Balancing the books… and what happens when they don’t

It’s not often that being a chartered accountant is a good thing. We’re always cast as the boring guy in the movies. The beancounter who likes to say ‘no’. Small children snigger at us behind our backs. And we never get invited to the best parties. But it does have its advantages. I don’t panic when the bank calls. I can do my tax return in under fifteen minutes. And I can spot a looming financial car wreck from several miles off.

And, I can tell you, there are a lot of them about.

The one currently hitting the headlines is the energy price cap. Normally, when businesses operate, there’s some kind of link between their income and their expenditure. They work out how much something costs to make, add some profit and that’s the price they charge. If people won’t pay that price, businesses either cut their costs, improve the product, launch a snazzy marketing campaign or go on to making something else.

But this only works if businesses can choose the price they charge for their products or services. Or if they can choose to stop making something because it’s not making them any money and focus their activities on something else. But this is not how the domestic energy market in the UK works. And we’re now, quite literally, all paying the price for it.

Because energy companies can’t choose how much they charge their customers for their energy, by which we mean primarily electricity and gas. Or rather, they can charge what they like, up to a price cap (per unit of energy used) set by the UK Government’s energy regulator. The ideas is that the price cap stops energy firms from charging excessive prices or from making unseemly profits.

This idea harks back to when the energy market was privatised in the late 1980s and early 1990s, because the government of the day was keen to reap the short-term financial benefits of privatisation (i.e. from selling off state-owned companies), without the rest of us feeling that we were being taken for a ride so that a small number of investors could get rather rich.

A propos of nothing in particular, between 2011 and 2020 the ‘big six’ energy firms paid out £23 billion in dividends to their shareholders.

Because the thing with energy is that we’ve come to rely on it. Other than a few hardcore preppers, very few of us would be able to cope without mains energy for longer than a few hours. No light. No heating. No phone. No internet. No Netflix. And so it’s important that people are able to afford the energy that they need to live their lives.

So the idea of an energy price cap sounds good in principle. But the snag is that there’s no equivalent cap on how much energy companies need to pay for the energy that they sell on to us. As long as wholesale energy prices remain comparatively low and comparatively stable, though, it all works fine.

But if wholesale energy prices rise substantially, as they tend to do in response to issues of supply or demand, the whims of the major oil-exporting nations or adverse world events (such as the threat of war involving one of the world’s leading suppliers of gas, for example), we start to have a problem.

The other thing to note here is that a unit of energy is, well, a unit of energy. They’re essentially interchangeable. When you switch electricity supplier, you don’t get different electricity. You just pay someone else for the electricity you get. And so pretty much anyone can set themselves up as an energy company, buy some energy from the wholesale market and sell it on to domestic customers.

You don’t need a power station or a wind turbine or a massive battery or anything like that. You just need a computer. Indeed, the Government has in recent years actively encouraged more companies to enter the domestic energy market. A broader range of energy companies would, so the thinking went, help to increase competition, bring down prices and reduce the dominance of the ‘big six’ firms.

Then wholesale energy prices started to go up. At first, the price cap rose slowly, too, to keep pace with energy companies’ rising costs. But then a perfect storm of a cold previous winter, reduced energy generation, lack of storage capacity, supply outages, lack of investment, pandemic stuff and declining geopolitical relations kicked in. Wholesale energy prices went through the roof and the energy companies had nowhere to go.

They couldn’t increase their prices without the regulator’s say so. And they were energy companies. They existed to buy and sell energy. It’s not like they could exit the energy market and start making vacuum cleaners. And many lacked the financial clout to weather the storm. In the last year, some 29 energy companies have gone bust. This has left 4.3 million domestic energy customers in the lurch.

Now, I’m no expert on the energy markets. So I don’t know what the answer is to the complex question of how best to manage supply and demand for electricity, gas and other energy supplies. But I’d imagine it would include things like ramping up renewable energy generation, reducing our dependence on overseas energy sources, developing more and better energy storage and, perhaps most important of all, reducing the amount of energy we use in the first place.

I am, though, an expert on finances and financial management. Numbers are my thing. And I can tell you that price caps and similar mechanisms are not the answer. They are simply a sticking plaster on a broken system. They might work for a while, when things are calm, but they don’t fix the underlying problem. That problem remains lurking underneath, waiting to unleash the type of havoc that we’re now seeing unfold in front of us.

The price cap is set to rise substantially in April, which will stick the plaster back down for the moment. But at a massive cost to the energy companies and to us as consumers. And yet, as any accountant will tell you, the problem hasn’t gone away. It’s still there. Waiting for next time.

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