Does the concept of “investment” apply to retail? A key part of the intense political scrutiny of UK energy retail prices and profits is a call for greater transparency. Companies have provided standardised segmental accounts to the regulator over the past four years and Ofgem is consulting on ways of improving transparency further. There has been much talk about trading revenues and transfer prices, but is there a more fundamental problem with traditional retail accounts?
Centrica’s annual report states that the British Gas Residential energy supply segment made an operating profit of £606 million in 2012 on average capital employed of £212 million. Is this excessive? Some energy retailers are currently offering fixed-price deals to customers at price levels that could imply accounting losses. Is this dumping upstream production below cost or investing in customer growth? The answer to both of these questions depends on whether you think traditional accounting standards deal adequately with the financial realities of retail.
As the Competition Commission highlighted in its Inquiry into the aggregates industry, the asset value given by historic cost accounts might be less appropriate to consider than the replacement cost of equivalent assets to a new entrant.
Could a new company entering a competitive energy retail market establish a business equivalent to British Gas with IT systems, contractual positions, branding and over 15 million accounts for an investment of £212 million? If not, then perhaps the accounts understate the asset on which investors in British Gas can legitimately expect to earn a return.
Do retail customers have any ongoing value in a competitive market once they have signed up? If so, then perhaps it is legitimate to offer attractive deals to win new customers, even if this results in short-term accounting losses.
Such accounting discussions may seem abstract but they go to the heart of establishing what a “fair” level of profit is in energy retail. If the concept of investment and value has no place in retail then it will be seen at best as a breakeven route to market for upstream production. Utility retailers need to show why a competitive customer business has a value that goes beyond the numbers shown in their reports and accounts.
Martin Brough, utilities equities analyst,
Deutsche Bank