At SSE, we understand that the profit we make should be fair and reasonable. We also understand that we must earn the right to make a profit, by providing the energy people need in a safe and sustainable way, delivering excellent customer service and investing in the future of energy.
We’ve been very clear about our profits. In our last set of half-year results, we showed a profit margin of just 1.5 per cent from supplying energy. That’s lower than many other essential services, like supermarkets or mobile phones, for example. We’ve also said that our long term aim is to make a reasonable profit of just five per cent.
So it was disappointing to see a front-page splash by The Sunday Times yesterday rather dubiously using Ofgem data to claim that SSE and other energy companies are on the verge of making much higher profits. It must also be very confusing for customers, who are being given conflicting messages.
The Sunday Times piece was based on Ofgem’s Supply Market Indicators. This is a weekly update which includes an estimate for the ‘rolling average net profit margin’ made by energy companies for supplying a typical standard tariff dual fuel customer.
In its latest report, as The Sunday Times observed, Ofgem predicted that this will rise to approximately ‘£110 per household’ for the twelve months from March 2013.
However, analysis shows that Ofgem’s figures have been consistently higher than the actual profit margins reported by suppliers in their ‘segmental accounts’ in recent years.
A quick comparison between Ofgem’s estimates and the segmental accounts – totalled for all major suppliers in 2010 and 2011 – shows that Ofgem’s estimated profit margins averaged £73 per customer over the two years, which is more than double the £30 average actually earned by suppliers per customer during this time.
So what’s causing this discrepancy?
Ofgem’s methodology appears to have a consistent bias towards overstating profit margins. There are a number of reasons for this:
• Customer usage. Ofgem’s calculations use historical consumption figures that do not reflect the ongoing reduction in demand. Using more accurate consumption figures would see the forecast profit margin reduced by £12 per dual fuel customer.
• Energy costs. Ofgem’s methodology for calculating the cost of energy on wholesale markets is based on a simplistic model, designed to estimate an average price for how much suppliers have paid to procure their energy over an 18-month period. But, as Ofgem says itself, this cannot accurately reflect the actual cost of energy paid by a particular supplier. We estimate that using a more accurate model would cut margins by a further £26 per customer.
• Discounts. Ofgem does not factor in discounts for prompt payments in its bill size calculation, for example. We estimate that on average this cuts the bill size by a further £6 per dual fuel customer. Other offers, such as discounted tariffs, are also not reflected in Ofgem’s figures, and are likely to reduce the average profit margin by by another £12.
• Customer bases. Similarly, assumptions are made to weight costs by region, payment method and other factors. This generalised approach means that the assumed costs cannot be reflective of an individual supplier’s customer base.
• Non-energy costs. Ofgem is slow to reflect cost inflation within the government mandated schemes and network charges. For the Energy Company Obligation (ECO), for instance, independent analysis has shown that costs could be anywhere from £15-40 a year per customer more than the Government expects.
Similarly, the cost of Feed-in Tariffs has increased rapidly and we forecast this will be close to £10 per customer per year. Network operators provide long-term forecasts of their costs which could be incorporated into the outlook much earlier. Failing to reflect these cost pressures accurately will also lead to an inflated view of the amount of profits being made by suppliers.
Energy is a fundamental resource and, as a supplier, we have to earn the right to make a profit. It is only right that suppliers’ profits are scrutinised to ensure that the amount of money they make through selling energy is fair and sustainable. But it doesn’t help anyone if customers are given conflicting messages, so clearly more work needs to be done on representing costs and profit margins accurately and transparently.