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Tim Dodd

11.11.2013 | 4:10pm
ScienceHow energy companies make profit: A closer look at the data
SCIENCE | November 11. 2013. 16:10
How energy companies make profit: A closer look at the data

Two of the UK’s biggest energy companies – SSE and British Gas – are expected to release their latest financial statements this week.

The media will be paying closer attention than ever to see how their profits are faring after both companies announced significant price hikes in October.

Energy companies make some profit from the energy they supply to households, as anyone who has had a bill clunk through their letter box will no doubt be aware. But they also make money by generating the power supplied to the UK’s homes and businesses.

Companies which generate energy and supply it to consumers are described as ‘vertically integrated’. All of the UK’s big six energy companies are structured in this way.

The recent slew of headlines has largely been concerned with the bit of the businesses that supply power to consumers. But some of the energy companies make most of their money by generating and selling energy wholesale. Market regulator, Ofgem,  estimates that while supply profits are around 5 per cent, generation profits can be as high as 30 per cent.

We take a closer look at where the big six make money, how they differ, and what that could mean for future UK energy policy.

Energy company profiles

Energy companies are required to give Ofgem annual data on how much profit each part of their UK business makes.

It’s striking how much variety there is in the way different companies make profit, as the graph below shows.

Supply _generation

Source: Chart by Carbon Brief from energy company segmental statement data submitted to Ofgem

While EDF and SSE appear to make the bulk of their profits from generation, British Gas owner Centrica’s biggest earner is supplying gas to households. Scottish Power and RWE npower have a more even profit spread across each part of their business.

That makes some companies more sensitive to changes in the energy market – such as wholesale gas and electricity price rises – than others. And this means different companies are likely to have different reasons for increasing household energy bills.

Because the companies are set up so differently, it can be difficult to directly compare their profits.

Some companies borrow a lot of money to bankroll their activities. They have to pay interest on those loans, denting their profit margins. Likewise, the amount of tax a company pays varies depending on what kind of generating capacity it owns.

Since each company has different levels of debt, and will pay different amounts of tax, Ofgem’s data shows profits before tax and interest are included. That allows the profits from each part of the big six’s business to be compared.

The down side of that approach is that the figures don’t show final profits. That means Ofgem’s figures differ from those quoted by the companies.

Policy implications

Since four of the big six energy companies announced price hikes last month, there has been a lot of speculation about how the government might adjust the UK’s energy policy to bring bills down.

Ofgem’s data shows the impact on energy company profits will vary depending on how the government goes about it.

For instance, since EDF made all its profit from energy generation last year, policies which harm or incentivise investment in big infrastructural projects – such as power stations – are likely to impact it the most.

As EDF’s supply business made a loss last year, it’s perhaps no wonder it held out for so long in negotiations over a deal on the electricity from two new nuclear power plants it is set to build in Somerset.

In contrast, British Gas made the most profit out of any of the big six last year from supplying gas to households. As such, it arguably has the greatest interest in policies which affect how cheap or expensive it is to get and supply that gas – for instance, developing domestic sources like shale gas.

That might explain why British Gas’ parent company, Centrica, has a stake in shale gas company Cuadrilla.

Analysing profits

All this is worth bearing in mind when trying to dissect the stories around energy company profits and energy policy.

Energy companies sometimes justify household bill price hikes by saying they are needed to cover losses in other parts of their businesses.

Ofgem’s data suggests that while this might sometimes be the case, it’s not always so.

Vertical integration makes it hard to assess companies’ overall profits. It’s not always clear how much power each of the big six sell to their supply arms and sell to other companies. It’s also not clear how that relationship impacts their profits, on either the generation or supply side.

Labour leader Ed Miliband has called for a ‘ring fencing’ of the two sides of the business to address this. The government has also called on Ofgem to find ways to get energy suppliers to provide more detailed accounting information. Politicians hope the changes could increase transparency and help to assess energy companies’ overall profits.

This may lead to the publication of standardised or more detailed profit figures.

But it’s clear that while most of the headlines to this point have been on how much money energy companies make from household bills, generating profits for some power companies are much larger.

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