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E.ON’s price cut – the reality for business energy

Aeon logomid all the excited chatter of E.ON being the “first of the Big 6” to reduce domestic gas prices, the economically illiterate call from the Chancellor of the Exchequer, Energy & Climate Change Secretary and Opposition Leader to pass on the oil price falls to gas consumers appears to have been forgotten or indeed trumpeted as some sort of triumph.

The analogy of Fiat slashing the price off used 500s and a customer walking into the Rolls Royce showroom asking for a similar discount on a new Wraith is about as close as the relationship between crude oil and UK gas supply get.

They’re both cars, but they’re not exactly the same market Sir. Ergo Oil and Gas, yes they’re both energy sources, but no, their prices are not linked, other than through a minority of European gas contracts and general economic trends.

Yet E.ONs 3.5% cut in the cost of gas was met with much gusto.

But over the last three months gas, as our own BJMMI shows, has fallen by 20% and electricity by 14%, and so E.ON’s paltry reduction pales in comparison and simply reinforces how opaque and greedy energy suppliers really are. Or does it?

In the world of Red Ed Miliband certainly, but with a Conservative Chancellor? Most unusual, except this is an election year and businesses don’t vote.

The truth as ever is more involved, with only 46% of the retail price of gas for businesses being made up of the wholesale price, even a big, prolonged movement will have a more limited impact on the price than one would expect, or the media and politicians would have you believe.

With the suppliers taking just 12% of the cost of gas, yet 23% going to the government in taxes we might not be quite at the level of taxation of petrol at the moment but we’re not far off.

Indeed we couldn’t put it better than Professor Stephen Glaister, Director of the RAC Foundation, who challenged George Osborne saying that:

“An astonishing 70p in every pound we spend at the pumps is now destined for government. Last week the Chancellor again publicly urged fuel companies to pass on oil price reductions to motorists. Clearly he thinks the price of fuel is still too high. Well he has an easy solution. Cut duty further.”

Yet this truism hasn’t stopped the populism, indeed it perversely seems to have encouraged it with Red Ed calling for a vote in parliament as to whether or not Ofgem should have the power to force energy companies to cut prices.

Caroline Flint, Shadow Energy and Climate Change Secretary, said:

“This shows that Ed Miliband was right to challenge the energy companies to cut their prices and pass on the falls in wholesale costs to consumers. But given gas prices have fallen by at least 20% a price cut of just 3.5% looks pretty measly and means consumers still aren’t getting the full benefit of falling wholesale prices.

“The other energy companies must now cut their prices too. MPs must back Labour’s motion on Wednesday and vote to give the regulator the power to force them to pass on the full savings from falling wholesale costs to consumers.”

For their part Ofgem described E.ON’s move as a “step in the right direction” saying:

“We have consistently called for suppliers to explain the growing gap between falling wholesale prices and retail prices… Cutting prices is an explanation that consumers will understand and in a competitive market we would expect others to follow suit.”

With any luck Number 11 Downing Street, the Shadow Cabinet, DECC and Ofgem will have noted the investment briefing from RBC Capital earlier this week that explained the implication of the Big 6 energy suppliers’ legitimate hedging strategies of buying wholesale energy on a 3-year horizon, smoothing energy costs for customers. The investor note explained:

“This [strategy] stops customers from experiencing large swings in energy costs, both up and down. In a declining commodity cost environment this means benefits from falling costs cannot be passed straight onto consumers.

“Therefore, declining commodity costs are bad news for the Big 6 for two reasons. First, smaller suppliers will become more price competitive potentially making further inroads into the big six’s customer base. Second, if the big six are forced to pass on lower energy costs they may then be faced with a tariff freeze post elections which could coincide with commodity prices once again rising,”

Whilst it is clear that wholesale prices HAVE fallen, and have done so over such a prolonged period that some effects of 3 year hedging policies that would otherwise prevent pass through of falls have been mitigated, the fall of 20% on a share of 46% of the retail price would be around a 9.2% drop in the retail price with all other things being equal. E.ONs cut therefore is over a third of this. Not all admittedly but then if we accept that not all hedging effects will yet have washed through this level of reduction could be justified.

We have no evidence of this or its contrary, indeed we have no particular bias on this issue however we do pursue and value a culture of honesty and transparency, exactly what their many critics claim the Big 6 energy suppliers fail to offer, sadly from the latest populist messaging it once again confirms that our politicians are all too similar to those nasty energy companies when it comes to such values.