Citizens Advice criticises Ofgem over “unjustified” energy network profits

Citizens Advice has said energy network companies should return £7.5bn “unjustified profit” to consumers.

The charity has published new research which estimates that key decisions made by the energy regulator Ofgem are allowing energy network companies to make billions in returns on their capital investments, without reflecting how efficient they have been..

In its new report, Citizens Advice finds three decisions by Ofgem that are costing consumers money by being favourable to energy network companies’ interests over the current 8-year price control period:

  • First, costing consumers £3bn, Ofgem overestimated the business risk for investors in energy networks. They estimated that energy networks are 90-100% as risky as the average company but market data suggested a more reasonable figure would be 60%;
  • Second, costing consumers £3.4bn, Ofgem assumed interest rates and returns for government bonds would be 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 that inflated their initial estimates for the cost of staff and materials.

In addition, Ofgem forecasts that network companies will currently earn an average of 10% return for their investors, which is an average 19% profit margin. This is compared to the 4% profit margin earned by the largest energy suppliers.

Gillian Guy, chief executive of Citizens Advice, said: “Energy network firms are enjoying a multi-billion pound windfall at the expense of consumers. Decisions made by Ofgem have allowed gas and electricity network companies to make sky-high profits that we’ve found are not justified by their performance.

She added: “We think it is right that energy network companies return this money to consumers through a rebate. If energy network companies fail to return these unjustified profits to the consumers that paid for them then the government should consider stepping in.”

The £7.5bn estimate was using Ofgem’s Price Control Financial Models, RIIO Annual Reports, OBR/ONS inflation data and Bank of England data on daily real returns on Government bonds as an estimate of the risk-free rate. These were combined in Citizens Advice’s own price control model. Citizens Advice made adjustments to five key financial variables (the risk-free rate, the equity beta, cost of debt allowance, totex and other incentives) to better reflect actual market conditions and Ofgem’s aspirations when it set the price control. This model provides a range of estimates, depending on the scale of the adjustments to these variables that are made – £7.5bn is the medium savings estimate.

The estimate of energy networks earning an average 10% return on capital over the course of the price control is calculated from Ofgem’s RIIO Annual Reports. The estimate of energy networks earning an average profit margin of 19% is taken by dividing the total equity returns by total revenue in Ofgem’s Price Control Financial Model. The Competition and Markets Authority estimated that the six largest energy suppliers earn a 4% profit margin.

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