Our research, Energy Consumers’ Missing Billions, found that consumers are paying too much for the energy networks by £7.5 billion over eight years.
Because they’re natural monopolies, energy networks’ spending is set through a negotiation with Ofgem, the energy regulator. This negotiation is not easy for Ofgem. The companies know more about their costs and can afford expensive lobbyists and consultants. There is a risk, therefore, that these decisions about total spending levels lean in industry’s favour, meaning excess profits and unjustifiably high prices for consumers.
This is exactly what has happened in the RIIO price control. While it’s an improvement in many ways over previous agreements, it’s still not giving consumers maximum value for money.
Under the current system, Ofgem intended the best-performing companies to earn double-digit returns while anticipating that the worst would earn only enough to pay the cost of their debt. Instead, the average company return is 10 per cent and none earn less than 7 per cent. They are forecast to return over £25 billion to investors and creditors in the course of the current price agreement.
This wouldn’t necessarily be a problem if it was all driven by increased efficiency. But our modelling suggests this isn’t the case – in fact, consumers are overpaying to the tune of £7.5 billion over the course of this price agreement. This is because of three key decisions made 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 £3 billion, Ofgem overestimated the business risk for investors in energy networks. They estimated that energy networks are 90-100 per cent as risky as the average company but market data suggested a more reasonable figure would be 60 per cent.
- Second, costing consumers £3.4 billion, Ofgem assumed the costs of raising investment funds (i.e. interest rates and returns for government bonds) would be considerably 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 simply because the costs of staff and materials were significantly lower than forecast.
Energy networks are earning jaw-dropping profits and action should be taken to return this money to consumers. We welcome Ofgem’s recent open letter making clear that the cost of capital is too high and we have made a series of recommendations to ensure this never happens again. But further action is required.
Firstly, network companies have an opportunity to do the right thing. Network companies should voluntarily return money to consumers through a rebate on their bills. This has happened before in the water industry, when similar overpayments were discovered by the regulator.
But if network companies don’t do this, the government must act to make sure consumers get their money back. When many consumers are struggling to pay their bills, it’s unacceptable for companies to be gifted billions in excess profits.