UK energy companies get their retaliation in first

 

Energy companies are blaming government policies for increasing the price of domestic energy and gas. They say that the regulations that force them to buy renewable electricity and alleviate fuel poverty are having a huge effect on home energy costs. But I show in this article that the full impact of these policies is no more than 6% of average household bills in 2012 and this number will probably only rise marginally in 2013. The published justifications for recent price rise imposed by the Big Six UK energy companies on domestic users substantially exaggerate the effect of government regulations to reduce carbon emissions and improve household heat loss.

This article asserts that the scale of the price rises imposed increase seems to be driven not by the likely level of costs in 2013 but rather by two decisions made by the energy companies. First, their choice to load the costs of government policy on to domestic – rather than commercial – users and, second, to recoup their unexpectedly high expenditures on home insulation in 2012 by levying increased prices on homeowners in 2013. These are highly contentious points and I approached three of the Big Six to discuss them in detail. None returned my calls or emails to the press offices. I’m nevertheless providing the incomplete analysis in this article because I believe that the energy companies are – consciously or unconsciously – stoking up unjustified public resentment about the impact of carbon saving measures. This threatens public support for continued action to reduce greenhouse gas emissions.

The background

The big utilities – bar E.ON – have now announced price rises coming into force for November 2012 onwards. The typical percentage change for homeowners is said to average about 9%, although no outsider is able to check this figure because of the complexity of the charging structures used by the companies.[1]

The justifications used in the companies’ press releases are superficially similar: higher costs to implement government schemes, increased wholesale energy costs and more money spent on distributing the energy to the home.

The suppliers all agree on the increase in distribution costs. They say this element of a customer’s bill has risen by about 10%. It now  represents about a quarter of the bill. Estimates of the increase in wholesale energy charges, which are about half the bill, vary dramatically. Scottish and Southern (SSE) says they have gone up 14% while npower suggests the figure is 5%. Scottish Power is in the middle at 8%. EdF says gas costs have risen by 5% but electricity is much more expensive than last year.

These are big differences but the real surprise lies in the third explanation for the need to increase the bill. The costs of what are usually called something like ‘environmental and social charges’ are, on average, said to be about 10% of the total bill, although this varies from 20% (British Gas’ stated figure for electricity) to 4% (EdF’s estimate for gas). These costs include the following elements.[2]

Scheme Purpose of the scheme
Renewable Obligation Certificates for Electricity To encourage the production of large scale renewables
Feed In Tariffs To encourage the production of small scale renewables
CERT To improve the insulation of houses and reduce energy consumption in this and other ways
CESP To improve the insulation of houses in the most deprived parts of the UK
Warm Home discount To reduce the bills of the most vulnerable households

 

Scottish Power and SSE say that costs they have to bear that are imposed by government have risen by about 30% while npower claims that costs in 2013 will ‘be approximately double’ the figures for 2011. The company places this explanation first in the list of why prices have to go up. There is no consistency about any of these figures, even though the companies are all under exactly the same obligations.

The companies’ press releases about their price rises reflect their apparent irritation with the government schemes, particularly the CESP and CERT.

Why are the companies complaining that ‘environmental and social charges’ are increasing sharply?

The costs of providing each of the five programmes in the table above are published by government bodies, at least in estimated form. The following table gives the estimated costs for the years 2012 and 2013. (I have adjusted the cost of the Feed In Tariffs upwards because I believe latest figures show the published estimate to be significantly too low).

Scheme Approximate 2012 cost

Approximate 2013 cost

Renewable Obligation Certificates for Electricity £2,055m[3] £2,456m
Feed In Tariffs £300m[4] £450m
CERT (‘ECO’ in 2013) £1,300m[5] £1,300m
CESP £100m[6] 0
Warm Home discount £250m[7] £265m
TOTAL £4,005m £4,471m

 

The expected rise in 2013/14 is about 12% above the figure for the financial year finishing in April 2012. Not the 30% or 100% quoted in energy company press releases.

Let’s also calculate what should be the impact on the average domestic bill of these five different schemes.

  • Assume that the £4.5bn ‘social and environmental’ costs borne by the utility companies in 2013 is recouped equally all units of energy supplied by gas and electricity companies. (This, broadly speaking, is the assumption made by the government when it calculates the cost of carbon cutting and insulation schemes).
  • About 38% of electricity sold in the UK is supplied to domestic users. About 65% of gas that is supplied to final users (ie excluding sales to power stations to be used to convert into electricity) is sold to households.[8] (Combine these two figures and just less than 50% of all units of gas and electricity sold in the UK are supplied to homes.)
  • ROCs and Feed In Tariffs only relate to electricity. So the cost of these schemes should probably be ‘smeared’ (the technical term for spreading a cost across users) according to the share of electricity consumption
  • Other costs relate principally to gas use. The cost should be allocated according to the share of gas supply.
  • Multiply these numbers together and the 2013 ‘social and environmental costs’ borne by domestic users should be about £80 per household, up from £75 in 2012.

