To be completed by 6:30pm UK TIME
Hi, I need 2 questions out of 3 to be answered within the next 2/3 hours.
2 A4 pages maximum please of a high standard A grade
Section A [SEEN]: Read the case study and answer only two out of the three questions.
British Gas sees profits up 24% BBC: 24 February 2011
Operating profits at British Gas rose 24% in 2010 to £742m, its parent company Centrica has said. The news comes two months after the UK utility announced a 7% rise in domestic energy bills, which it blamed on rising wholesale prices. British Gas said it had increased its number of customers by 267,000 during the year to 16 million. The results helped Centrica to achieve pre-tax profits of £2.8bn, with operating profits up 29% to £2.4bn.
‘Bitter pill’
The 24% rise in British Gas’s operating profit was largely because of an increase in profit per customer, with the number of customers up just 1.7%, as revealed in the group results of its parent Centrica. Some 85% of British Gas’s profit came in the first half of last year, according to a Centrica spokesperson, when customers increased energy usage in response to cold weather, and the firm attracted new business with a price cut in February. The second half was less profitable for the group’s residential energy unit as wholesale prices rose more quickly. Centrica has claimed the decision in November to increase British Gas customers’ energy bills was necessitated by a 67% rise in wholesale gas prices during the year, and a 29% rise in the cost of wholesale electricity prices. Price comparison website Moneysupermarket.com called the rise in British Gas’s profits a “real bitter pill to swallow for Britain’s hard-pressed households who have suffered the double whammy of an extremely cold winter coupled with high gas and electricity prices”. British Gas launched what the comparison website considered the cheapest online tariff on the market in February. But Moneysupermarket’s Scott Byrom said that “customers shouldn’t be fooled” into thinking British Gas was the cheapest provider overall because its standard, and most popular tariff, was still much more expensive.
Ofgem investigation
“British Gas is the only major UK energy supplier that breaks down its results in any great detail,” notes Mike O’Connor, chief executive of Consumer Focus. “As such it acts as a lightning rod for the industry.” Amid allegations that energy suppliers were making excessive profits, government watchdog Ofgem announced a review of the retail energy market in November, that is expected to be published at the end of March. “The issue is not about one company or one year’s profit or loss but it is about whether the energy market is working properly and Ofgem’s review must try to answer this question once and for all,” said Mr O’Connor. “There is a compelling case for much more transparency across the market.”
Upstream growth
Centrica comprises a lot more than just British Gas, including business energy supplies and power generation, as well as substantial operations in North America. Indeed, its UK residential energy supply unit contributes just 37% of the energy group’s revenues. Operating profits at Centrica’s upstream business – which deals with power generation and oil and gas drilling, among others – were up 46% to £771m. The company has been expanding quickly, according to chief executive Sam Laidlaw, with two major acquisitions last year designed to secure new sources of gas, and to expand into nuclear energy. “We invested £4bn,” he said. “Clearly therefore we have a much bigger group [than just British Gas]. We’ve been investing £1.60 for every £1 of profit for the group.”
Ofgem to probe Scottish Power price rise promotion BBC 22 June 2011
Energy watchdog Ofgem has launched an inquiry into a “potentially misleading” offer promoted by Scottish Power after it announced 19% price rises. The firm had guaranteed prices would remain a minimum of 1% per year below its standard monthly direct debit prices until 30 September, 2012. But Ofgem insisted the small print did not match up to the promise. Scottish Power said: “We believe that all figures that have been quoted by us are accurate.” The regulator said it also wanted to press ahead with radical market reforms and force the so-called “big six” energy suppliers to simplify tariffs. British Gas, Npower, E.ON Energy, EDF Energy, Scottish Power and Scottish and Southern Energy have all signed up to the reform process.
Ofgem said it would be using its consumer protection powers to investigate the promotional offer which was announced by Scottish Power when it revealed it would be putting up prices in August. The watchdog outlined that the investigation would focus on the claim of £459 savings from the Direct October 2012 offer. The increases, which will see the cost of gas go up by 19% and the cost of electricity by 10%, will affect some 2.4 million householders in the UK. Scottish Power had blamed a 30% rise in wholesale gas costs for the increases. In response to the launch of the inquiry, the utility company said: “We agree that information about all energy tariffs across the market should be as clear as possible and we will fully co-operate with the Ofgem investigation.”The tariff in question was a very limited offer with considerably discounted prices, which is now fully subscribed. “However, there are a number of similar products still available on the market from competitors. We believe that all figures that have been quoted by us are accurate. ” Consumer Focus said it welcomed Ofgem’s announcement and added that the utilities market needed to change. The body’s chief executive, Mike O’Connor, said: “The fact that Scottish Power was trying to push a dubious product to cover for their price rise shows just how far the penny needs to drop. “Energy suppliers have been in denial about their poor reputation, about the health of the market and about the scale of changes needed to put it right. This market needs to change. “Ofgem has taken another step today and we welcome it.” Meanwhile it was confirmed the six energy suppliers will be questioned by the Scottish Parliament’s economy committee next week.
Committee convener and Tory MSP Gavin Brown said he wanted to hear the justification for price rises, adding: “It is important the committee is convinced that the suppliers and the regulator are doing all that they can to minimise the impact of these price rises on low income families and not to prejudice a return to economic growth.”
