In the latest in our series analysing the responses of key players to the CMA investigation into the UK energy market we again focus on the market commentators and their thoughts on the underlying problems of the energy market.
Three main themes emanate from the comments:
- The market structure,
- the transfer price and
- energy company profits
Unusually there is consensus amongst all commentators, they all report that something indeed is wrong with the market for us to find ourselves in this situation but not necessarily in the way one would expect.
MARKET STRUCTURE
It’s a forlorn hope for the CMA investigation not to turn into a Big 6 energy supplier bashing exercise given it is inevitable that people’s ire will be focussed in their direction.
Indeed given the Big 6 – Centrica (British Gas), SSE, Scottish Power, EDF Energy, E.ON and nPower -are estimated to supply 95% of the domestic energy market, and generate around 2/3 of the nation’s electricity needs it is no surprise that all the market’s ills are laid at their door.
We have said before however that just because they’re big doesn’t mean they are bad, and just because they’re vertically integrated does not mean they are a cartel, in the same way that just because a supplier is new or small does not necessarily mean they are a paragon of virtue.
The Big 6 themselves defend their model, which to a greater or lesser extent is mirrored across them all, by arguing that it is their ability to ‘balance’ the supply (of generated energy) and the demand (of their customer base) in an efficient and cost effective manner that delivers a better market to their customers.
Nigel Cornwall, from Cornwall Energy, the energy consultancy however counters that the dominance of the Big 6 is the sign of an uncompetitive market, saying:
“In most markets, such as insurance or telecoms, you will see fewer larger players and more intermediate players.
“This is what happens in properly competitive markets without cost barriers. We clearly do not have that in energy.”
“The independents’ growth is potentially very brittle, there is a risk that independent suppliers go bust if wholesale markets become more volatile, while customers of integrated companies are at less of a risk.”
The underlying cause of this lack of competitiveness in the vertically integrated model is the ability for large businesses owning both generation and supply capacity to shift profits from one side of their organisation to the other to thereby ‘hide’ their true profitability.
It is alleged that this enables cross-subsidy whilst reducing liquidity and raising costs for non-vertically integrated supply businesses. The crux of the complaints is the existence of opaque ‘transfer prices’ amongst the arms of vertically integrated suppliers.
TRANSFER PRICE
It is the alleged existence of ‘secret’ transfer pricing that Ofgem and the CMA are keen to investigate and understand.
For their part the Big 6 claim, somewhat unconvincingly, that it is only a relatively small amount of their generation capacity that is sold internally with the remainder being sold on the wholesale market at competitive prices.
The reaction from independent suppliers to these claims can safely be described as ‘disparaging’ with Darren Braham, Finance Director of First Utility, the Warwickshire based energy supplier, saying:
“I do not know how they can justify claims that they only self-supply a small fraction of their power.
“It’s difficult to know what the[ir] true level of profits are because it’s very easy for the Big Six to move the number around.
“If wholesale prices had been going up instead [of down over recent months], it would have been harder for independent suppliers to be competitive.”
Indeed independent suppliers accuse the Big 6 of not only shoring up their own portfolio with their self generated electricity but of overcharging for that power which does ultimately make it onto the wholesale market.
Ultimately the argument boils down to one of profit, and what is reasonable and fair, against what is manipulative and destabilising.
PROFITS
Unsurprisingly therefore the relative profits of the Big 6 energy suppliers face direct scrutiny under the CMA investigation. Yet the companies themselves argue that their profit levels achieved are marginal, in line with other industries and crucially are a deserved commercial reward for the investments made and the risks managed by their businesses.
It is an uncomfortable conversation to criticise a business for making profit from legal activities and something that Business Juice prefer not to do, however if wrongdoing is proven and market manipulation is discovered then clearly accepted protocol changes.
Commentators note that the Big 6 energy companies’ traditionally targeted pre-tax profit margins of between 5% and 6% have diminished over the last half decade to around 3% or less. The companies themselves make clear that not only is this reward for ‘risks’ taken but also essential to ensure reinvestment in new generation capacity. Objectively 3% is not a spectacular bottom line number, however it is the scale of the businesses and their huge customer bases that ramp up the pound note figure of final profits. And it is the suspicion that the 3% is a whole lot more once the transfer price is smoother out that rankles with many.
Defending the level of Big 6 profits John Feddersen, from Aurora, an energy research company said:
“Retail profits are in line with comparable industries, given the inherent risks. Suppliers are earning pretty reasonable margins, given the risks they take, being exposed to wholesale energy markets. But they have still drawn criticism from politicians.”
And Peter Atherton, an analyst from Liberum Capital, added that the fear of the CMA investigation and the political hot potato that energy has become has led the Big 6 companies to lose their bearings and begin to manipulate their profit margins to lower levels in order to escape the worst of the sanctions ostensibly for running successful businesses.
Atherton said:
“Industry is sucking up some of the costs — it’s self-imposed discretion.”
Whatever your opinion on the current state of the market it cannot be encouraging for traditionally ‘safe-bet’ companies appearing to be so disorientated by and fearful of political oversight.
Chairman of the cross party Energy Select Committee, Tim Yeo, has highlighted this dichotomy saying:
“Companies have got to act in a rational way in the interests of shareholders. I expect them to make profits.
“If there was a properly competitive market and companies were operating in a transparent way and people could switch companies, they should be able to make as much money as they can get away with.
“I have a problem with a non-competitive market.”
And therein lies the nub of the issue, despite headlines to the contrary the existence of profitable businesses is not the problem, far from it, indeed it is essential to the health of our nation and our very well being that we have successful and profitable businesses.
However it is the perception of dishonesty or obfuscation that is the real cause for concern.
It is that, and not the achievement of profitability, that needs to be the focus of the CMA investigation and its commentators.