanan said: “When consumers face energy bills at around £1,345 they must have complete confidence that this price is set by companies competing in a fully competitive market. At the moment that is not the case.

“That is why a radical break with the past is needed. Ofgem’s tariff reforms offer the quickest way to create a market where consumers can have confidence that prices are set by effective competition. Suppliers have told Ofgem they want to restore confidence in the industry and now they have the chance to do so.
“With £200 billion of investment needed to overhaul Britain’s energy industry and the pressure this and rising energy prices puts on bills, consumers rightly demand a major improvement in the way suppliers behave towards them.”

One of OFGEM’s complaints is that the energy tariffs set by companies is too complex. This is undoubtedly true. But it is hard to see that, looking at the margins of the energy companies, simplifying the price structure will yield much of a positive effect for the consumer. These margins are not big. Yet if you listened to the likes of Chris Huhne — who claims that consumers can save themselves £100s by switching tariffs — you would form the impression that energy companies are making £100s per customer. They aren’t. Yet he blames energy suppliers for deliberately confusing customers, and he blames customers for failing to shop around for the best deals. He, the DECC, the ENGOs, and the quangos then blame the monopoly — as though it were a cartel.

But even if these reforms did break the ‘cartel’, how would new players in the market cope with such low margins? For five of the last seven years, the margins seem to have been negative. Who would be foolish to enter such a market? Given the emphasis that the actual cartel — the DECC, quangos, and ENGOs — have put on renewable energy, which rewards new players on the electricity market with such high returns, making conventional energy even more expensive, it is hard to see how the plans to transform the market will yield any benefit to the consumer. Will new players simply be subsidised by the old, just as ‘renewable energy’ is subsidised by conventional energy, and won’t the net effect be to increase prices even further?

The argument from the idiots at Left Foot Forward would seem to suggest that it would be:

Ofgem say the consultation unveiled today is “the first of four waves of reform” – in November, they will unveil detailed proposals to reform the energy market to help the business sector; in December there will be further decisions on proposals on liquidity to break the stranglehold of the Big Six in the wholesale electricity market; and in the New Year they will publish a report into how to make energy company accounts more transparent.

As the BBC’s Damian Kahya writes, the new plans, though still complex, are likely to bring down prices:

In addition to the new simple tariffs, companies will still be allowed to offer an almost infinite range of fixed rate deals, similar to mobile phone contracts. Though complex, those deals may end up cheaper than a standard rate, especially if they are tied to the planned roll out of smart meters.

These complicated deals may also offer greater savings to households that can afford special devices designed to use more electricity when the price is low. It’s exactly that type of complexity which has put many lower income households off switching to cheaper tariffs, a problem Ofgem is trying to solve.

The coming consultation will give the regulator a chance to see if it can be fixed, perhaps by making all tariffs – even smart meter deals – directly comparable on the same terms.

Let’s hope they do.

Let’s hope they don’t get the chance. As a rather more sober BBC article claimed in 2009,

Plans for smart meters for millions of homes have been unveiled with trials suggesting the £8bn scheme may help people save £28 a year.

Hurrah! A saving of a whopping £28! But, the article continues…

Energy suppliers, rather than distribution networks, will be responsible for the roll-out of the meters at a cost of about £340 per household.

So where’s the money going to come from?

From energy bills, of course. The energy suppliers are going to want to recoup that £8 billion capital cost. They’re not making enough money to pay for them. In fact, if they really were making £15 a year back in June, then it would take 23 years to raise that much in profit, or 3 years, at the October margin of £125. It gets worse, though. More recent estimates suggest that the government is being very optimistic…

Margaret Hodge MP, who chairs the Committee of Public Accounts, said the government’s track record on delivering large programmes is patchy at best. “At the moment the estimated cost is £11.3bn, but all our experience suggests that this budget will be blown,” she said.

The government predict savings of up to £18 billion, according to the National Audit OFfice, who seem rightly sceptical. I don’t trust the claim in the slightest.

