An alternative view on energy prices



Simon Adler
Fund Manager, Equity Value
Andrew Evans
Fund Manager, Equity Value

As we wrote in our article Forget the acronyms, we care about the treatment of stakeholders in a company. Not just investors but staff, customers, suppliers and regulators. Given the political, regulatory and media pressure on the so called “Big Six” energy companies, the situation at market leader Centrica is worthy of closer examination.

Are customers paying too much, as some have been arguing? The short and perhaps unpopular answer, based on our own research, is that we think they’re getting a fair deal, on the whole.

Understanding the energy “trilemma” will help explain our conclusion.

The nature of a trilemma is that there are three attractive options. While you would ideally like to pursue all of them, in reality choosing two prevents the third. In the context of UK energy policy, there are three aims of energy policy:

-          Affordability

-          Decarbonisation

-          Keeping the lights on (“security of supply” in energy parlance)

Unless or until batteries come and save us from the trilemma, only two of those are achievable at the same time.

For example, solar and wind farms provide very clean (de-carbonised) energy but the wind doesn’t always blow and the sun doesn’t always shine when EastEnders comes on, leaving security of supply as an issue. Coal is really cheap and very reliable but it, of course, fails on the de-carbonisation front. Nuclear power is good for de-carbonisation (ignoring how do you get rid of the stuff at the end!), pretty reliable but super expensive. And so on, hence the trilemma.

The really tricky bit for any government is which of the trio to sacrifice. For over 10 years, the political consensus was that it was acceptable to forego affordability in the pursuit of decarbonisation and security of supply.. However, at the Labour party conference in September 2013, the then leader Ed Miliband changed the terms of the debate.

Miliband – who had earlier spent 18 months as secretary of state for energy and climate change in Gordon’s Brown’s government - changed his mind and announced that, if Labour won the next election, it would freeze energy prices for two years. All of a sudden, affordability was the key policy from the trilemma for energy policymakers. They didn’t say how they’d achieve this. The reality was that Miliband was sacrificing security of supply and Cameron was giving up de-carbonisation.

Centrica’s share price fell almost 20% in the two months following Miliband’s speech, and it became public enemy number 1. Regular visitors to The Value Perspective will be aware that, rather than relying on the opinions of others, we prefer to carry out our own in-depth analysis of companies. With Centrica, we wanted to answer two questions: how expensive are UK gas and electricity prices and is Centrica overearning from them?

The time we have spent doing our research has led us to conclude UK gas and electricity prices are not expensive and Centrica is not making egregious profit margins. Below shows a chart on respective energy prices across Europe – we suddenly don’t look so bad do we?

Average household energy prices in 2013 (2014 prices) in the EU- including taxes


Source: Eurostat data as of June 2014, published in DECC’s Quarterly Energy Prices available at Note: Data sorted by electricity prices. Information on the gas price in Finland was not available.

When we looked at the Big Six, we found some interesting numbers for 2015. The average profit per customer was £26 – cheaper than buying a beer for each member of the value team. The average profit margin (EBIT or profit before tax and costs of financing) for the Big Six was 2.9%, as the chart below shows.


What happens to the revenue from energy bills


EBIT- Earnings before Interest andTax

DA- Depreciation and Amortization (an asset's re-sale value minus the cost paid)

Source: Ofgem 2015

Centrica  is the biggest in the industry and thus can be expected to make higher margins. The figure was 5.3% in 2015 (higher in gas, lower in electricity). Compare that to some other household names: M&S at 7.4%, Reckitt Benckiser at 26%, easyJet at 11%, Vodafone at 11%, Diageo at 30%. We could go on.

Some customers may be paying more than is necessary and should ask for a cheaper tariff or vote with their feet. It can seem a daunting and complicated process but we note that customers are able to easily change suppliers and have more choice than they would do in some of the other consumer decisions in their lives. 

Our analysis therefore leads us to conclude that neither the industry or Centrica are overcharging or overearning. The UK government is obtaining a good deal. Political consensus will inevitably change once more and another element of the trilemma will gain ascendancy. Investors should watch events carefully.  As things stand, shareholders needn’t have a cold chill owning Centrica.


Simon Adler
Fund Manager, Equity Value
Andrew Evans
Fund Manager, Equity Value


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