 

Scheme Share borne by households Cost per household in 2013
ROCs 38% £35
Feed In Tariffs 38% £6
ECO 65% £32
Warm Home Discount 65% £6
Total £80

 

To put this figure in context, £80 is approximately 6% of the average 2013 bill of a domestic customer, assuming the current prices remain for the entire year. This compares with the 10% figure proposed by SSE and the 16% or so estimated by British Gas. (I suspect that BG has lumped VAT into its ‘governmental charges’ and the real figure it wishes to use is 11%. My call to the BG press office about this was not responded to).

British Gas also provides an estimate that in 2013 the cost of Government social and carbon policies will add £40 to the average domestic bill. (Please see the last paragraph of note 6 in its price rise press release of 12th October 2012. http://www.centrica.com/index.asp?pageid=1041&newsid=2588). This is an inexplicable exaggeration and cannot be justified by any prospective costs. Nor can Scottish Power’s figure of a 34% increase or npower’s 30% estimate. EdF is the only supplier of the five companies that have increased prices that doesn’t exaggerate these costs.

It therefore seems to me that the utility suppliers are doing two things. First, they are loading far more of the cost of their obligations on to domestic suppliers than can be justified. In the case of British Gas it appears that the company has pushed all these charges onto domestic users. This means that industrial and commercial suppliers are paying relatively less. Second, they are justifying high levels of increase in domestic prices by reference to very high levels of prospective increase in carbon and fuel poverty mitigation costs. These increases will not in fact occur.

Why are the energy companies acting in this way? The loading of the cost of government policies entirely on to domestic users has two possible rationales. The utilities know that large users find it easy to switch suppliers and so their prices to these customers have to be keen. Few, and decreasing, numbers of domestic customers switch and it is therefore easier to offload the costs of government policies onto them. Competition for large commercial customers pushes the prices for large users down and smaller customers are paying the price.

The second possible rationale is that the energy companies are seeking to avoid public criticism of their pricing increases. By blaming government for 10% or more of the domestic bill (and giving this group of costs far greater prominence than the much larger portion of the bill represented by distribution expenses for example) they are seeking to distract consumer groups from focusing on the energy companies themselves.

It’s also a possibility that the energy companies seek to exaggerate the financial implications of government policies because they are unhappy with the drive towards renewable energy. Permission to engage in a ‘dash for gas’ power, rather than building wind farms, biomass plants or nuclear power stations, would give them a much easier life, at least for a few years.

These are the possible explanations for why they exaggerate the absolute size of the charges the government forces them to bear. But why have they separately overestimated the rate of increase in these costs in 2013? Here I think we have to look at the problems the energy companies have had over the past couple of years in meeting the government’s requirements for home insulation under the CERT and CESP rules. Both schemes demand that the electricity companies use their cash to reduce carbon emissions from homes, initially mainly by filling cavity walls and now by solid wall insulation.[9] Each successful home insulation is awarded a certain number of tonnes of CO2 and the companies have to provide evidence of meeting a target CO2 reduction over the course of the scheme.

The cost of achieving these targets has risen sharply over the course of the last year. CESP, in particular, requires that most savings are achieved in areas of high levels of financial hardship. The companies complain that identifying and persuading homeowners to take insulation is increasingly costly. The schemes are burdened with expensive bureaucratic requirements, they say, making it difficult even to get initial approval for proposals to work in specific geographic areas. These are reasonable concerns. They haven’t provided the data for outsiders to assess their assertions but the massive flurry of marketing spend (incidentally including three spam calls to my  office in the last 48 hours) to try to meet the 2012 deadlines for carbon saving must be breaking the government’s £1.3bn 2012 budget for the CERT scheme.

SSE says that the cost of insulation measures have ‘more than doubled’ in the last year and ‘are continuing to increase’. ‘Energy suppliers (are) compet(ing) for the limited number of opportunities that will enable them to meet their targets ahead of the December 2012 deadline’. The problems of cost inflation in the provision of domestic insulation in 2012 were probably not predicted by the energy companies and this year’s profits will have been knocked, perhaps badly.

But will this inflation continue in the way that the energy companies are asking us to believe? January 2013 will see the complete replacement of the CERT and CESP schemes by the ‘Green Deal’ and the ECO. The Green Deal will involve no net cost to the energy companies, or to their customers. The budget for ECO, which will cost the utilities and thus their customers’, is set at the same level as this year’s CERT cost – around £1.3bn. From the energy companies’ point of view the crucial change is that next year’s money is required to achieve far lower carbon savings than CERT. Next year, the figures I have seen suggest the number will be less than a quarter of the 2012 saving.

