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.

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. 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. 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.