What really pushes up energy prices

Robert Powell takes a look at what really causes gas and electricity rates to rise...

All successful businesses must know their customer base, and one sector that excels at this more than most is the energy industry. Not that it is any hard task when what you’re selling makes up an essential part of almost every person’s life.

But while energy companies know exactly what we want (or more accurately need), we know very little about them. Which is why when energy tariffs are upped, we are often left wondering why...

What they tell you

Hikes in energy prices have become common place over the last ten months. Almost every member of the ‘big six’ group of energy companies has upped their rates twice-over since November last year.

The reason given by energy companies for rate increases rarely strays from the ‘party line’. To paraphrase; "not our fault guv, wholesale prices are increasing."

Yet looking at these graphs from Consumer Focus comparing wholesale gas and electricity costs to the ‘big six’ average retail price, it becomes clear that the relationship between wholesale costs and tariff rates is not as close as utility companies make out.

What they don’t tell you

The wholesale cost of gas and electricity will always make up a majority of what we pay for our energy. Yet, in terms of the immediate influence on energy bills of wholesale cost fluctuations, the relationship is less clear.

The wholesale cost of gas makes up around 50% of the price we pay in our bills. So, in theory, if wholesale gas prices drop by 20%, our bills should fall by a tenth. But as I’ve already noted, this is not the case. The reason for this is the sheer complexity of the gas buying processes that go on within energy companies.

For example a large proportion of the gas that is delivered to your home will be bought in advance by energy companies. The official line for doing this is to enable providers to ‘smooth out the volatility in the wholesale gas market’. However I suspect that stocking up when wholesale prices are low also plays some part.

The multi-national nature of most energy providers also increases this distortion since – as lovemoney.com reader and energy industry professional UtilityBaron commented on a previous article – no one knows where the money is being made and who is making it.

Don’t get me wrong, wholesale costs undoubtedly play a part in tariff increases. But to suggest that a rise in wholesale costs within a set period directly translates in an immediate rise in retail rates is to simplify the issue.

Indeed, industry regulator Ofgem has become so concerned about the murky relationship between company profits and wholesale costs that it has deployed a forensic set of accountants to examine the ‘big six’ energy companies in light of their recent price hikes.

So what else pushes up energy rates?

Taxes

One key reason for energy price hikes is the toxic cocktail of state-levied taxes and the commercial drive behind utilities providers.  Take this example from earlier this year.

Remember that unexpected reduction in fuel duty back in the Budget? Well, funding for that cut came from an increase in tax on the profits of North Sea oil and gas companies. One such company that felt the pinch of this hike more than most is Centrica – owners of British Gas. In response to the tax hike Centrica decided not to fully re-open its Morecambe gas field – the largest in the country. The company said that with the new hike, gas from the field would be taxed in total at 81%, making profitability marginal.

The closure of such a facility, that at its peak produced nine million cubic metres of gas a day, obviously hit the wholesale supply side of Centrica as well as British Gas, meaning that if the company was to continue to hit its target profit margins, retail tariffs would have to rise.

But profit levies aren’t the only energy taxes that have been ramping up recently...

Green levies

It’s estimated that green taxes now make up 15-20% of energy bills. Energy consultants Utilyx forecast that by the end of the decade green taxes will make up more than a third of energy bills – up from the current estimate of 18%.

The think-tank Global Warming Policy Foundation also contend that green levies make up between £154 and £206 of the £1,032 average annual household spend on gas and electricity. These taxes sit alongside other schemes implemented by the government as part of its commitment to slash Britain’s CO2 output by 34% by 2020.

For example, all energy providers will have to fit smart energy meters into every home they service before the end of the decade. British Gas began installing the touch-screen meters that wirelessly transmit readings last week. However they stated that the roll-out bill would be footed by future savings (from meter reading staff and estimated bills) and not increased bills.

So why, when taxes play such an important part in energy prices, do providers continue to solely blame wholesale costs for tariff hikes?

Blame game

It’s up for debate why energy providers rarely mention the impact of taxes on rate hikes. But a fair conclusion could lie in a desire by the utilities industry to not make too many (more) enemies.

After all, blaming tariff hikes on government-levied tax rises would not translate well to a financially squeezed public, also being hit by upped taxes, while pointing the finger at green levies would roughly translate as the PR equivalent of stapling a ‘climate change = rubbish’ banner to a polar bear.

Factor in the possible reaction of politicians to such dissent and it becomes obvious why blaming the faceless, ambiguous ‘wholesale market’ emerges as a more attractive reason.

But nevertheless, this does not mean that it is the taxes that are at fault. An environmentally sustainable approach to energy production is obviously needed. Green levies are perfectly justified. However there is a debate to be had about achieving a level of taxation that guarantees both a sustainable and affordable energy sector.

The real problem here is the commercial drive that fuels private energy companies. It is this commercial drive that shuts down gas plants if profit margins fall below a set level; that passes on taxes to the consumer rather dissolving them in profits; and that obscures the relationship between the wholesale and retail prices of gas and electricity through savvy purchasing and trading.

Stem this drive to pull profit out of a product that we all require to live, and you’ll stem energy price hikes.

What’s your take?

Why are energy prices rising?

Have your say using the comment box below.

Thanks to Mark Todd and Marghaid Howie from the utility comparison website energyhelpline.com for information for this article.

More: Six energy firms under investigation for price rises | 100,000 energy customers overcharged | The secret trick you can use against your energy provider

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