Ofgem: why questions on energy bills are piling up

Robert Lea
24 Sep 2009

Three questions. Has anyone heard whether their household energy prices are coming down any time soon?

Given that wholesale prices have been falling like a stone, has anyone heard any good reasons why retail prices are not budging? Is there anyone left who believes the Big Six energy suppliers act in the best interests of their customers?

The answer to all these is probably no. This column last week argued that consumers have been kept in the dark as to why retail domestic energy prices have not been cut at a time when it appears the profit margins of the suppliers are rising.

We wondered whether these suppliers — British Gas, E.On, npower, EDF, Southern Electric and Scottish Power — are acting as a cartel to keep prices high or at least that competition in the industry is plainly not working.

We wondered what Ofgem, the regulator is doing about it. Right on time, Ofgem has released information that seeks to explain the latest wholesale price movements and what they have done for the profit margins of the energy suppliers.

Those not yet enraged at paying on average around £100 a month for their household electricity and gas may wish to turn away now.

According to Ofgem analysis of the last quarter, the energy companies' average gross margins on supplying a household over the next year are around £170 for a dual fuel customer — 55% higher than the average gross margin achieved over the past three years.

To make that plain: the wholesale price of gas has been falling, the retail price has stayed the same, energy companies profits margins are soaring.

Ofgem has in the past given the rule of thumb that your average bill is made up of 60% commodity cost (the wholesale cost of buying natural gas or electricity), 30% other overheads (distribution and transmission costs, carbon costs and investments in renewable energy, metering costs and VAT), leaving the gross profit margin at around 10%.

That gross margin only translates to a pure bottom-line profit after the costs of staffing, sales, marketing, IT and bad debts are subtracted.

However, what the latest Ofgem breakdown of the average dual fuel bill indicates is that the commodity cost actually only makes up 50% of the bill. The costs of greening their businesses means those “other” costs now account for 35% — leaving a gross margin that has now risen to 15%.

When the gross margin figure was 10%, the companies claimed only 2% was the pure profit margin.

Therefore if the companies are keeping, as promised, a lid on their operating costs, it follows their pure profit margins are leaping.

But what if the wholesale price that Ofgem is quoting — its analysis is based on a suppliers' hedging programme of forward buying 18 months in advance — is a nonsense? We don't know what wholesale prices the suppliers are paying because they don't disclose it. But it could be way lower than what Ofgem thinks.

Or as gasguru, an energy procurement expert who blogs on the nohotair.co.uk website says: “Ofgem seems to actually believe that the energy companies all buy gas and electricity 18 months in advance and that they can't get out of that price. Have they ever heard of options or derivatives?”

Which leaves three more questions: Is it highly unlikely the energy companies will cut prices ahead of the prime winter usage season? With households using less energy — down by around 7% year-on-year as price and green issues effect our consumption — are the suppliers keeping the price up to protect their profits from falling revenues? Should Ofgem look again at whether so-called competition in the energy sector is actually working?

The answer to all these is probably yes.