Why energy bills should be falling faster

Energy prices are back in the news as politicians call on the energy companies to reflect the oil price fall in their gas and electricity prices.

EoN were first out with a gas price cut, followed by British Gas and now ScottishPower. The Prime Minister claimed this undermined Labour’s price freeze, although just how a cap stops a price cut isn’t really explained. Ed Miliband described the 5% fall as “too little, too late” when wholesale prices were falling by approximately 20%.

As oil prices have more than halved, why haven’t the energy companies been quicker to pass on the savings to consumers?

It is certainly the case that wholesale reductions don’t have a similar impact on retail bills. Primarily because wholesale costs only make up half the average consumer bill. Only 30% of the gas in Europe is now bought on the price of oil, probably even less than that in the UK. Companies also buy a lot of supply in forward markets, up to two years ahead of use. In the longer term, companies will point out that the Autumn Statement says levies on energy companies are set to rise by £6.3bn over the next seven years.

However, falling prices do give some headroom for reductions and there is a suspicion that companies are defending their retail margins after the mild 2013/14 winter. Gas demand was down 10-20% last winter.

A 25% drop in forward wholesale prices for gas should drive at least a 10% cut in retail prices. Ofgem estimates that the supply margins of the Big Six have doubled in the last twelve months, increasing from 4% (£49) in 2013 to 8% (£105) today. The average household’s annual energy bill is now £260 higher compared to 2010 and the poorest 10% of households have seen their energy bills rise nearly twice as fast as other households. Hardly surprising then that Ofgem has referred the energy companies to the Competition regular stating: “We found that suppliers do not adjust their prices as quickly when costs fall compared to when wholesale costs rise… “. Typically masterly understatement from the toothless regulator!

We are also not seeing reductions on the scale expected because companies are more focused on share price than consumers. Every 1% off retail prices cuts around 5% off SSE’s earnings per share. Another by-product of a privatised industry. Smaller companies are able to respond to wholesale price changes more quickly because they have less risk. Another argument in favour of a more diversified ownership model that includes local authority energy generation.

Labour’s solution is to give Ofgem (or its replacement) the power to make energy companies pass on cuts in the cost of oil and gas to bill payers. Ed Miliband said: “Let’s reduce energy bills for consumers. We can do that as well as having this freeze to make sure energy bills don’t rise.”

The SNP has not taken a strong line over the energy companies, but instead have been calling for an increase in the Winter Fuel Payment. Chic Brodie MSP said: “Energy bills have increased by over 37% since 2000-01 and if winter fuel allowance had increased by inflation since 2000-01, pensioners would be £76 better off in 2014-15 than they are”. This allowance is to be devolved to Scotland under the Smith agreement.

Whatever the economics say, Miliband and Osborne both calling for price cuts is going to keep the energy companies spin doctors busy in the run up to the General Election.

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