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British Gas wins as Ofgem hits consumers with an extra tenner

And the big winner from Ofgem’s latest price cap announcement is … British Gas. Shares in the parent company, Centrica, popped to the top of the FTSE 100 leader board for an understandable reason. While the cost of energy is indeed falling, the slice of the bill that is allocated for suppliers’ profits is going up – and increasing substantially in percentage terms. From October, we’ll all be paying, on average, £47 instead of £37 to our suppliers in the hope that fewer of them go bust.

A tenner may sound modest in the context of a price cap of £2,074 from July, but crunch the numbers to see the effect on British Gas, a company with about a fifth of an overall retail energy market of 28 million customers. An extra £10 per account equates to an additional £56m of earnings if nothing else changes – a very nice uplift from last year’s profits of £72m.

Outrageous? Well, there is regulatory logic of a sort at work here. The entire retail supply market, taken as a group, has not made annual profits since the price cap was introduced in 2019; British Gas is usually the outlier. When 30 suppliers collapsed after the surge in wholesale gas prices, they did so at a cost to bill-payers of £2.7bn, or £83 per household on average. So it would be cheaper for consumers in the long them, runs the thinking, if fewer firms fell over in future.

Thus the change in so-called “Ebit allowance” (the initials stand for earnings before interest and tax) from a rigid 1.9% under the old model to a more sliding formula that, in essence, is more generous percentage-wise to suppliers at all price caps under £4,000. At the expected October cap level, the Ebit rate is 2.4%.

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But, before giving Ofgem a free pass on this reform, two points should be made. First, the cost from past corporate failures was only so enormous because the regulator allowed hopelessly under-qualified individuals to buy off-the-shelf software and set themselves up as energy suppliers.

It was a monumental act of naivety on Ofgem’s part. In essence, the flimsy operators were making a bet with little downside: if wholesale prices fell, they’d make a packet from under-hedged positions; if prices rose too far for too long, they’d hand back the licence. The real level of at-risk capital was minimal. If Ofgem had required suppliers to show sufficient financial resources to withstand the odd storm – the system it is now belatedly trying to implement – the overhaul would not have had to be so sweeping.

Second, the extra revenue from the uplift to £47 has to flow to the right place. Ofgem has told suppliers only to pay dividends to shareholders if they can meet the new financial resilience tests, complete with higher capital buffers. But writing a warning letter is the easy bit. The harder part is policing transfers of cash within some of the complex corporate structures that still exist within privately-owned suppliers.

So, yes, for as long as the price cap exists, there is a reasonable argument that the Ebit allowance should be boosted. But the reform has to be seen to produce the intended benefit. Ofgem is clearing up a mess of its own making. Its credibility would not survive any more failures that rebound on billpayers.