On Budgett: An occasional post by utilities analyst Richard Budgett…
Less than seven years ago, in October 2008, Ed Miliband became Secretary of State for the newly created Department of Energy and Climate Change and immediately announced that the UK would cut greenhouse emissions by 80% by 2050 rather than the 60% cut previously announced. And so began the shift away from relatively cheap gas and coal fuels to far more expensive renewables, all of which would be funded by the consumer.
Not surprisingly the pursuit of the greenhouse emission targets has seen customer bills rise considerably. In 2007 government energy policy initiatives cost the consumer just £40 per year. Now as we enter 2015 the cost is over £200 and rising*.
Fast forward to September 2013, as the now Leader of the Opposition and presenting at the Labour party conference, Ed Miliband promised that he would freeze energy tariffs for 20 months if elected in May 2015 because the energy market was ‘broken’. He claimed that energy bills were rising at too fast a rate because the suppliers were overcharging their customers.
Of course the chances of us seeing a Labour government come to power later this year are quite high given their current lead in the polls. Consequently the energy suppliers have been hedging forward their exposure to commodity prices, which make up 50% of the energy bill. This gives them better visibility as to their future costs, allowing them to maintain a reasonable level of profits, although a far cry from the supernormal levels claimed by the Labour party (for example, British Gas, the largest and most profitable is forecast to earn a 5% margin this year – hardly a sign of price gouging).
Scottish and Southern Energy (SSE) stated in March 2014 that it would freeze tariffs until at least 2016 – the longest unconditional price guarantee the domestic energy market has ever seen. SSE said that the freeze would cut profits and lead to 500 job losses. It also shelved 4 planned offshore wind developments. At the time UK gas prices were close to 70p/therm.
Step forward Ed Miliband again… on the Andrew Marr Sunday programme this week he announced that he now wants the energy suppliers to cut tariffs to reflect the recent fall in commodity prices; the forward UK gas price is now below 50p/therm. But how can they do this if Mr Miliband’s previous price freeze policy has led the industry to hedge forward more than they would have done if left untouched?! It will only be after the election, once future government policy has been clarified, that the energy companies will be able to have more clarity on their future hedging strategies.
The reality is that Labour’s energy policy has left many worse off. The consumer has lost out on a potential tariff cut. The energy companies have lost out as policy uncertainty has increased their cost of capital and hit their share prices**. And the environment has lost out as investment decisions to reduce greenhouse emissions have been deferred.
* Source: Morgan Stanley estimates
** This is no recommendation to buy or sell any particular security