Gas Attack

by Prof Ryan Spox

Things that annoyed me today:

Mostly it was the vexed question of energy pricing. Yes, yes, we know that sounds like a topic for discussion by those voodoo priests of pseudo-science, the economists but, with the nights drawing in and winter fast approaching, energy prices are a subject close to every Briton’s frigid little heart.

In particular, there were three items of energy-pricing-related news that annoyed us this week. The first, and simplest to deal with, is BritGov’s heroic plan to cut back our national carbon emissions, reduce traffic congestion and cut the annual road death toll by the simple expedient of adding an extra 3p to the roughly 75p tax already payable on every litre of petrol and diesel sold in the UK. (Fuel Me Twice…) Now, we do understand the argument that, in order to function a government needs money, that the easiest way to get that is through taxation and, if a government is going to tax anything, it ought to be something you do that, at least potentially, harms other people. So taxing vehicle fuel makes some sort of sense. (Although, if the intention really is to discourage you from your anti-social driving habits, it does leave the question of how your government will raise funds in the future.)

Anyway, we understand why they tax fuel, even if we don’t necessary agree with the rates at which they tax it. What we do find difficult to stomach is their intention to slap this extra 3p on each litre at a time when the oil industry has been playing merry havoc with the price at the pumps which goes up and down all the time, but mostly up. Given that we already have some of the most expensive fuel in Europe, if not the world, and no-one can afford it at its current price, for either personal or business use, it seems unnecessarily harsh to us to slap an extra 3p on the price just because young Gideon Osborne can’t figure out how to balance his spreadsheets. (Hint to Gideon – balancing a national budget is one of those areas of life where your 2:1 in Modern History isn’t the most useful training you could have had. If only you’d done 1/3 of an Economics degree, like your boss, that Nice Mr Cameron.)

Next on the agenda is the – rather unsurprising – accusation that big energy companies have been conspiring to fix the wholesale price of gas (Gas Leak). The details are excruciatingly boring but, in the proverbial nutshell, this is the energy equivalent of the recent banking LIBOR scandal – speculators are conspiring to fix the wholesale price of gas in a manner that is most advantageous to them, allowing them to make savings that they then don’t pass on to their customers because that, frankly, would be madness. How else is an ambitious city-bound wide-boy supposed to turn an honest profit, if not by breaking the law? Naturally, all six of the UK’s leading energy suppliers deny any knowledge of, or involvement in, this activity.

A cynic might suggest that this is about as valid a protestation of innocence as the various highly-paid banking wünderkinder’s denials of any knowledge that the banks they were being paid a fortune to run were illegally fiddling with the LIBOR rate. We are not such a cynic, if only because we are not entirely sure of the extent to which any of these suppliers are directly involved with wholesale gas prices which, to a large extent, owe most of their price fluctuations to profit-seeking speculation by commodities traders. (You know how it works – buy at this price, sell at that, make a profit – or a loss – whilst contributing nothing of any tangible value to any human activity yet still clinging to the forlorn hope that – somehow – “economic activity” is not bound by the Laws of Thermodynamics.)

Although we were amused by the statement from Energy UK, the  industry’s representative body that its members would:

“co-operate fully to rebuild trust.”

Hmm. So not to investigate wrong-doing? Or to ensure prosecution of the guilty? Or even to guarantee that all savings are passed on to the customer? No, they’ll just co-operate in order to rebuild trust. Is this because, if the consumers don’t trust you, they’re harder to scam? Good to know where the industry’s priorities lie.

Bizarrely, the BBC article linked to above went on to tell us that:

“The cost of wholesale gas makes up the majority of our energy bills – 45% of the average energy bill is made up of the cost of wholesale gas, supply costs and profit margins.”

That’s not really a very useful fact. How much of that 45% is wholesale cost as opposed to supply costs and profit? It could be 40% profit and 2% wholesale for all we know.

Which leads us to the icing on the cake – SSE, one of the UK’s afore-mentioned big six energy suppliers, announced that its half-year profits for the six months to the end of September are a stunning 38.3% up on the same period last year. (It’s a Gas, Gas, Gas!) (Obviously, as they are a socially responsible wholly British company, we can assume that they will be paying the full 24% corporation tax on that profit.) Now, we fully understand that it is a fundamental tenet of the capitalist system that companies must make profit and we also understand that publicly-traded companies (i.e. those whose shares are flogged on the Stock Market) have a legal obligation to make profit in order to benefit their shareholders who receive their share of the profit in the form of dividends. However, we are, we confess, a little confused as to how they managed to increase their profits to this extent when – price fixing not withstanding – the price of their raw material (e.g. the gas they either supply directly as, well, gas, or which is used to generate at least some of the electricity they also supply) has been going up.

Now, obviously, so long as your entire business model isn’t based on selling stuff for less than you paid for it, you can generate a bigger profit by shifting more units, which is to say, selling more gas or electricity, but this seems unlikely over the six “spring and summer” months, regardless of how bad they were this year. So, you can also generate extra profit, by putting the price up, which SSE, like everyone else, has certainly done recently, but that 9% price hike doesn’t seem to explain the vast 38% profit rise. Oh, unless they are actually paying less for the raw material they are selling to you at an inflated price. Which can’t be the case because they keep telling us that the wholesale price they pay is rising and, unfortunately, they have no option but to pass that price rise on to the end user (i.e. you).

