How Do Energy Suppliers Make Money?

Energy prices go up and down almost every year. If you think your business is being overcharged for its energy use should look into the financial conditions of the energy supplier. It will give a clear idea of how the energy supplier makes money and whether it charges fairly or not.

Three Ways Energy Suppliers Make Money

There are three ways in which energy companies make money.

Production of Energy

Generally, electricity is produced in huge power stations that are connected to a major transmission channel. However, small scale producers generate electricity on minor levels that are connected to local distribution channels.

Distribution and Transmission of Energy

Some energy companies make money through the transmission and distribution of energy. Do not confuse between the two functions. Transmission channels transfer electricity over long routes like around the country. While the distribution networks carry electricity from the larger transmission network to your business.

Sale of Energy

Some energy suppliers purchase energy from the wholesalers and sell it to final users. Buyers are free to choose any supplier.

An energy company might be involved in one two or all three of the above operations. Companies that produce and distribute energy to their users are known as vertically integrated energy companies. As an example, we can have the UK’s six big energy companies.

According to Ofgem, some energy dealers make a large sum of their total money by producing and selling electricity in the wholesale market. The regulator estimates that supplying energy generates up to 5% profit while producing energy can pocket up to 30% profit.

Factors Affecting The Profit Margin Of Energy Companies

The Big Six’s Financial Profile

All of the UK’s six major energy companies are vertically integrated. They earn from both generating and supplying energy. However, it’s surprising how much their profit margins vary in each sector. One company is making a large part of its total profit from the electricity supply, while the other is suffering a loss in this sector.

According to Ofgem’s report of 2009-2019, the profit made by the Big Six through energy generation during the time has changed drastically. In 2009, EDF was the major energy producer. It made a profit of about £1131 million. However, it faced a loss of about 130 million in 2018, while in 2019 it only made about £50 million in energy generation.

SSE made the highest profit in energy generation in 2019, earning about £614 million. It had maintained a consistent profit margin over the years.

Npower and Scottish Power also seem to have difficulty in the energy generation sector. However, these two along with RWE have an even profit distribution in the three sectors.

On the other hand, British Gas made almost nothing in the sector last year. But it has been the biggest player in the supplier market. Since companies earn profit from multiple sectors differently, comparing their profits can be difficult.

Such variations in profit margin make companies sensitive to changes in the market. For example, the price rise in the wholesale market will not affect the Big Six due to their energy generation and supply.

Based on the areas of operation, each energy company has a different reason to increase or decrease your business’s energy bills. There are many internal factors that force businesses to increases their charges.

For instance, a company has borrowed a hefty sum from the bank and has to pay interest on it. Those interest payments would reduce its profit margin; hence, it starts to charge its customers more. Similarly, huge companies have to pay heavy taxes that they recover from their customers by increasing their energy charges.

Due to these internal variations, Ofgem compiles and presents the profit of businesses before interest and tax. Comparison charts based on such data are not accurate as they only provide a profit estimate.

Government Policies

In case, the Big Six excessively increase their prices, the government has to step in to bring them down. That’s’ another factor which determines the profit of the energy suppliers and the prices they charge. For instance, in 2012, EDF earned most of its profit through energy production. The policies encouraging investments in energy generation will affect EDF’s business.

Similarly, British Gas made the biggest profit in energy supply in 2012. Hence, any policy reducing the cost of energy supply would have positively affected its business.

Unexpected Events

Events like COVID-19 also affect the business of energy suppliers. During this pandemic, a lot of businesses faced losses, and dozen of them had to shut down. For these reasons, they failed to pay their energy bills. However, the energy suppliers had to recover their cost, which led to increasing their charges for the businesses that were paying bills.

Ofgem’s Role In Providing Energy Supplier’s Financial Information

Since 2009, Ofgem has required all the big energy companies to create an annual report called Consolidated Segmental Statements or CSS. These reports include the cost, profit, and revenue of all businesses in generation and supply segments. Every business must publish its CSS within four months after the end of its financial year.

The market regulator makes this information available to businesses who want to know about their supplier’s financial situation. To ensure credibility each business has to separately audit its CSS. It increases consumers’ confidence in the provided information.

Conclusion

When analysing its energy bills, a business must consider all these pointers. It is better to look into authentic information from Ofgem. However, vertical integration and sectorial divisions have made it difficult for Ofgem to get accurate figures. The government is also pressurizing the regulator to get more detailed financial information from the companies to improve transparency. That will help businesses decide which company is worth their money.