15th January 2015
Manager of the CF Woodford Equity Income fund, Neil Woodford, explains how the political interference in the UK’s energy industry has actually meant households are paying more for their utilities…
Calls from politicians for the energy companies to cut prices have once again come to the fore. Political interventions can often be frustrating and unhelpful to investors and fund managers – they create uncertainty.
I can, of course, understand the political motivations behind some of these interventions but on this occasion it seems to be a case of good politics, bad economics – again. The UK energy industry is a vital and competitive part of the economy and, in my view, it deserves to be treated better by politicians.
Labour’s call for an energy bill price freeze at the 2013 party conference was very popular with voters and the party has been campaigning on the “cost of living crisis” ever since. More recently, the proposals have been taken a step further, with calls for price cuts to be forced upon the sector, following the collapse in oil prices. Ironically, the inability of the ‘Big Six’ energy suppliers to pass on lower energy costs to their customers here and now has, in part, been a result of the previous, ill-conceived policy proposal.
This is clearly an issue that concerns all parties. Chancellor George Osborne has already asked the Treasury to look at the issue and Energy Minister, Matthew Hancock, has written to the Big Six, asking them to justify themselves and/or cut prices. The matter is also the subject of a parliamentary debate today. It is worth remembering that the backdrop is that we are literally weeks away from a General Election.
The issues are, as is often the case, more complex than politicians would like us to believe, however. The Big Six energy suppliers ‘hedge’ their wholesale oil and gas exposures forward – in effect, this involves them buying supplies in advance to reduce their customers’ exposure to the underlying price volatility of these commodities. Wholesale energy costs account for broadly half of customer’s utility bills and changes in wholesale prices therefore never flow into end-user prices immediately.
Typically, utility companies will build up hedges on a 12-18 month basis but it must be borne in mind that the proposed Labour price freeze has encouraged the Big Six to hedge their wholesale exposures further and deeper than they normally would have done, in order to reduce the risk to their businesses that would materialise in the event of a Labour election victory and a consequent price freeze.
The reality is, therefore, that the proposed utility bill price freeze has now led to consumers paying more for their energy than they otherwise would have had to.
This is another classic example of the law of unintended consequences and it gives the impression that politicians across the political spectrum either do not understand, or simply do not care, what effect their politically-motivated interventions have on this vital industry.
The industry has been hitting the headlines for several years now, usually for the wrong reasons. Energy companies haven’t been great at customer service and some have been found guilty of mis-selling practices. The industry has also been accused of ‘profiteering’ and has been the subject of numerous competition investigations, one of which, by the Competition and Markets Authority (CMA) is still ongoing.
But the subject of energy prices is rarely discussed in its full political context. Energy prices have been influenced by the decarbonisation policies introduced by the previous government and pursued by the current coalition government. This is not a costless exercise – far from it.
Rather than apply direct taxation to fund the ‘greening’ of the economy, the cost has been embedded in energy utility bills and has therefore been a significant contributor to the higher cost of that energy. It is also worth bearing in mind that profit margins in the UK energy sector are currently depressed and have been for several years.
So, although we can understand why politicians are concerned about the “cost of living crisis”, recent energy policy posturing by politicians do not represent helpful interventions. Indeed, the political risk that is now very evident in this industry, ultimately poses a pretty material risk to the long-term viability of the industry. As long as the industry is treated as a political football, it is unlikely to invest in the UK’s energy infrastructure – at a time when the UK economy badly needs that investment!
As we have previously outlined, the UK is already perilously short on generation capacity and these recent political interferences do nothing to relieve the risk of power outages in the future. Indeed, they heighten that risk by increasing political uncertainty, thereby reducing further the likelihood of investment in new generation capacity and compelling the incumbents to consider exiting the UK.
The consequences for the economy of this policy failure will therefore become all too clear on some cold, still winter’s day in the not too distant future.