Energy firms are raising prices, sparking complaints from consumers and government. Are the increases justified? Matthew Partridge investigates.
How fast are prices going up?
Five of the six major energy companies (Scottish Power, British Energy, SSE, British Gas and EDF) have announced large price increases, between 6% and 9%, for both gas and electricity. James Hall in The Daily Telegraph points out that these latest price hikes come on top of years of above-inflation increases.
Indeed, since 2004 “average energy bills have risen by 151%, according to uSwitch.com, the price comparison website”. Hall also notes that, according to National Energy Action, “an estimated 5.6 million households will be in ‘fuel poverty’ next year – defined as those that spend over 10% of their income on adequately heating their home”.
What do the energy firms say?
Energy firms argue that they have been forced to charge more. Angela Knight, the CEO of Energy UK, the industry trade association, has stated that, “We have to wake up to the new energy reality. Prices may still go down as well as up, but the era of cheap energy is over.”
The industry argues that there are four main factors putting pressure on prices. The most obvious of these is that wholesale gas prices, the price that the suppliers have to pay for the raw product, have gone up sharply. Indeed, British Gas estimates that they will be 13% higher this winter compared with the same time last year.
However, this is not the only pressure point. Indeed, the fees that the National Grid charges for the use of its power lines, the second single biggest cost, have gone up by 9%. There are also complaints that environmental regulations now account for 10% of the average bill. Finally, the energy firms point out that they have to reinvest profits into upgrading infrastructure.
Are the hikes justified?
Critics remain unconvinced by these arguments and point out that price rises are a lose-lose scenario for consumers – firms seem eager to pass on increased costs to consumers, but strangely reluctant to cut prices when costs are falling. There are also complaints that the opaque pricing structure, with the biggest six companies offering 80 different packages, makes it hard for consumers to compare prices. But while pricing could be simplified, it’s hard to find evidence of price gouging.
The estimates from the industry regulator Ofgem suggest firms are operating with rolling net margins of about 3.4%. The current price hikes will not make much difference. The problem is that the end of North Sea gas has increased the proportion of gas imported to around 50%, making Britain much more sensitive to increasing world energy prices. Renewable energy sources, such as wind turbines, are also more expensive than conventional fuels (see below).
What is the government proposing?
In response to growing pressure for action, David Cameron has promised legislation, “so energy companies have to give the lowest tariff to their customers”. While he has been criticised for being too vague, his aim is to encourage greater price transparency, making it easier for consumers to shop around, while ensuring that those who decided not to switch are also protected.
Overall, Ed Davey, the energy secretary, has stated that the focus will be on “fewer tariffs and simpler bills”. However, the evidence suggests that any gains from price switching are limited. While uSwitch.com puts the difference between the cheapest and most expensive energy deal on the market at £300, the lowest-cost deals require consumers to commit to fixed prices for two years.
For consumers who buy their energy monthly, and pay online, the potential savings are much smaller. These proposals also do little to address the wider cost-push issues identified by the energy companies, such as higher wholesale energy prices and environmental regulations.
Are things any better in other countries?
The energy companies claims that, while prices may be going up, they are still cheaper than most of their counterparts in Europe. Indeed, Scottish Power contends that “the British energy market is one of the most competitive in Europe”. A recent survey by Ofgem found that London energy prices were significantly below those of other major European cities.
However, the regulator has been criticised in the past for being biased towards energy firms. It admits that the study was based on prices charged last year, excluding the impact of the forthcoming hikes. It also doesn’t take into account differences in taxes.
The Department for Energy and Climate Change reckons that, once these are taken into account, British prices are the fourth most expensive in the EU. The lowest prices are to be found in lower wage countries, such as Portugal, Greece and France, which benefits from its past investment in nuclear power.
The high cost of wind power
Wind power has been one of the main beneficiaries of the drive to cut carbon emissions by increasing the proportion of energy generated via renewable sources. Last year companies were required to generate at least 11.1% of their energy this way, with the amount rising to 15.4% in 2015. The ability to sell renewable energy to firms that don’t meet the requirement provides wind farms with a de facto subsidy.
Yet while wind doesn’t require the large capital investment of nuclear energy, and is more viable than solar power, it is still relatively expensive. This year wind farms are expected to receive more than £1bn in subsidies. Energy firms argue that they are already forced to pass these increased costs onto consumers, and have asked the government to consider reducing, or even scrapping, the subsidy.