The press and politicians are currently full of outrage at the announcement by British Gas of a 12.5% increase in its electricity prices from September, describing the rise as “extortionate”, “unjustified” and a “slap in the face” to families, and once again there are rumblings of price caps.
“Energy firms should treat all their customers fairly and we’re concerned this price rise will hit many people already on poor-value tariffs. We are not ruling anything out – whether it is action by the regulator or legislation – to increase fairness for customers.”
The components of electricity bills…
According to Ofgem, the contribution made by wholesale electricity prices to consumer bills is falling, and network costs and environmental and social costs are becoming relatively larger. Interestingly, the most recent breakdown shows that the Big 6 earned pre-tax losses of -1.72% on their retail electricity businesses in the past year.
Wholesale electricity prices have fallen back since the start of the year, although they are higher than they were this time last year. Daily pricing isn’t necessarily instructive in terms of the electricity input costs of the Big 6 since most will use various hedging techniques, typically over 2-year periods, and volumes are not even through the day.
As the amount of renewable energy used increases, so suppliers need to rely on weather forecasting tools to try to inform their trading strategies in order to avoid paying imbalance prices which are highly variable. Since the imbalance price reforms in November 2015, these costs have generally been higher and more volatile. This all means that although trends in wholesale prices affect the suppliers’ cost bases, there certainly isn’t a linear relationship between the two.
According to Ofgem’s most recent RIIO annual reports, the consumer costs associated with transmission and distribution networks fell by 5% between 2015/16 and 2016/17, from a combined cost of £130 per consumer to £124 per consumer.
The Office for Budget Responsibility data from March 2017 indicates that the value of environmental levies has increased from £4.6 billion in 2015/16 to £6.9 billion this year, which corresponds to £169 and £255 per household respectively. This is a year-on-year increase of £86, or 51%.
From these data it is clear that the large increase in environmental costs more than offsets the small fall in network costs, leaving an overall increase of £80 per household. Worryingly, OBR data shows the impact of environmental policy is set to grow even further, reaching £500 per year in 2021/22.
In addition to this, suppliers are also responsible for the Government’s £11 billion smart-meter roll-out, the cost of which is recovered through bills, at over £400 per household. According to moneysupermarket, most suppliers are adding around £6 per year to bills to cover this, which suggests a 68-year life span! A more reasonable recovery rate would be £27/year, since most meters have an estimated 15-year life, although the in-built obsolescence means that many current smart meters are likely to need replacing well before then.
In its press release, Centrica says that the price increase equates to £76 per year for the average customer. It can easily be seen how this increase relates to an additional £86 for environmental costs less £6 for reduced network costs.
….are almost impossible to understand due to lack of transparency
According to Ofgem, the average electricity price for a GB user is 16.86 p/kWh. At an average household consumption rate of 3,500 kWh per year, this translates to an annual bill of £590 for electricity alone.
The OBR data tell us that environmental costs were £169 last year. Ofgem tells us that this equates to 15% of electricity bills (and it is clear that the bulk of these costs apply to electricity rather than gas), so this would suggest total electricity bills of £1,125 which is clearly far higher than the actual level of electricity bills (but close to Ofgem’s level for average dual-fuel bills at £1,142).
Which brings me back to an old complaint which is the overall lack of transparency in electricity billing. Ofgem’s data are derived from the Consolidated Segmental Statements produced by the Big 6 suppliers. Ofgem also produces a cost index to try and explain the cost inputs to electricity prices, but refuses to publish the underlying data for it, making auditing the outputs almost impossible. Attempting to re-produce the data properly accounting for regional differences in transmission and distribution costs is extremely difficult – particularly for anyone who is not already an expert in how these costs work.
The regulator should do more than re-produce data from the Big 6. Instead, it should be publishing independently verifiable data illustrating exactly how various input costs translate into bills, and ensuring that any discrepancies between data sources are investigated and explained.
Are energy bills unfair?
Despite the outrage from sections of the popular press and some politicians, more measured commentators point out that this is a delayed price increase by British Gas, who made a commitment in February to freeze their prices until the summer, when the rest of the Big 6 were implementing increases. As money-saving expert Martin Lewis explained:
“This is British Gas’ catch-up price hike. It was the only one of the Big 6 firms not to raise prices at the start of the year, and now, as predicted, it’ll do it from September. And that means, if, (as is possible) we see another batch of rises this coming winter, its customers will feel like they been price-slapped twice in rapid succession.
While this freeze has given people a little respite from price moves over the key high use winter period – the problem is for many the false sense of security that it wouldn’t move prices meant they did nothing, when they could’ve cut their rate, and locked that in for longer, by actively picking a far cheaper 1 year fixed energy tariff.”
The BBC, usually a cheerleader for all things relating to renewable energy, admits in its Reality Check segment that most of the increased costs came from Centrica having to pay more for renewable energy.
British Gas has not increased its standard variable rate since 2013, and is promising to protect its most vulnerable customers from this increase. It is blaming the current price rise on increasing government and environmental input costs, saying that these costs should be more evenly distributed among energy retailers – currently, smaller suppliers are exempt from contributing towards some policy costs, like the Energy Company Obligation.
It also claims to have been earning little or no profit on its electricity supply business – a claim that is reflected in the most recent Ofgem data for the Big 6 electricity bills.
“We have been selling electricity at a loss, due to transmission and distribution costs associated with feed in tariffs, renewable energy, and the smart meter roll out programme alongside the Data and Communications Centre. We were always very competitive, so we need to restore the balance with these losses. Nobody is trying to apportion blame, but we are recouping the losses through bills rather than general taxation,” ~ Iain Conn, Chief Executive, Centrica.
And this is the crux of the problem. For as long as the costs of Government policy are recovered through bills rather than direct taxation, it will appear that suppliers are to blame for cost increase, when in fact they fall entirely outside their control. Indeed, as I have argued before, the growing levels of external costs faced by suppliers in the form of network, and environmental and social policy costs, the less competitive the market will become.
Rather than re-hashing the same old arguments every few months whenever one of the large suppliers announces a price increase, it’s time to introduce proper price transparency so the consumers and politicians alike can understand the exact drivers of price increases. Moving environmental costs into general taxation would be a good first step, and might have the added benefit of bringing increased scrutiny onto the policy choices behind these ever-increasing costs.