If oil prices are coming down, how come my bill isn’t?

 

Lauren Bravo meets Nazim Osmancik - the man who’s responsible for monitoring and analysing the wholesale energy markets in Centrica.

 

In these times of rocketing house prices, inflated transport costs, and cups of coffee that seem to get more expensive in the time it takes to find your wallet, it’s rare to read about anything getting cheaper. Except oil. Since 2014, crude oil prices have dropped dramatically across the globe. But despite all the excitement at the petrol pumps, household energy bills haven’t fallen at the same rate. Confusing… unless you’re an analyst like Nazim Osmancik, Director of Fundamentals at Centrica, who is responsible for monitoring and analysing the wholesale energy markets in Centrica. I caught up with him to ask why.

 

Lauren: Hi Nazim! Firstly, can you explain to someone who hasn’t been paying much attention (me) why oil prices have fallen so much in the last couple of years?

Nazim: Put very simply: there is too much oil. We’ve had a very big increase in production in the United States through 2014, where the process of extracting oil from shale rocks (fracking) has boomed, and in turn that’s created an increase in available supply in the world markets. Production has also started to come back in areas of conflict like Libya and Iraq, and countries such as Saudi Arabia have ramped up production to compete with the United States. Meanwhile growth in global consumption slowed in 2014, because economies are plateauing after the big recession back in 2009, though low prices helped stimulate it a bit in 2015.

 

So cheap oil doesn’t mean we’re all just using more? 

Not enough to match the supply! Imagine that suddenly petrol is cheap – you might choose to drive more as a result, but you’re not going to buy 10 cars and drive them all at once, are you? 

 

Good point. So, the biggie: if oil prices have plummeted, why haven’t our bills fallen with them?

Well firstly, the cost of most of the gas that’s bought and sold for the UK market is not actually based on oil prices. And the small proportion of gas that is sold based on oil pricing tends to be based on the price over the past six months, nine months or 12 months – not the price it happens to be today. The other main reason is something we call ‘forward-buying’. Companies like British Gas buy energy in advance for their millions of customers because, especially in the case of gas, prices can be very volatile, driven in part by variations in demand – it varies a lot, both day to day and throughout the year, and in the UK it is highly dependent on the weather.

 

And if there’s one thing we all understand in Britain, it’s that you can never rely on the weather…

Quite. Not having enough gas in a cold snap or having to procure it at heightened prices would be undesirable for us and our nine million energy customers. So British Gas and other large suppliers do everything we can to manage our customers’ demand and minimise price volatility. That includes buying energy months or even years in advance.

 

So there’s always something in the cupboard for a rainy (or snowy) day? Like stockpiling tins of beans?

Absolutely! It means we have “reserved” some of what our customers need at a price that we know – because otherwise there is a risk that if it suddenly gets very cold, there just might not be enough to go round and wholesale prices shoot up, which can happen. Since we have reserved the price far in advance, our customers’ bills don’t drop as soon as the oil or wholesale gas prices do. Imagine that you went to the supermarket and one day bread was 5p, then the next day it was £10. You’d want some kind of stability, wouldn’t you? By forward-buying, we protect ourselves and our customers against the constant ups and downs of wholesale prices.

 

So if you’re buying energy a year or two in advance, does that mean our bills will go down in a year or two’s time? 

It’s not quite as simple as that. One reason is that the wholesale price of gas is only (roughly) 45% of your gas bill and a much smaller proportion of the Dual Fuel energy bill. The rest of the price covers everything else that’s needed to get the gas to customers and businesses safely – maintaining all the systems and pipes, investing in upgrading them as necessary, providing customer call centres, paying the staff, everything. That half of the bill tends to go up, because of inflation. And especially in the case of electricity, quite a lot of the cost is government taxes and levies to help finance investment in green energy for the future. The UK is a world leader in these types of investment, which is great, but the small print is extra money on our energy bills. I don’t think people always realise that.

 

So, will our bills ever see that knock-on effect?

If wholesale commodity prices continue to go down, I think it’s probably safe to say that component of the bills will follow. We’ve already reduced our prices three times since the start of 2015 - that’s nearly £100 off the average household annual bill - and we might well be able to pass on more of those changes in future, if the wholesale price trend continues. But it’s a gradual process, not a sudden drop – to keep the cupboard well-stocked, you might say.

 

That’s oil, folks.