Energy networks making £7.5bn in unjustified profit over 8 years, Citizens Advice finds
Citizens Advice is calling for energy network companies to return money to consumers through a rebate
Energy consumers are subsidising £7.5bn in unjustified profits made by the businesses responsible for the UK’s gas and electricity networks over an 8 year period, new research from Citizens Advice reveals today.
The national charity has published new research which estimates that key decisions made by the energy regulator Ofgem are allowing energy network companies to make billions in returns on their capital investments, without reflecting how efficient they have been.
Consumers pay for energy networks through gas and electricity bills and Ofgem is responsible for restricting the amount of money they get from consumers. It does this partly by making forecasts that limit how much they make over an 8 year period.
Energy networks are regulated monopolies - meaning it is not practical for there to be competition between them to drive down the amount consumers pay. Ofgem forecasts the costs for building and maintaining energy networks - including the cost of staff, materials, and the cost of capital used to finance investment - as well as estimating the level of business risk for investors. Energy network companies’ profits are taken from the difference between their actual costs and the amount that Ofgem allows for these costs.
Ofgem forecasts that network companies will currently earn an average of 10% return for their investors, which is an average 19% profit margin. This is compared to the 4% profit margin earned by the largest energy suppliers.
The regulator has itself said only the best performing energy network operators should be able to make double-digit returns.
In its new report, Citizens Advice finds three key decisions by Ofgem that are costing consumers money by being favourable to energy network companies’ interests over the current 8 year period - called a “price control”:
First, costing consumers £3bn, Ofgem overestimated the business risk for investors in energy networks. They estimated that energy networks are 90-100% as risky as the average company but market data suggested a more reasonable figure would be 60%;
Second, costing consumers £3.4bn, Ofgem assumed interest rates and returns for government bonds would be higher than they were;
Third, costing consumers £1.1bn, the financial incentives Ofgem has put in place to reward efficiency - such as allowing energy network companies to keep some of the underspend on projects as profit - actually rewarded companies that inflated their initial estimates for the cost of staff and materials.
Citizens Advice is now calling for energy network companies to return this £7.5bn to consumers. Ofgem could work with the networks and suppliers to make sure the rebate is passed onto consumers through lower energy bills.
This would be similar to action taken by the water regulator Ofwat in 2013. Ofwat worked with water companies to return £435m of excess profits to consumers, out of a windfall of around £1.2bn over the course of their price control.
Gillian Guy, Chief Executive of Citizens Advice, said:
“Energy network firms are enjoying a multi-billion pound windfall at the expense of consumers.
“Decisions made by Ofgem have allowed gas and electricity network companies to make sky-high profits that we’ve found are not justified by their performance.
“Through their energy bills, it is consumers who have to pay the £7.5bn price for the regulator’s errors of judgment. We think it is right that energy network companies return this money to consumers through a rebate.
“If energy network companies fail to return these unjustified profits to the consumers that paid for them then the government should consider stepping in.”
In addition to asking for a rebate for consumers, Citizens Advice is calling for Ofgem to learn lessons and reduce costs for customers when designing the next price controls for energy networks.
Notes to editors
- The £7.5bn estimate has been calculated using Ofgem’s Price Control Financial Models, RIIO Annual Reports, OBR/ONS inflation data and Bank of England data on daily real returns on Government bonds as an estimate of the risk-free rate. These were combined in Citizens Advice’s own price control model. Citizens Advice made adjustments to five key financial variables (the risk-free rate, the equity beta, cost of debt allowance, totex and other incentives) to better reflect actual market conditions and Ofgem’s aspirations when it set the price control.
- Citizens Advice’s model provides a range of estimates, depending on the scale of the adjustments to these variables that are made - £7.5bn is the medium savings estimate.
- The estimate of energy networks earning an average 10% return on capital over the course of the price control is calculated from Ofgem’s RIIO Annual Reports.
- The estimate of energy networks earning an average profit margin of 19% is taken by dividing the total equity returns by total revenue in Ofgem’s Price Control Financial Model. The Competition and Markets Authority estimated that the six largest energy suppliers earn a 4% profit margin.
- The Citizens Advice service comprises a network of local Citizens Advice, all of which are independent charities, the Citizens Advice consumer service and national charity Citizens Advice. Together we help people resolve their money, legal and other problems by providing information and advice and by influencing policymakers. For more see the Citizens Advice website.
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- You can get consumer advice from the Citizens Advice consumer service on 03454 04 05 06 or 03454 04 05 05 for Welsh language speakers.
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