Energy suppliers feeling the heat

Power firms are in Labour's sights over profits - but they can play the green card, says Tim Webb
Tim Webb
The Observer, Sunday 11 January 2009

One Friday evening in September, the chief executives of Britain's biggest energy suppliers received a surprise phone call. Shriti Vadera, the government's formidable business enforcer, was on the line. She was brutally to the point: unless they signed up to a fuel poverty package to help their poorest customers, she said, the government would levy a windfall tax on their profits. "We will do something much worse which you won't like" was her warning, prompting suppliers to complain that they were being blackmailed.
Bashing the energy companies seems to be the government's preferred sport these days. Not that there's much sympathy for them. Electricity and gas bills surged last year on the back of the record oil price of $147 (£97) in the summer. The utility companies said this was because gas prices are index-linked to the price of oil. Since last summer, oil has plummeted to $40 a barrel and wholesale gas prices have slumped too. Yet none of the leading suppliers has announced across-the-board reductions in consumers' bills.
Ed Miliband, the head of the newly created department for energy and climate change, has taken up the theme of telling energy companies what to do with gusto. Last week, he warned them not to use the dispute between Russian giant Gazprom and Ukraine, which led to a temporary spike in gas prices, as an excuse not to cut bills - or else. Such intervention is a world away from the previous policy approach of letting energy companies decide what power plants to build and how much to charge consumers to pay for them. State intervention to bail out the banks has hogged the headlines, but energy companies are now feeling the heavy hand - or arm - of government too.
Whether the industry likes it or not, companies have effectively become arms of the state, at least in Whitehall's eyes. They are expected to deliver secure and clean supplies of energy, all at an affordable price. Britain has signed up to the EU's renewable energy targets, which require one third of electricity to come from renewable sources by 2020, up from barely 3% today. Building wind farms is a lot more expensive than building conventional coal and gas plants. Poyry Energy Consulting estimates that it will cost at least £2,000 per household on top of current utility bills to meet the target by 2020, or about £200 extra per year. Yet wind farms don't work when the wind isn't blowing, requiring back up power plants and adding further to the bill.
In public, energy bosses say meeting these targets is "challenging" even if they could pass on the costs to consumers. Privately, they say it is impossible, and that was before the worsening credit crunch made it even harder to raise the estimated £100bn investment needed. Tony Ward, director at Ernst & Young, says: "This three-way dilemma will be with us for decades to come."
Not surprisingly, energy companies don't seem to be too happy with the new way of doing things. One chief executive of a FTSE 100 energy company says wearily: "We have got targets coming out of our ears."
The industry's lack of transparency has not helped their cause. Companies do not have to reveal how much it costs them to generate electricity. This makes their justification for not cutting bills even when wholesale gas prices have slumped unconvincing, particularly as they continue to make bumper profits. The "Big Six" suppliers - npower, E.ON, British Gas, Scottish Power, Scottish & Southern Energy and EDF - have the market sewn up, preventing any serious competition from new entrants.
But consumers are starting to realise that they will have to pay more for greener energy. Mike Clancy, deputy general secretary of the union Prospect, says a windfall tax on profits to subsidise energy bills for the poorest customers would be self-defeating, as higher profits are needed to build new power plants.
The utility companies know they hold this trump card: if a windfall tax is imposed or they decide their profits are not high enough, they can threaten to scrap plans to build new power plants or wind farms. This threat is even more real because four of the Big Six are foreign owned, with domestic markets more important than the UK's. This means that they can easily choose to invest in other markets instead of ours if they decide that this would be more profitable. This was not an option when the utilities were focused purely on the UK.
Relations between the government and the energy industry will be bruising for some time to come.