Posted by Jake on Saturday, May 12, 2012 with 7 comments | Categories: Article, energy, OFGEM, regulation
Many companies duck and dive to avoid accusations that their charges are too high and their profits excessive. From plumbers to car repairmen to bankers, they all have a perfectly incomprehensible reason why they charge so much. Few do this more than the Big Six energy companies (British Gas, SSE, EDF, Scottish Power, Npower and EON).
To expose the degree of profiteering that may be happening the energy companies would have to be transparent about both their operating costs and the profits they make on their wholesale energy sales. Something that has as much chance of happening as a snowball surviving in a working gas-fired boiler. The energy companies know keeping their businesses incomprehensible provides them with most excellent protective insulation from the chill wind of the free market. A mantle they weren't going to shed without a struggle.
In a rare show of courage OFGEM, in August 2011, decided to do something about all the obfuscation. OFGEM commissioned BDO, the accountancy firm, to conduct a forensic investigation and make recommendations on how to improve transparency. BDO duly made a set of eight proposals (see table on right).
Regrettably, by January 2011 OFGEM's courage was wavering. By May 2012 OFGEM had reverted to the same old obsequious poodle. This act of rank surrender by OFGEM was in spite of the Hills Report on fuel poverty, published by the Department of Energy and Climate Change in March 2012, which stated
"From a health and well-being perspective: living at low temperatures as a result of fuel poverty is likely to be a significant contributor not just to the excess winter deaths that occur each year (a total of 27,000 each year over the last decade in England and Wales), but to a much larger number of incidents of ill-health and demands on the National Health Service and a wider range of problems of social isolation and poor outcomes for young people."
Final report of the Fuel Poverty Review, Professor John Hills
OFGEM dropped six out of the eight BDO recommendations, and 'varied' the remaining two.
Profits are hidden by the vertically integrated energy suppliers by splitting themselves into two businesses. The Wholesale Business generates electricity, and the Retail Business sells it to domestic and business customers. The Retail Business uses high Wholesale prices to justify high prices to its customers. When buying electricity from itself, a vertically integrated company has every reason to keep Wholesale prices high, so they can claim their Retail profit margin is low and sometimes can even pretend to sell at a loss (and earn a little sympathy).
This is all equivalent to a baker, whose cost per loaf of bread is 50p, selling it to customers for £1, and claiming a margin of 2p. How is this done? The bakery splits itself into two businesses - the baking business at the ovens and the retail business at the counter. The baking business, run by Mr Baker, 'sells' the bread to the counter business, run by Mrs Baker, for 98p - giving Mr Baker a markup of 48p. Mrs Baker then takes £1 from the customer, claiming to have a markup of just 2p. Mr & Mrs Baker then go home with a tidy 100% markup between them - bonuses and cream buns all round!
This dodgy story is supported by OFGEM, which publishes the energy companies' "net margin" - by which they mean net retail margin - without disclosing what their wholesale margin is (because the companies won't say, and OFGEM is too shy to ask).
OFGEM's methodology document for producing this graph admits the wholesale margin is left invisible, stating:
1.17. Gross margin is calculated as the difference between the average customer bill and the sum of wholesale costs and other supply costs.
1.18. The net margin is calculated as the difference between gross margin and operating costs. Operating costs include customer service staffing, IT, sales and marketing, billing and bad debt costs.
Consumer Focus' commented, after OFGEM's initial response to BDO in January 2012
"In our view, the failure to take forward BDO’s recommendations for the reporting of trading activities will mean that the CSS continue to give a misleading picture of the value of generation assets....
There still appears considerable scope for companies to under-report profitability, principally due to the continued opaqueness of trading arms, which represent something of an information black hole....
There is a risk that CSSs could introduce misleading information into the public sphere, which will ultimately serve to erode, rather than rebuild, consumer confidence in energy companies."[CSS=Consolidated Segmental Statements]
The energy companies are famed for tricking and misleading their customers, most of whom are unable to see through the smoke and mirrors of the various deals they are offered. Richard Lloyd, executive director of Which? responded after SSE Plc was fined for mis-selling:
As SSE Plc is fined of £1.25M after being found guilty of using doorstep sellers to trick people into switching energy supplier, Which? executive director, Richard Lloyd, says:
“It’s right that SSE has been punished for this bad practice, but this fine will not help all those customers who may have been signed up with their misleading script."
“SSE should waste no time in contacting all those customers who were affected, and compensate them for any financial loss they may have suffered.”
At the end of April 2012 SSE promised to offer all its generated electricity on the open market - available to any wholesale purchaser. The idea is to encourage competition from smaller retail-only companies selling to end consumers. Of course this is a further burst of obscurantist hot air. In the open market the goods go to the highest bidder. The Big Six vertically integrated energy companies have every reason to bid high to buy their own electricity because the high price goes into their own pockets and disguises their retail margins.
It is disappointing, though characteristic, that OFGEM seems unwilling to clear away all the smoke being puffed around by the Big Six to provide cover for continuing price hikes.