Big energy firms' prices challenged by Ofgem

Prices for consumers do not automatically track wholesale prices

Energy suppliers risk "undermining public confidence" in the market by failing to respond to falling wholesale prices, the regulator has said.

Ofgem said the "big six" gas and electricity companies should explain to customers why falling wholesale prices have not been passed on to household bills.

Under one measure, wholesale prices are at their lowest level for four years.

Wholesale costs make up nearly half of a household energy bill.

British Gas, the UK's largest supplier, said this meant the wholesale price could fall, but this might not push down prices overall.

"Our recent trading update demonstrated that these reductions in wholesale costs have most definitely not translated to increased profits for British Gas," a British Gas spokeswoman added.

Falling costs

The big domestic suppliers tend to buy energy in advance, in what is known as the forward market, in an attempt to avoid any short-term rises in costs.

The forward prices for the coming winter are 16% lower for gas and 9% lower for electricity than last winter, Ofgem said. The mild winter in the UK and Europe has left record levels of gas in storage, pushing down prices.

Spot prices - when firms buy energy for next day delivery - have fallen even more sharply. These tend to be used by smaller suppliers who have more flexibility owing to their smaller market share.

Spot gas prices were down 38% in early June compared with the same time a year ago. This left prices at their lowest level since September 2010. Spot electricity prices were 23% lower than a year ago, taking them to their lowest level since April 2010.

In a competitive market, a sustained reduction in costs would encourage suppliers to cut prices for customers, as they would be worried about losing customers to other suppliers, Ofgem said.

However, the regulator said falling wholesale costs had not been reflected in falling household bills.

Although it has no power to tell companies where to set their prices, Ofgem has written to suppliers outlining its view that confidence could be damaged if wholesale prices continued to fall, but household bills were unchanged.

"The big six suppliers tell us that they think the market is competitive, but our research shows that consumer trust is low," said Dermot Nolan, chief executive of Ofgem.

"Therefore, if suppliers are going to start rebuilding that relationship they need to take the initiative and explain clearly what impact falling wholesale energy costs will have on their pricing policies.

"If any of the companies fail to do this, consumers can vote with their feet. Independent suppliers are currently offering some of the cheapest tariffs on the market."

Ofgem letter in full:

Wholesale Costs

I am writing to you today in relation to the significant falls in wholesale gas and electricity prices we have seen over the past year or so.

In a competitive market, I would expect the threat of losing market share to encourage suppliers to pass on sustained reductions in wholesale costs as savings to consumers as soon as possible. If that is not happening, it could be seen as further evidence that competition is not working for consumers as well as it should be. A concern that savings were not being passed on to customers was one of the reasons why we have proposed a referral of the energy market to the Competition and Markets Authority for investigation.

I should stress that pricing decisions are entirely a matter for individual suppliers. Each supplier will of course have its own strategy for purchasing energy, which will determine the impact of falling wholesale prices on its business. However, the downward trend in falling wholesale prices seems clear and should reduce wholesale costs increasingly over time.

Given the need to rebuild consumer trust in the market it is important that suppliers explain to their customers these changes in the wholesale market and what impact they will have on their pricing policies. I would welcome an explanation of how you are doing this.

Yours sincerely,

Dermot Nolan, Chief Executive Officer

Price promises

A large chunk of household bills - 46% - is made up from wholesale costs.

Environmental and social costs make up about 7% of a household bill. When the government announced plans to reduce green levies, many energy firms cut prices, or did not raise them as high as they expected to.

The last major reduction in household bills was in early 2012, when all the big six firms made cuts of between 4.5% and 6% in gas or electricity bills.

In recent weeks, a number of suppliers have said they would not expect any price rises over at least the next year.

The Labour Party has promised a price freeze until the start of 2017 if it wins the general election, arguably adding a political dimension to any pricing decisions.

"In a properly competitive market, there is no reason why cost reductions should not be passed on as quickly as cost increases. If there is evidence that this is not happening, that clearly suggests that competition is not properly functioning and that some kind of regulatory intervention is needed," said Caroline Flint, shadow energy minister.

Competition

A spokesman for the Department of Energy and Climate Change said: "Energy suppliers are responsible for their prices and must justify those prices to their customers. The best way to keep prices down is to introduce more competition, and our reforms have led to the number of suppliers trebling since 2010."

Energy UK, the trade association for the industry, said: "Wholesale energy is just one of a number of costs outside of an energy company's control, which make up a household bill. All energy suppliers aim to hold costs as low as possible for as long as possible. There are now 24 domestic energy retailers in the UK. They buy gas and electricity months and even years in advance to smooth out the swings in the market."

EDF Energy said in a statement: "We keep our prices under constant review and understand the importance of value to our customers."