Ponies and Gas Bills

Sir John Major rather put the cat among the pigeons, with his suggestion that the energy companies pay a windfall tax, with the proceeds going to help those in fuel poverty. A windfall tax is generally levied on what are considered to be excess profits. So, are energy bills spiking because of the excess profits made by the energy companies?

Helpfully, British Gas publishes a break-down of exactly what makes up an energy bill. In 2012 the average energy bill was £1,188. Of this:

£568 (47.8%) was the wholesale cost of the energy;
£283 (23.8%) was the cost of getting it to the customer;
£112 (9.4%) was the cost of environmental and social levies;
£72 (6.1%) was the cost of taxes;
£104 (8.8%) was British Gas's operational costs; and
£42 (3.5%) was British Gas's profits.

British Gas's profits therefore made up 3.5% of last year's energy bill. It's an odd definition of excessive. Apple's profit margin on the iPhone runs somewhere between 49 and 58%. As a sidepoint, 4 of those 6 categories are more or less fixed costs for the provider. Discretionary costs are limited to operational costs (and these aren't very discretionary - these are the wages of employees, the rent on premises and so on) and profits. Let's have a little experiment, using Ed Miliband's proposed price freeze. By way of example, between 2011 and 2012 wholesale gas prices went up by £94 for the average bill.

Case 1: the wholesale gas price goes up by £94 again. Where would British Gas find £94 to save? Well, first of all they could eliminate their profit margin entirely (causing a profits warning, and a collapse in share value, not to mention a problem for pension funds and so on). But that still leaves more than £50 to cut from somewhere else. Operating costs? Pretty tough to halve the operational costs for an energy company I'd have thought. And by that I mean entirely impossible.

I suppose taxes would drop a bit (because BG isn't making any profit any more), but environmental levies aren't going down, and nor are the costs of transportation and distribution. Basically, British Gas are now making a loss of more than £50 on the average gas bill. Ouch. Two or three years of that (and if prices are going up overall it's only going to get worse) and companies are going to start falling over.

Case 2: the wholesale gas price falls by £94. Well, prices are frozen remember, so bills can't fall. And there isn't much discretion in how much to spend on operations. Tax will go up a bit, but by far the most of this benefit will be seen in BG's profit margin. Hurray for shareholders and all that, but I don't think that's quite what Ed had in mind.

Ultimately, the campaign against the energy companies only really works if they really are gouging profits out the consumer on their bills. And I'm not sure that the figures really stack up to support that.