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Latest Ofgem SMI Controversy

Supply Market Indicators

Normally our review of the latest Ofgem Supply Market Indicators is a dry affair with us generally underlining the prevalence of government levies and network upgrade costs as key drivers of the energy price.

We often also point out that Ofgem’s obsession with supplier profit is unhealthy and at times misleading.

This month however we have seen Ofgem’s SMIs brought into the mainstream media and being attacked by all and sundry.

With headlines like “Has Ofgem rewritten history over controversial energy profit estimates”, condemnation of Ofgem’s stance from Energy UK, and direct and vehement criticism from suppliers, Ofgem have had a rough time of it. So much so that Ofgem have even resorted to re-publishing their methodology and writing open letters to their critics.

Firstly though let’s look at the report itself, Ofgem report in their July 2014 SMI that:

  • They estimate that the average annual dual fuel bill will fall over the next 12 months by around £18 or 1.4%
  • That the average bill will fall because of a reduction in expected consumption and not a fall in prices
  • That wholesale prices have dropped markedly over the last 12 months with the gas price 37% lower than July 2013 and the electricity price 25% lower
  • That winter 2014 prices are lower than the winter 2013 prices at the corresponding stage last year by 14% for gas and 7% for electricity
  • That network costs will constitute £298 of the average bill
  • That environmental and social obligation costs will decline to £84 from the £92 forecast of last month
  • That supplier operating costs will be around 4% higher over the coming year than last and finally
  • That supplier profit margin will be 8% of an annual duel fuel bill or £106

It is this latter statistic that has caused the furore.

Suppliers, Energy UK and market commentators have lined up to criticize Ofgem’s apparent obsession with highlighting (incorrectly according to some) the profit level made by supplier which even at it’s Ofgem estimated level is dwarfed by the cost of energy, the cost of network operation and maintenance, and the cost of government levies.

Indeed our own analysis shows that Supplier operating costs including their margin is the smallest element of the 4 main price drivers. With the generators taking 35%, the government 30%, the networks 23% and energy suppliers ‘just’ 12%.

That though doesn’t grab headlines and it appears the industry has finally had their fill of Ofgem’s claims.

Nick Luff, British Gas Business owner Centrica’s Chief Financial Officer, announcing a fall in their own profit levels of 40% said the Centrica’s forecast for the full year was a profit of £50 per customer and that there was no justification for Ofgem’s claims that this level would double in 2015.

Luff said:

“It’s certainly very hard to see that in our numbers published this morning…. the way its [the SMI supplier profit forecast] calculated is not giving the right impression.

“We have 25 independent analysts following the company [Centrica], and if you look at their forecasts for 2015, there isn’t a single one who is forecasting that profit margins will double or anything like that.

“This [Ofgem’s SMI] is a completely different set of numbers.”

Energy UK, the energy suppliers trade body, weighed into the attack calling for customers to receive “clear explanations of profit” and the not the current apparently self-serving headlines dished up by Ofgem each month.

Angela Knight, Chief Executive of Energy UK said:

“It cannot be right to publish numbers and estimates which imply profits which turn out not to exist. Customers are concerned enough about their bills. What we need is an honest discussion on energy, what it costs and how it is paid for. Using estimates that are as inaccurate as these, and which often result in misconceptions and misunderstandings, gets us nowhere.

“At a time when massive investment is required to change how the UK generates electricity to meet the UK’s climate change targets companies have to make a fair profit and customers need to know what they are paying for.

“We all need clear explanations and this should include common definitions of the terms we use particularly when talking about profit, that is left after all costs, investment and taxes, which have been paid. The SMIs are not reliable, are being used in a way that is misleading and must be reformed.”

Dermot Nolan, Ofgem Chief Executive, fresh from his excruciating appearance on BBC’s Watchdog blithely ignored the reality and said that the “rise in margins” (that his organisation alone had calculated) showed that there was “scope for greater competition leading to price cuts”. Again painting the energy suppliers as Ofgem’s favourite bogeyman.

This was too much for some, continued criticism, misrepresentation and scaremongering reached its zenith and the energy supplier bit back.

Centrica’s Luff pointed out that Ofgem had ‘quietly’ marked down similarly excessive claims of 12 months ago:

  • At the start of 2013, Ofgem estimated that pre-tax margin would increase to £120 per customer.
  • Analysis shows energy suppliers’ pre-tax and pre–interest profits actually fell to 4 per cent in 2013 to £53 per customer.
  • This is less than half the Ofgem SMI estimate. The actual audited figures have now been provided to Ofgem.

Anyone can make a mistake but what Ofgem have done feels uncomfortable at best.

In a rewriting of history that has made the industry wince, Ofgem now claim that:

  • Their forecast at the start of 2013 was actually £28 not £120. Patently untrue though that claim is.
  • Their forecast of £90 profit per customer they made in July 2013 was actually £53. Again untrue but interestingly the actual number that energy suppliers audited accounts suggest.

Ofgem claim these retrospective changes were made following complaints of inaccuracy brought by commentators, the energy suppliers and Energy UK.

Let’s just hold that thought.

Ofgem have ‘admitted’ that their SMIs are inaccurate and that the data they have historically provided could not be trusted.

As a result rather than starting afresh with an agreed, transparent and balanced methodology, Ofgem have scurried away to overwrite history and attempt to present a different picture to their forecasts, one that reflects the reality of the recent past but curiously for future estimates sees yet another sudden spike in profit to £106.

Unsurprisingly, the market wasn’t impressed.

Energy UK’s Knight leading the chorus of derision, saying:

“They [Ofgem] should have stood by their £120 estimate and put their hand up and said ‘terribly sorry, we got it wrong’.”

Ofgem in response released their increasingly common defensive statement claiming:

“Our monthly forward look at cost and pricing trends is making the energy market more transparent for consumers.”

This in itself is very much a moot point, transparent is a fine principle, being accurate however would be better.

Ofgem continued:

“Our SMIs help consumers understand what is likely to happen to the different costs that make up their bill over the next 12 months.”

That is the same SMIs with no consistency in methodology, no auditability, and a policy of erasing and re-calculating to suit Ofgem’s current thinking and the actual market movement.

In a bizarre statement that only Ofgem could issue they went on to say:

“We have made this clear that this [their claim of £106 profit per customer] is not a measure of profit but an indicator showing trends.”

That is a ‘trend’ that they have already admitted never existed and that they have resorted to erase from their records each time they are found to have made exaggerated claims about energy supplier profits.

Finally, Ofgem said:

“Consumers need a clear explanation from suppliers as to why, when costs are falling, they are not seeing cuts in energy prices as we would expect in a competitive market. Concerns that savings weren’t being passed on to customers when wholesale prices fall was one of the reasons we have proposed a referral of the energy market to the CMA for investigation.”

That is the suppliers who by Ofgem’s own estimates make up (or take) 12% of the average bill in the costs of supply and profit whilst government levies hit 30% and the cost of network maintenance and operation (which Ofgem sets directly) exceed 20%.

Facts and Ofgem appear to be estranged bedfellows these days. Energy customers deserve more from their regulator.

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