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Ben Pile: Diversion Tactics Over Green Energy Fiasco

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. 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.

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 quangoConsumer 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.

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