Energy Firms making bigger AND smaller profits

We have heard a lot recently about how rising electricity and gas prices are a result of the large profits of the energy companies. Ed Milliband went on the attack at the Labour Party Conference, proposing a price freeze if Labour gets into power. With energy prices going up 10% a year I wandered how large these profits must be. The BBC today gives some clues.

Regulator Ofgem says the big six energy suppliers saw profit margins in the supply of gas and electricity rise to 4.3% in 2012, up from 2.8% in 2011.

And the watchdog says supplier profit per household customer rose to £53 last year, from £30 a year earlier.

However, the power generation profit margins at the firms fell from 24% in 2011 to 20% in 2012.

Overall, profits in generation and supply across the half-dozen firms fell from £3.9bn in 2011 to £3.7bn in 2012.

So the retail profits have increased, but the overall profits have decreased. This is despite turnover having increased due a large hike in prices. It is a incorrect to say that the double-digit price increases paid for larger profits of the big six energy suppliers. The following tries to explain why.

Ofgem has not uploaded this latest data to its website, so I have to piece together from what is available. Factsheet 118 details the comparison of 2011 with 2010. It says


•     the average profit margin across all six suppliers for

supplying gas and electricity to homes and businesses

declined from 3.8 per cent in 2010 to 3.1 per cent in


•     the margins in generation, however, increased from

18.4 per cent in 2010 to 24.4 per cent in 2011. This is

because of higher wholesale electricity prices. Typical

generation margins also tend to be higher than in supply

to finance the capital investment needed to build power


A summary of these figures is below

In other words, there is mostly an about face from the very profitable 2011, but still much higher profits than in 2010.

Given that the profits from power generation are much higher, we need to look at this more closely. What should be recognized is the relevant rate of return generation is not ROS (Return on Sales), but ROCE (Return on Capital Employed). An indicator of this can be gleaned from Ofgem’s summaries of the major’s accounts for 2011.

For example, Scottish power has two power sectors. In 2011 it had an EBIT of 168.5 on sales of 1677.0 on “generation” and EBIT of 91.0 on sales of 172.0 on “renewables”. So the older generation has a ROS of just 10%, and the newer, cleaner, renewables a ROS of 53%. To some extent this is not surprising. Renewables – mostly wind turbines – require a huge upfront capital investment, but low operating costs. Also, the renewables capital stock is much newer. But an additional figure is also revealing – the terra-watt hours sold. The “generation” produces £82.60m/TWh, whilst “renewables” produces £101.20m/TWh.

The only other producer to give a split of energy generation is EDF energy, only this time between nuclear and non-nuclear. For nuclear power, the ROS is 40% and £48m/TWh, and for non-nuclear power, the ROS is 10% and £47m/TWh. With Hinckley C, the guaranteed index-linked rate is a minimum £92.50m/TWh.


  1. The large profits are in power generation.
  2. The profits in terms of ROS will increase with new investments, even if ROCE stays the same.
  3. The profits in terms of ROS will additionally increase with the investment in renewables and nuclear, even if ROCE stays the same as initial outlay per unit of electricity is much higher, and the operating costs are tiny, when compared with a coal or gas-fired power stations.
  4. Higher capital investment will mean above-inflation rises in headline profits and ROS, even if the proper measure of profit for generation – ROCE – stays the same.
  5. The responsibility for the Climate Change Act 2008, that generates the higher ROS figures (and much more expensive electricity) is primarily due to the last Labour Government. It was steered through by the then Environment Secretary Ed Miliband. To freeze retail prices will reduce the ROCE of the energy companies, giving a clear signal not to invest in the power generating capacity to stop the lights going out. If you want lower prices and profits, then have a truly liberalized market with fossil fuels given equal status.

Kevin Marshall


NICE Supports Big Business Profits at Expense of Consumers

The impact health watchdog NICE, consisting of non-economists, should be aware of a couple of points of economics when they propose a minimum price for alcohol. (Times and BBC)

First, alcohol is inelastic with respect to price. This is why, like tobacco and petrol, there can be such huge taxes with very little impact on consumption. In particular, those dependent on alcohol, like those dependent on class A drugs will absorb the price hike by reducing expenditure on other things (food and clothes for the children), rather than reduce consumption.

Second, the minimum price would raise the price of all alcohol, with the impact of squeezing shifting demand away from the cheapest varieties. Those who buy premium beers and £5 a bottle wine will see the price of their tipple rise, though maybe not quite as much a the white cider and the cheapest plonk. It is only the drinkers of 25 year old malt, first estate Chateaux Laffite and the older vintages of champagne and port who may not notice the difference.

Third, is to combine these two factors and see who gains. Consumption overall will drop very slightly, but the profit margins on 95% of the market will increase substantially, with the worst of the cut-throat competition eliminated. Add to that proposed restrictions of advertising, that will eliminate potential competition and the biggest gainers will be the retailers and the drinks companies. The losers will be the 99% of consumers who do not reduce total spend on alcohol.

Excessive alcohol consumption is a cultural, not an economic problem. From 1900 to 1930 consumption fell by 70% due to two factors – the temperance movement and the elimination of young men, the heaviest drinkers, in the Great War. It is only by a cultural change that consumption will fall. See my earlier posting here. A small change in price will not save thousands of lives per year. Any economic model that predicts this is flawed.