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Chris Weston response to Ofgem on wholesale prices

Dear Dermot,

Pricing decisions in a competitive market are, as you say, a matter for individual suppliers. British Gas remains committed to being transparent and clear with customers about the underlying drivers of cost in our customers’ bills. Equally importantly, we strive to have retail prices which are both competitive and reflect our costs.

It is also worth noting that commodity costs make up just under half of a customer’s bill and some of the major non-commodity items, such as transmission and distribution costs and Government obligations, are continuing to increase. When taking pricing decisions, suppliers like British Gas will take in to account all costs they face, and not just commodity costs

In reality supplier costs will also be affected by changes in forecast demand over the hedging period, requiring ongoing management and incremental cost. Suppliers may additionally adjust their hedging strategy to take account of perceived future risks.

Our retail price decisions are based on our actual WACOG and WACOE figures (i.e. the costs we face), not necessarily the day ahead wholesale price. Our recent trading update demonstrated that these reductions in wholesale costs have most definitely not translated to increased profits for British Gas.

I’m sure you will agree that, at a time when the industry is under such scrutiny, it is hugely important that information available to consumers about energy prices is accurate and consistent. With this in mind, Ofgem should also consider the impact that the publication of the Supply Market Indicators (SMI), and the way it is treated by industry commentators, has on consumer confidence.

Ofgem’s latest publication would imply that British Gas annual profits from domestic operations would be £800m, when the reality is that we have just had to issue our second profit warning in six months and analyst’s consensus places us nearer £400m. It is important for Ofgem to take steps to correct the misleading impression on the level of supplier profits the SMI creates now (principally due to the assumptions Ofgem uses for consumption), and prevent further issues arising in future.

I also accept that suppliers have a role to play. Whilst it is important not to signal future price changes to the market, helping consumers understand how energy companies hedge, and therefore why short term movements in commodity costs do not lead to changes in the retail price, is important. We do take steps to explain this at the moment, and are currently looking at how we can improve communications further in future.

Whilst I fully expect the relationship between wholesale and retail prices to be comprehensively explored and properly understood by the Competition and Markets Authority in the event of any market investigation, we would welcome the opportunity to help your teams understand more about how the processes described in this letter work in practice.

Please let me know if this would be helpful.

Yours sincerely

Chris Weston

Managing Director, British Gas

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