ECO is focused on insulation of homes without cavity walls and the companies will concentrate on finding older homes with brick or masonry walls and no cavity between the external and internal surfaces. The UK has about 7 million of these – any home built before about 1925 has solid walls. Under the new ECO scheme, the utility industry has to reach a couple of hundred thousand of these houses each year and install internal or external insulation. External insulation is very expensive, costing over £10,000 in some cases compared to a few hundred for filling a cavity wall. The carbon savings are larger but only by a factor of perhaps two or three.

The energy companies have accepted the principles behind the new scheme but, scarred by the cost inflation of the last six months in cavity wall insulation, they have sought to increase domestic energy prices by a sufficient amount to meet any conceivable unbudgeted increase in solid wall work. In the language of city centre Saturday nights, this is called ‘getting your retaliation in first’.

Perhaps we should see this as properly conservative financial management. But I’m tempted to suggest that the companies are also trying to recoup from customers this year’s unbudgeted costs by exaggerating the likely costs of next year’s schemes. Second, I suspect that by engaging in apocalyptic talk about the costs of ECO they are seeking to give ammunition to those politicians who want DECC and Ofgem to reduce the emphasis on carbon reduction targets. CERT and other schemes have been nothing but trouble for the Big Six, and by  publishing estimates of cost inflation such as npower’s forecast that costs will be ‘approximately double’ in 2013 what it was in 2011 they may hope to get some aid from sceptical politicians. And several newspapers are only too willing to swallow the line that carbon reduction is adding many hundreds to householder bills.

To summarise: the costs of ‘social and environmental’ programmes are a small fraction of the customer’s bill, nothing like the level estimated by most of the Big Six. (In particular, the subsidies for renewable electricity are no more than 3% of an individual bill). The companies appear to be loading almost all the government-mandated costs on to domestic customers, rather than spreading them among all users. Supporting more renewable generation will mean that ‘environmental’ costs will rise in the future, but at a far lower level than suggested by the suppliers. The shrill warnings of cost inflation in the future in the provision of home insulation are a response to unbudgeted losses in 2012 rather than carefully constructed forecasts of the costs of implementing ECO in 2013. If the costs of ECO turn out to be in line with what the government and other third parties currently believe, we are all due a substantial rebate in 2014. We are unlikely to get it, of course.

 



[1] In fact, even the companies cannot work out what the percentage price rise is, or what the average customer bill is likely to be. Prior to its September 2011 price rise SSE (Scottish and Southern) said the industry standard calculation meant that average dual fuel customer would pay £1,265 a year in 2012. It reduced its average gas bills by £28 in early 2012, implying an average cost of £1,237. But in its most recent pricing press release it wrote that the calculation showed its customers paying £1,172. These figures are all on the basis of the standard assumption of 16,500 kWh of gas and 3,300 kWh of electricity used in the average household.

[2] I have not included emissions trading certificates under the EU ETS as they should be part of the wholesale cost of the wholesale electricity purchased by the supplier.

[3] August 2012 Parliamentary Briefing Paper by Dr Elena Ares at http://www.parliament.uk/briefing-papers/SN05870. I have calculated the figures for the calendar year by  assigning 2011/12 one quarter to 2012 and three quarters to 2011.

[4] This is my estimate based on the Ofgem figure for the cost of FIT payments in the latest published quarter (April-June 2012). Dr Ares uses a much lower figure for 2012/13 and onwards that I believe does not fully reflect the likely payments.

[5] CERT will cease on 31st December 2012 to be replaced by the Energy Company Obligation (ECO). Government estimates that the cost of CERT will be about £1.3bn in 2012. The press release at http://www.decc.gov.uk/en/content/cms/news/pn10_075/pn10_075.aspx suggests a figure of £2.4bn for the period March 2011 to December 2012. The energy supply industry organises the installation of insulation or improved heating measures and is allowed to reclaim the cost from all its customers.

[6] CESP is a much criticised scheme that targets homes in the poorest areas. Like CERT its aim is to improve insulation and energy consumption. The costs are borne by the energy companies. It will cease on 31st December 2012 and not be directly replaced, though ECO is partly also directed at the poorest households.

[8] Figures from http://www.decc.gov.uk/en/content/cms/statistics/energy_stats/source/total/total.aspx. Converted from Thousands of Tonnes of Oil equivalent.

[9] Emissions reductions caused by replacing old and inefficient boilers are also allowed.

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