And yet… curiously, SSE’s own chairman, Lord Smith of Kelvin, justified this massive increase in profits by saying that:

“higher gas and non-energy costs unfortunately had to be reflected in the increase in household energy prices”.

Which might be true but, as we have said above, doesn’t really explain how a rise in wholesale prices that triggers a rise in retail prices produces a rise in profits of more than 4 times the percentage increase in the retail price.

Confused? Well, let us explain.

SSE is, at heart, a retail business and any retail business gets its income by flogging stuff to consumers. The business earns money (let’s call that Money Earned) by exchanging its products for the customer’s hard-earned cash. But the business has a variety of costs associated with that process – the price it paid for whatever it is selling, the cost of storing and transporting said products to the point of sale, the cost of staff salaries, of rent and utility bills on premises and so on.  Let’s call that Money Spent. As the old adage has it, you have to spend money in order to make money and the profit you make is simply given by:

Profit = (Money Earned – Money Spent).

A simple calculation which is not entirely unfamiliar to the average household budget-keeper.

Now, for the SSE case, things are a little muddy because they supply both gas (which is directly affected by changes in the wholesale gas price) and electricity (which is bought from electricity generating companies who may be burning gas to generate their product). So, let’s restrict ourselves to the simplest case – the direct supply of gas to consumers. We confess that we do not fully understand exactly how many cost-attracting processes are involved in the long journey from an underground gas reservoir via a gas-pipeline, a storage tank, miles of smaller pipes and a few pumping stations to the unlit stove-top burner you only remembered as your Ryan Air flight landed in Majorca but, for the sake of illustration, let us assume that the Money Spent by SSE per unit of gas delivered covers more than just the wholesale price they paid for the gas, with the rest being composed of the cost of storing and transporting the gas, delivering it to you, administering the whole process and paying all the salaries and other costs required to support everyone they employee in their entire business. On top of that they add a modest Profit, to make it worth their while, and we thus find the price they need to charge you, the consumer, for said unit of gas. Let us be generous and speculate that a rather high 30% of the price they charge you is down to the wholesale price they paid for the gas.

Now, to keep the arithmetic simple and stop your heads exploding, let us assume that this mythical unit of gaseous power is sold to you for £1.00 which, of course, includes their profit on the sale. Accordingly, of that £1.00, 30%, which is to say, 30p, was the wholesale price of the gas. So if that wholesale price rises by, say, 10%, then the gas now costs 33p which means, in order to maintain exactly the same level of profits, SSE needs to charge you £1.03 for that precious unit of heat and light-delivering methane. That, in case, you hadn’t realised it, is a mere 3% price rise.

We concede that a more sophisticated analysis, if we could be bothered attempting it, would not only uncover more accurate figures for all these stages but also allow for a variety of other real-word factors, such as the extent to which the transport, storage, delivery and administration stages all, themselves, involved some use of the energy which has just got a little more expensive. It might even take into account that SSE’s business includes delivering electricity to your door, as well as gas, and that not all the ‘leccy it sells is gas-generated. But, frankly, supplying that level of detail would require an entire book, or possibly a Parliamentary Inquiry. Beside, accuracy is not required in order to make the important point: a given rise in the cost of raw materials does not translate directly into an equivalent (or greater) rise in the cost of getting the “finished product” to the consumer.

You might want to mull over the fact that the same simple logic applies in other energy-related products. Thus, a 10% rise in the price of a barrel of crude oil does not remotely justify a 10% rise in the forecourt price of petrol.

So, we find it a little hard to make sense of the final utterance by the arithmetically and analytically challenged Lord Smith of Kelvin, who went on to say:

“While some observers may choose to criticise SSE for making a profit and paying a dividend I believe that profit and dividend allow SSE to employ people, pay tax, provide services that customers need, make investments that keep the lights on and create jobs, while providing an income return that shareholders like pension funds need.”

An amazing statement which is mostly complete bollocks, as we have shown above. Why is this man in a position of responsibility with an important utilities company when he clearly does not understand that profit is what is left after you have met all your “running costs”, which includes the “employing people, investments and job creation” parts of that statement while the “providing services that customers need” part is, in fact, being directly paid for by the customers?. That profit is then taxed by a grateful government (at a standard rate of 24%, as we would like to remind SSE’s accountants) and what’s left is the “after-tax” profits which can then be paid to shareholders in the form of a dividend.

We do, however, admire the man’s chutzpah in suggesting that the sole reason a company like SSE makes any profit is in order to pay out dividends to the pension funds who are, obviously, its main shareholders. The thought that your meagre pension payments have been secured for another year must be very comforting to all those pensioners who face freezing to death this winter because they can’t afford their energy bills.

Still, as we’re sure Lord Smiffy would agree, “Hey, it’s just business.”