Energy firms’ Labour-inspired price freeze is backfiring badly

 
Allister Heath
ENERGY companies haven’t helped themselves. Their biggest mistake over the past decade was to collude with the political establishment. Instead of putting the interest of their consumers first, they agreed to take part in the dash for green energy, safe in the knowledge that this would push up prices. They messed up in other ways, too, and failed to deliver proper customer service. The result was to damage trust in an industry that would always struggle to win the hearts and minds of the public, even at the best of times.

Yesterday’s attack by Ofgem will therefore come as yet another unwelcome blow to the largest energy producers. The regulator, which is fighting for survival and which in many ways has made a bad situation worse with a number of ill-judged reforms to the market, has decided to take the industry to task on price. It is asking a simple question: given that wholesale energy prices have recently taken a tumble, why haven’t consumers benefited?

It’s a good question, and one which the industry, if it had any sense, would have already pre-emptively answered. The public is already convinced that it is being ripped off and it is unlikely to give the firms the benefit of the doubt. So what is going on – is this evidence of profiteering or even collusion, or something less unpleasant?

Wholesale gas and electricity prices for the coming winter have tumbled by 16 per cent and 12 per cent respectively since last summer – and yet consumer prices haven’t. If energy companies didn’t have any other costs, and if they purchased all of their gas and electricity on the spot market, then this would be very fishy. The good news, if that is what we can call it, is that neither of these assumptions is true.

First, there are lots of other costs, and they are going up, led by network costs and payments to renewable generators, which are surging as more off-shore wind and solar projects benefit from subsidies. Liberum Capital, always the most sensible source of analysis in the energy debate, calculates that these charges will boost the total cost faced by the biggest energy suppliers by 3-5 per cent this year. These costs represent around half of the total, which means that roughly 6-10 percentage points of the drop in wholesale prices has already been offset in this way.

Second, the reality is that the energy firms hedge their energy purchases – they buy vast quantities in advance at a pre-determined price, which means that market fluctuations don’t lead to immediate changes in prices to end-users. This makes sense: nobody would want their gas and electricity prices to change every day, in the same way that the price of petrol at the pump varies daily according to supply and demand.

The problem this time is that the firms took out their hedges when prices were higher than they are today. One reason they did this was political pressure: the Labour party was calling for a price freeze, and some firms sought to pre-empt this. So they locked themselves and their customers into expensive energy by agreeing even longer hedges than usual in what now seems like a bad miscalculation.

There is another reason why suppliers will be reluctant to cut prices: a Labour victory would mean prices frozen from their current level – so best, from the industry’s perspective, to make sure that these are set at the highest possible level to protect themselves in case wholesale costs bounce back again after next May.

Despite all of this, however, some of the companies – those that are less locked in than their rivals – ought to be able to push through price cuts at some point this year. The best way to ensure that they do so isn’t the odd broadside from Ofgem: it is to make sure that there is enough competition in the market. Fortunately, the situation does seem to be improving: nearly 123,000 customers switched to suppliers outside of the big six in May. About 244,000 customers switched in total. That’s certainly more like it.

allister.heath@cityam.com
Follow me on Twitter: @allisterheath

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