And if this wasn’t enough, the UK National Grid requires £200 billion investment over the next decade, to make sure that the government’s ill-conceived emphasis on wind energy doesn’t cause chaos.

National Grid will be critical in ensuring Britain’s energy sector is given a £200bn overhaul over the next decade, making sure that new wind farms and nuclear power stations are connected to the grid.

Steve Holliday, chief executive of National Grid, said: “The year has started well with our businesses making good initial progress toward their priorities and delivering solid operational and financial performance.

Yet not a single penny of this vast sum of money will yield a single watt of advantage to the consumer who will end up paying for it. The aim of the UK’s emphasis on renewable energy and emissions-reduction is simply to keep the lights on at best. Keep the lights on, that is, if you are lucky… Steve Holliday, chief executive of National Grid, was also on Radio 4′s Today programme earlier this year.

Evan Davis: “Get a move on”, is your message. Let’s talk about one or two specifics. Wind – as you fly in now over the Thames Estuary, you fly in to Heathrow, you begin to really see quite a lot of wind is being created – a lot of wind turbines are being created – in the Thames Estuary and around the country, aren’t they?

Steve Holliday: They are, and yet that’s still a drop in the ocean, compared to, in our own forecasts, if you look at the energy mix that we believe we are likely to need, to hit a low-carbon generation fleet by 2020 and 2030. Today we’ve got about 5 gigawatts of wind, we’ll have nearly 30 by 2020…

Evan Davis: Does it work?

Steve Holliday:…just imagine…

Evan Davis: Because if the wind doesn’t blow, how does the older grid cope?

Steve Holliday: The grid’s going to be a very different system in 2020, 2030. We keep thinking about: we want it to be there and provide power when we need it. It’s going to be a much smarter system, then. We’re going to have to change our own behaviour and consume it when it’s available, and available cheaply.

We have to consume it when it’s available? So if there’s no wind, we can’t have showers, heat, light… or listen to the moron chief executives of the companies managing the UK’s essential infrastructure on the radio… It’s not some eco-warrior or Guardian eco-loon telling us that the Grid will not be supply power to our homes when we most likely need it; it’s the CEO of the company which operates it. The thinking behind this idea is that continuity of supply will be predicated on the consumer’s ability to pay. Even if the range of tariffs on offer today are baffling, the choice offered by the ‘simplified’ schemes being considered now would be recognised best by Hobson: pay more money, or accept interruptions to your supply. That’s a ‘smart grid’. That’s the ‘future’ of our energy supply. It will cost more. It will deliver less. It will cause real harm to poorer people. And it will be less reliable. And it will be so, because those are today’s political priorities. They are shared by many companies, by politicians and government departments, ENGOs, and the quangos whose legal responsibilities are to protect the interests of the consumer.

The attempt to blame energy retail companies for increasing bills is a grotesque political manoeuvre. It is rank propaganda, designed to capture discontent for the ends of a self-serving consensus. Even if energy retailers made zero profit, it would make almost no difference to the average consumer. Energy prices rise, not because of a cartel of energy companies, but because there is a political consensus in Westminster, in Brussels, and at the UN. The bubble in which these policies are formed it impervious to criticism and to challenge. It’s inhabitants emerge from the bubble, to discover that prices have risen, and that people are angry, and so they blame the retailers.

It’s a bit like imposing tariffs on farmers and restricting the land they may use for agricultural production, and then blaming the shopkeepers for the price of bread rising. ‘We must open more bread shops’, say the government. But now the low margins are split between more people, with greater net overheads. Prices rise. ‘We must control demand’, says the government, and forces the shopkeepers to install ‘smart tills’ that vary the size, quality and price of loaves, depending on customers use of bread. When it becomes apparent that these policies have failed, who will the government turn to next? Will they continue to blame the retailers and consumers, or will they move up the supply chain?

