Outraged by the 889% increase in profits at British Gas? It’s an entirely reasonable view: an operating profit of £969m is one hell of a sum in a six-month period for a regulated business supplying the commodity products of gas and electricity.
But complaints, in the first instance, should be directed towards the regulator Ofgem. The bonanza at British Gas is intended. Not to the precise million, obviously, but a temporary surge in profitability for the whole sector has been blessed from above. EDF Energy and Scottish Power also demonstrated on Thursday that they coined it in the first half of 2023 in their retail operations.
Welcome to the complicated world of “cost recovery” under the clunky price cap mechanism. In short, the suppliers get to recoup the extra expenses they incurred last year by having to supply gas and electricity at a capped price that was below wholesale levels.
Put another way, the formula was not designed for a volatile period in which wholesale price were all over the shop during Covid and during the early months of Russia’s invasion of Ukraine. Parent Centrica says about £500m of British Gas’s £969m profit came via such backward-looking “allowances” under the price cap.
That part of the tale, at least, is relatively easy to follow. But the controversial bit is still to come. If Ofgem’s latest proposals are implemented, there will be a permanent change from October in the price cap formula affecting the so-called “Ebit allowance” (Ebit stands for earnings before interest and tax), the portion of our energy bills that is notionally allocated as profit for an efficient supplier.
Instead of a rigid 1.9% under the old model, there will be a sliding formula that is more generous percentage-wise to suppliers at all price caps under £4,000. At the expected October cap level, the Ebit rate will be 2.4%.
The regulatory justification is that, first, the sector as a whole hasn’t made profits for the four years before the current one; and, second, unprofitable suppliers tend to go bust (30 did during the volatile months), heaping the costs of failure on to bills, which can be more expensive in the long-run. Ofgem was still unforgivably asleep at the wheel in awarding licences to so many grossly under-capitalised companies – a point that should emphasised time after time. But, within the internal logic of the price cap, there’s a case of sorts for allowing a higher return to suppliers.
But there are still big real-world problems. If an averagely efficient supplier can earn 2.4%, the better operators should be able to achieve more. By dint of sheer size, that usually means British Gas, which managed to make profits even in the “down” year of 2022. The market is sitting very pretty.
The other problem is that a “one size fits all” price cap now looks hopelessly out of date. It’s not designed for a “net zero” future of time-of-day incentives and more generation from renewables. And the cap is not equipped for average bills that could be permanently above £2,000, which is unaffordable for many. A social tariff, or some formula to give discounted rates to defined “vulnerable” groups, still looks a sensible way forward, as argued here previously.
Ofgem itself, note, sounds increasingly frustrated by the rigidity of the price cap – a “blunt instrument”, its chief executive, Jonathan Brearley, has called it. But fundamental changes to the cap can only be done by government. In the second instance, that is where to go to complain.
