Warning Low Power

There was a time, perhaps, when politicians believed they were in the business of Government; that is the responsible stewardship of a nation. Sadly those times are long past, and our current crop are clearly in the business of power-retention. With that end in mind, it is increasingly obvious that the preferred model for winning elections is now to throw money at swing and core voting blocks, with whichever party offers the greatest bribes buying its way into office. Hence we come to the latest debacle in a long line of debacles.... Mr Miliband's plans to revert to cold war communism and begin setting the prices private companies can charge.

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As far as I can tell there are three issues which need to be addressed in the energy debate;

1.) Should the provision of electricity be run as a utility or as a private enterprise?

2.) Are energy bills too high? And if so why?

3.) Is it 'acceptable' to make a profit off the provision of a 'basic' requirement like power?

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1.) Nationalise, Privatise, Re-nationalise...

The question of whether power companies should be utilities is further complicated by the split issue of whether we are talking in ideological or practical terms. On ideological grounds I see no problem with nationalised energy companies - in the modern world electricity and/or gas is as much as requirement of existence as water and shelter. It is what allows us to heat our homes, cook our food, warm the water for our showers and power the lights (not to mention keep the internet-hamsters happy so we can write online blogs). As an a priorii principle I am happy that the government should consider the provision of basic utilities as part of its role in providing the institutions on which society functions. In this version of the world of course nationalised industries are efficient, well run, well funded and receive regular investment from central government to build, develop and maintain infrastructure.

From a practical perspective however, energy companies are now private and that is unlikely to change. The current market capitialisation of the big six energy companies is around £140 billion (share price x number of shares), so even without a take-over premium this is the kind of figure a re-nationlisation would cost. While I acknowledge this is a bit of an off-the-wall comparison, if renationalising meant no shareholder dividends had to be paid, but everything else was kept constant (i.e. no loss / gain in efficiency, no changes in price etc just no profits), then it would take about 125 years for the Government to earn back its £140 billion upfront investment.  Together with a potential backlash from investors over any mass appropriation of private companies, and possibly massive job losses as a result of amalgamating six companies back into one national one, it seems unlikely British Gas as a national entity is likely to be making a return anytime soon. Thus, for point 1 it seems safe to say energy is going to remain private.

2.) How much!?

Energy bills are certainly a material component in most people's outgoings. According to the industry body Ofgem the 'average' dual fuel bill is £1,315. This compares to a (bizarrely high in my opinion) average household income of £40,000 for a household with two adults (source: http://www.bbc.co.uk/news/magazine-15197860 - and I would be delighted with anyone who can find a more reasonable number, this is one must be skewed by super high earners dragging the average up). Assuming this is made up of 20x2 then your post tax household income is about £32.8k, and energy therefore accounts for around 4%.

I'm not going to dismiss 4% as trivial, but it is worth noting that energy bills are far more of an emotive subject than their actual costs warrant. A survey conducted in 2012 showed only 14% of respondents had a idea of what their energy bill was, or how the appliances in their home contributed. 81% admitted to having no clue whatsoever. This combination of huge ignorance, plus the rather painful experience of getting 6 months (or even annual) bills in one hit suggests its easy for people to get over-excited by energy costs.

Even putting to one side the issue of whether that £1,315 is a high enough percentage to warrant outrage, the question then arises of whether that number is in, and of, itself too high. To answer that let's look at what goes into the average energy bill (all taken from Ofgem):

Electricity Bills:
58% - costs of running the business (billing, sales, costs of having an office and staff etc)
16% - costs of distribution network (pipes and cables)
11% - costs of paying government subsidies for green energy schemes.
5% - VAT
4% - costs of high voltage transmission network (trunk connections)
1% - Rounding errors, misc, etc.

Which leaves a grand total of:

5% profit - or the equivalent of about £65 on your £1315 bill.

It's also worth pointing out the government takes another pop at that in the form of corporation tax at 23% (put another way the government takes  1.2% of your bill in tax, and the company makes 3.8% in profit).

The figures for gas are comparable - with some tweaking (the transmission is cheaper for gas, but the costs of the rest of the business are higher - the profit rate is comparable).

3.8% isn't a massive figure, and is comparable to entities like Tesco's who pay a dividend of around 4%.  It seems then that allegations of the energy sector making vast profits off the back of the exploitation of freezing children are somewhat unfounded. The tactical use in the media of the figure of £3.3 billion in profits is designed to be inflammatory, and ignores the fact that that represents 3 years profits on a combined industry investment of £140 billion.  While I sympathize (to some extent) with those who struggle to pay their heating bills, I can not, in all honesty, say the figures support a view of a market rampantly exploiting its customers, or its market position.

3.) Lawful Evil Incorporated

Economic arguments aside, I've heard many claims along the lines of 'its immoral to make a profit of providing basic human needs.' This extends to whatever the current target of vilification is - landlords? Shouldn't be allowed to make a profit, supermarkets? How dare you make a profit of people avoiding starvation! Medicine - outrageous that anyone could make a profit of treating disease! And so on..

This seems to me to be a symptom of a media and social paradigm that ignores the role of capital in production.