  7 Responses to “The Big Lie About the ‘Big 6′”

  1. The prospect of “smart meters” fills me with dread — haven’t these people heard of STUXNET?

  2. Well researched!

    Home owners would suffer under unreliable power but business would be destroyed.

    Some of the proposed plans for a very severe pandemic involve rolling blackouts and businesses have been told to consider how they’d deal with it. Only companies of a certain size have secure supplies, the others are advised to get generators. When the people given the task of planning are asked how they’d cope, many say that they’d probably work from home. What?!! It’s the type of vague thinking that plagues modern business and government. Ironically, only the biggest companies have put real effort into planning, in part because many of them can’t afford to be without power for even tiny outages. Continuous processes can be sabotaged by glitches in supply and longer, intermittent power cuts could see laborious start up procedures taking longer than the supply lasts. Shops would be at their wits end if the power went out, scrapping transactions and leaving customers and shop lifters literally in the dark. Most care homes are not on protected supplies so despite their frail occupants they’d suffer along with rest of us. Some big businesses are on interruptable supply – in that they get cheaper utilities on the agreement they’ll shut down if there’s a shortage. It’s a deal sometimes done in desperation to save money so a power cut might mean the difference between operation and bankruptcy.

    I can see the perfect storm of aging power stations, a gas demand war, stationary windmills, a bitterly cold winter and a strike amongst utility workers (pay cuts and job losses to cut costs). It would make the 70s coal strikes look like a picnic.

  3. Distinguishing between energy companies and politicians in order to blame one or the other just doesn’t make sense. Politicians created an artificial feedback game, called it a market, and then gave it our energy infrastructure to play with.

    Prices are going up because this game doesn’t work.

    Energy companies have to anticipate prices because they will lose the game if the price of energy drops below the cost to deliver energy and they don’t have enough money to cover this deficit. Now the inverse can also be true: the price of energy goes above the cost of delivery and then the game gives them huge amounts of free money. Of course they don’t invest in increased energy production with this money because that would drop the price of energy but not necessarily the cost of delivery(increased supply, same demand, same energy production).

    The game ends when the infrastructure has all been destroyed and the energy companies get to charge an infinite amount of money for an infinitesimal amount of energy.

    Any profits whatsoever for an energy company is a ripoff. This environmental nonsense is just a way of insuring the gov’s favourite players (energy companies) don’t lose the game. And in exchange for this the totally unaccountable energy companies will happily take the blame.

  4. In his 2009 book “The Real Global Warming Disaster:Is the Obsession with “Climate Change” Turning Out to Be the Most Costly Scientific Blunder in History?” Christpher Booker described how our obsession with climate change will destroy the world’s economy.

    His prediction is materialising, unfortunately. AGW has created an energy crisis which in turn destroyed manufacturing and is now destroying our economy…society…….

    The fall of the unholy AGW empire.

  5. [...] The Big Lie About the ‘Big 6′ – Rising bills and increasing levels of ‘fuel poverty’ have embarrassed the UK government. And perhaps for the first time, the UK public is finding itself exposed to the realities of climate change policies. In other words, climate change policies just got political. They are now part of people’s daily lives, exactly as the green NGOs wanted. Now everybody has to think before they turn their lights and heating on. Everybody is now forced to think of ways to cut their fuel consumption. And as a consequence, Quangos, NGOs, government departments, and their ministers past and present are trying to distance themselves from those consequences, by pretending to champion the interests of the consumer. “It wasn’t us”, they scream. (Ben Pile, Climate Resistance) [...]

  6. Well said, Ben. It’s laughable to listen to the government telling us that we’re too stupid to shop around. And now they’ll throw more good money after bad by sending us all letters telling us to swap suppliers. At what cost? How much is it going to cost to send 8 million or so letters stating the obvious? This is the letter they ought to be sending us:

    http://progcontra.blogspot.com/2011/10/letter-from-dave.html

  7. [...] The ‘Big Six’ and the current government’s demonisation of them has been discussed here before. No doubt energy companies are out for themselves. But Miliband’s paints a misleading picture [...]

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