Gas and electricity prices: How are they calculated? BBC:17 November 2010
Money Talk by Ben Essex Lead energy analyst at ICIS Heren
Energy prices are going up. Both British Gas and Scottish and Southern Energy (SSE) are putting up gas tariffs in December, and other major energy providers may follow suit soon. The companies have blamed a 25% increase in wholesale costs this year. But have wholesale prices gone up? And how does the wholesale price relate to the figure that appears on your energy bill? Is blaming the wholesale price justified?
Wholesale prices
With other costs to supply energy relatively fixed and constituting a small part of your overall energy bill, energy suppliers almost always cite wholesale prices as the reason behind a change in their tariffs. But at any one time there are many different wholesale prices, so to say they have gone up by 25% is meaningless. All of these wholesale prices have in fact gone up over the period quoted by SSE and British Gas. But anyone who knows anything about the energy market also knows that a wholesale price movement can be found to support pretty much any retail energy price change – whether up, down, big or small. So, how does the wholesale market work? Before gas and electricity gets into your home, it is first sold to the energy suppliers. In the UK, some of the big household suppliers produce or generate a proportion of their own energy. But they buy most of it either direct from the producers who generated the power or sourced the gas, and the rest is bought from the traded wholesale markets. In either of these scenarios, the UK suppliers are usually paying the price set by the traded market, where a variety of producers, utilities and speculators are active every day. Each energy supply company will have a small team of energy traders and analysts in their central office trading and monitoring price movements in the gas and electricity markets throughout each day. These energy traders are not dealing with a singular wholesale gas or electricity product – but a myriad of gas and electricity “contracts” which are defined by the period within which the energy is to be delivered. So, as an energy trader, today I can buy energy for today. And that energy will be priced differently to gas or electricity which I buy for delivery tomorrow. Both of these prices will be different to energy priced for delivery this weekend, next week, next month, next year, or even in five years time.
Complications
To further complicate matters, contract prices can change every second, as sometimes hundreds of trades are made on the same contract each day. So the difference in price between contracts, and even for the same contract over the course of the day, leads to a plethora of wholesale prices. The traded price of a gas or electricity contract on the wholesale market will be defined by a number of factors. In the near-term price changes are usually supply and demand-based. For instance, if it is colder next week, then the country will need more energy as households turn up central heating. As a consequence the price of energy for delivery next week will probably go up. Longer-term prices, for example, energy for delivery in 2014, are more likely to change on broader macro-economic factors, as well as the prices of other energy commodities, primarily oil.
What do the suppliers pay?
Because there is not a single wholesale price, energy suppliers are over-simplifying the matter when they say their prices went up as wholesale prices have gone up by 25%. In fact the gas and electricity flowing into households and businesses across the country today will have been bought by the energy suppliers anytime between now, and as far back as five years ago. Suppliers will likely have spread out their purchases of energy for delivery today over a long period of time, to mitigate risk caused by volatility in the wholesale market. Furthermore, each energy supply company will then buy and re-sell energy constantly in a bid to secure lower wholesale prices, further blurring the calculation of a wholesale price change. This makes the 25% figure even more disingenuous. It also means that the company with the most effective trading strategy can end up paying much less for their supplies of gas and power than a competitor. To give an example, if a supplier bought gas for delivery in the fourth quarter 2010, back in July 2008, it would have cost it over 100 pence per therm (p/th). Yet in spring this year, the same contract fell below 40p/th.
Competition
Since the liberalisation of the energy markets in the 1990s six major suppliers have emerged competing to supply us with gas and electricity. The “big six” – British Gas, E.ON Energy, EDF Energy, npower, Scottish and Southern Energy, ScottishPower – have successfully tied up 99% of the market share for both gas and electricity supply for the residential market. With only six companies dominating the market, many people question whether competition exists. An allegation given credence each time the suppliers change tariffs en masse, even if the tariffs change by different amounts. However, last year British energy regulator, Ofgem, investigated just this, gaining access to the suppliers’ energy trading portfolios, and concluded there was competition in the residential energy supply market. If there is competition, why do they change prices in unison? From the suppliers’ perspective, when they set residential energy tariffs, they have one thing in mind – profit maximisation. Tariffs need to be low enough to beat the competition, but high enough to keep their shareholders happy. But when one supplier changes their tariff, it is as if they are revealing their hand in a game of cards. Other companies become emboldened to either increase prices or are forced to slash them to remain competitive. So what can you do? From a consumer’s perspective, the key factor which will promote competition and fair pricing in the energy market is if individuals respond to price changes, and switch suppliers frequently. The more customers respond to price signals, the more the suppliers will be forced to compete with each other.
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Section A [Seen]: Answer ANY TWO of the following questions
1. Evaluate the level of competition in the UK Consumer Energy market, and, with reference to the ‘theoretical models’ of markets, indicate which of the four it most closely resembles.
2. Describe the nature of ‘price competition’ in this market, and evaluate its effect on the ‘degree of competition’ in it.
3. Describe Ofgem’s role as a ‘regulator’ of this market, and evaluate its effectiveness.
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