October 27, 2013 7:15 pm

Big six energy groups dispute Ofgem analysis of wholesale prices

Environmental levies on energy companies are being reviewed by ministers©Bloomberg

Environmental levies on energy companies are being reviewed by ministers

Britain’s biggest electricity providers show remarkable unanimity on what is the main driver of rising energy bills: the increased cost of buying gas and power on the wholesale market.

It was a theme that turned up repeatedly in the statements SSE, Scottish Power, Npower and British Gas issued to explain why they had put up bills by an average of 9.1 per cent before winter.

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But outside the big six energy companies, there is far less consensus. Figures from Ofgem, the energy regulator, suggest that wholesale costs only went up 1.7 per cent over the past year.

Others agree that something is amiss. “Wholesale prices don’t seem to be going up as fast as retail prices are,” says Jim Watson, research director at the UK Energy Research Centre.

As the heads of the big six and Ofgem prepare to be grilled by MPs about rising bills on Tuesday, the issue of who is right on costs is feeding straight into the debate about the cost of living.

But establishing how much companies pay for their energy on the wholesale market is difficult.

Ofgem bases its estimates on how a representative supplier would buy gas and power in the forward market to smooth out volatility in wholesale prices. It says that according to its central “hedging” strategy, companies start to buy energy 18 months ahead of time.

But the big six say Ofgem’s methodology is flawed, claiming each supplier has different hedging strategies, buying gas and power 12, 18, or 24 months ahead, and so costs vary.

“The Ofgem methodology is at best an approximation of what companies’ hedging profile is,” says Centrica , the company that owns British Gas.

But it is hard to verify the energy companies’ claims, because they do not reveal details of their hedging strategies. Each company has a complex portfolio of contracts – some short-term, some long-term, some indexed to oil prices, others to market prices – and all of them commercially sensitive. Experts say that with energy costs such a politically explosive issue, companies may be forced to open up more to outside scrutiny.

“If you’re trying to explain why your wholesale costs are going up, more transparency is needed,” says Mr Watson of UKERC. “Otherwise it’s very hard to tell whether what they’re saying is true.”

There is little doubt that wholesale costs are on an upward trend. Ofgem says wholesale electricity costs have risen about 140 per cent over the past 10 years with gas costs rising 240 per cent as the UK’s indigenous reserves of natural gas fall and its imports rise.

The UK is increasingly being forced to compete on the international market for supplies of liquefied natural gas: yet rising gas demand, particularly in Asia, means the benchmark price of LNG is nearly 20 per cent higher than a year ago.

However, there is still some uncertainty as to whether the increase in wholesale costs justifies such big rises in retail prices.

The big six are vertically integrated, meaning that they not only supply energy but generate and trade it. Critics say the companies can allocate profits between the three different activities. The big six say profit margins in their retail business are similar to those of big food retailers. SSE says it is “fair” that the annual profit in its energy supply business averages about 5 per cent over three to five years.

Ministers are working on a deal to change the way that some green levies are operated to lessen the impact on consumer bills. Results are to be announced in the forthcoming Autumn Statement.

One possibility is to reduce or scrap the Energy Companies Obligation, which is aimed at helping people insulate their homes. Caroline Flint, Labour’s shadow energy secretary, suggested on Sunday that her party could back such a move, calling the measure “bureaucratic”.

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