In the most basic sense production is a functional of  f(labour) x f(capital) [i.e some function of labour multiplied by some function of capital]. Capital in this instance means anything that isn't labour, and while traditionally has meant things like tools, factories, tech etc in the modern world it also has the very simple meaning of money.

All the above formula says is that output requires you to have people willing to work, and the infrastructure to enable them to work, and one without the other is pretty useless. It is the accumulation of capital over thousands of years that separates the modern day hedge fund manager from the stone age hunter-gatherer. Education has improved the quality of our labour (supposedly) and the investment and growth of capital has raised the capital stock available to support that labour.

Just like you expect people to earn salaries in exchange for their salaries, so too should investors earn dividends in return for their capital. To expect capital without returns is in the same boat to expecting labour without salary. Its possible (after all slavery is still going strong), but it generally requires a coercive element which isn't compatible with claims of liberal rule-of-law capitalist democracy.

If you truly want people to invest in pharmaceutical companies so fund new medicines, in tech companies to give us new gadgets, in supermarkets to make buying food easy (etc etc) and in energy companies to deliver power to the little sockets in our homes, then you need to let them earn a reasonable return on investment.

The alternative is to centrally fund things (i.e. the Army - we don't have a private military anymore, and so the government pays  the salaries, and coughs up the capital spending which would normally be attracted by the prospective dividends), now, as mentioned above, I'm not ideologically opposed  to a nationalised energy company, but I very much do not trust the current brand of politicians to fund such an enterprise properly. As any gamer will tell you Logistics Wins Wars (though they may know it as 'macro harder!'), and that translates to fund your infrastructure well, and fund it early. Research technology, upgrade hardware and reinvest the growth generated into faster and further improvements. But there is no political capital in funding energy infrastructure. High levels of capital spending that would keep things ticking along without issue and at a potentially lower cost to the taxpayer carry no benefits (people don't notice things working well), while taking the money away from infrastructure and spending it on headline grabbing policies buys votes, and therefore power. Plus, at the end of day, if an adviser tells you the whole national grid is going to fall over in 10 years unless you spend now - so what? Chances are the other side are going to be in power by then and you can blame the whole mess on them.  It therefore seems inevitable that a politically run power-company will invest insufficiently.

On the other hand, companies which generate profits attract capital flows - investors want to get in on a good thing, and so companies doing well can raise new funds to invest and grow further. Energy companies may be struggling to invest in the levels required without government subsidy, but maybe that's because they deliver such uninspiring levels of return. Why invest in Npower, with all the political risks, when you can invest in Tescos (which for the most part bumps along under the radar) and posts similar returns? Or even better invest in a major bank which despite all the recent flak still outperform utilities?

There is however a point which needs to be made in response to this - that of 'super-profits'. Under basic economics companies are able to derive a profit from their activities and still be in equilibrium. In fact equilibrium is achieved when a company can produce at a price which the market will pay, while covering sufficient salaries to attract the required labour, and sufficient dividends to attract the required capital. However, in some circumstances where perfect competition has failed (i.e. a monopoly or oligopoly), companies can make 'super-profits' - i.e. profits above that level required to attract sufficient capital for the business to function. These 'super-profits' are a market failure. In perfect competition the presence of super-profits should prompt new companies to move into the sector, and charge a lower price. Although they make a lower profit they still make sufficient profit to attract capital, and by undercutting the 'super-profit' firm should attract all the business.

If there is evidence of the energy companies generating super-profits than it is potentially an argument in favor of intervention (of one sort or another), but from the figures outlined above this seems hard to support.

4.)  Temet Nosce

The energy sector is not without potential improvements, and one key one would be in the realm of customer knowledge. Even as a fairly cynical (and clued up) contract reader, and someone with experience of the labyrinthine terms and conditions of financial products I found my energy bill difficult to decipher. For the average customer its borderline impossible. Clear, straightforward billing, in a standardized measurement, along with up front explanations on things like changing tariffs (i.e. you pay about 5x more per KwH in the winter because of a 'seasonal adjustment') would help boost customer confidence in the sector. The problem is not necessarily what the energy companies are doing, but the complete ignorance most people have of what that is.

The final point I'm going to touch on is the madness of politicians promising/threatening to set prices in advance. First off this wiped £3billion off the share prices of the big six companies instantly. At that rate we could afford Mr Miliband to make about 100 speeches a year for his first term in office, after which he will have talked into oblivion the entirety of the FTSE 100. One thing politicians of all flavors who aspire to government need to learn (and many never do) is that they are not talking to the electorate, they are talking to the incorporeal world composed of all the interlocking confidence tricks that make the modern world work - poke them at your peril.

Second, if this seriously looks like coming into force than all the energy companies will do is raise their prices pre-emptively - potentially bringing forward price rises planned for 2017 to 2014 or sooner, again I struggle to see how this is supposed to help with a 'cost of living' crisis.

Finally, this sends a very clear message that Labour is swinging towards a social model in which wealth creation via investment is outlawed. Profits will be hunted down and banned through price fixing. This means that investment has to come from central government, and how will it be raised? You know it - more taxing, and more borrowing.

Assuming the lights stay on that long,

/Z