Penny Brooks Royal Grammar School, Guildford

October 2013

Energy price capping – does it address
the right problem?
Ed M...
Penny Brooks Royal Grammar School, Guildford

Perhaps we have to conclude that, however much
we don’t like the rises in ou...
Penny Brooks Royal Grammar School, Guildford

arm in the first half of its financial year, but that it
was on course to ra...
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econoMAX - Energy price capping – does it address the right problem?

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Ed Miliband’s promise at the Labour Party conference to cap energy prices for 20 months if Labour were to win the next election, has raised many questions about what we pay for domestic energy, how it compares with other countries, and what the energy companies do with their profits. Pondering those points has led me to an over-riding question, which is whether the price paid by consumers is really the most important issue for government intervention in the energy market.

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econoMAX - Energy price capping – does it address the right problem?

  1. 1. Penny Brooks Royal Grammar School, Guildford October 2013 Energy price capping – does it address the right problem? Ed Miliband’s promise, at the Labour Party conference last week, to cap energy prices for 20 months if Labour were to win the next election, has raised many questions about what we pay for domestic energy, how it compares with other countries, and what the energy companies do with their profits. Pondering those points has led me to an over-riding question, which is whether the price paid by consumers is really the most important issue for government intervention in the energy market. But how do our prices compare with those paid by consumers in the EU and USA? This gives a slightly different perspective. In fact, in 2010 IEA research showed that average UK prices for electricity (including tax) were only the 5th lowest in the EU15 and the 4th highest in the G7, and for gas they were third lowest in both those areas. They also showed that the tax paid on domestic energy in the UK was amongst the lowest in the EU. Ofgem’s data for gas prices in 2012 showed the following, rather surprising, comparison: Firstly, the price we pay. Data from the IEA, Ofgem and the ONS confirms what we already knew – energy prices have risen very fast since 2005. In real terms, the price of gas has almost doubled, and that of electricity and ‘liquid fuels’ has gone up by more than 50%. This puts a huge strain on the household budget, particularly when household incomes have been pretty static.
  2. 2. Penny Brooks Royal Grammar School, Guildford Perhaps we have to conclude that, however much we don’t like the rises in our energy bills over the last ten or so years, we are better off than many of our competitors. Even if we do have to accept the high prices, should we be content to allow the privatised energy companies to make super-normal profits? This leads to another range of issues and questions. The first is whether they make a ‘fair’ profit or not. The companies themselves claim that their net profit margin is around 5%, which is the same as the profits made by supermarkets – notable as another oligopoly market, which while not regulated is constantly subject to investigation from the OFT and the Competition Commission. Ofgem seem to accept that the profits are not excessive, and their report issued in September this year gave figures showing that the ‘average’ annual combined bill for gas and electricity is £1,315 and the net profit from that would be £65. On the other hand, their net profits have been rising throughout the recession. The companies say that they need these profits in order to invest in renewable energy and new capacity – more on this below. They also pay very high dividends; in February The Guardian reported that “Centrica promised a £1.3bn handout to its shareholders just months after pushing through an increase in household bills” and in late September SSE said that it expects to report a loss at its retail
  3. 3. Penny Brooks Royal Grammar School, Guildford arm in the first half of its financial year, but that it was on course to raise payouts to shareholders by more than inflation. Shareholders, as the owners of the company, are entitled to a share of the profits – and vast numbers of the shares in the energy companies are held by pension funds and unit trusts which means that the dividends they receive are re-circulated into the circular flow of income as pension and trust fund payments. On the other hand, there is a critical need for further investment in energy capacity in the UK. In June Ofgem reported on capacity and investment in the electricity sector. They found that • The UK is facing a critical shortage of electricity supply which necessitates investment in greater capacity • The current probability of a large shortfall requiring the controlled disconnection of customers is 1 in 47 years • Assuming projected falls in demand for electricity, by 2015-6 the probability will be around 1 in 12. • If the projected decline in demand does not materialise, the probability may be 1 in 4. • The UK is also increasingly dependent on imports of gas It seems that, for the shareholders to maintain their dividends even in the fairly short term, they need to allow the energy providers to plough profits into building capacity as soon as possible. This leaves me with two big questions: What would be the likely impact on energy costs and prices of a supply shock in 2015-7? How could government intervention be used to achieve the objectives of reinvesting profits into energy generation, and encouraging further FDI into the industry? I am not sure that a price cap on domestic fuel in 2015 answers either of those.

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