UK gas and electricity distribution companies have higher profit margins than any other sector, prompting calls for intervention at a time of soaring energy bills and frequent electricity blackouts in parts of the country.
The regional infrastructure monopolies whose pylons and cables carry electricity from power stations to end users are achieving operating margins of 42.5 per cent, according to analysis by industry research provider IbisWorld, while gas distributors are earning 40.5 per cent.
The margins, which come before tax and financing costs are deducted, outstrip those in more than 400 other sectors including private equity at 32.5 per cent and commercial real estate at 33.4 per cent, according to IbisWorld.
High operating margins enabled the regional electricity networks to pay out £3.6bn in dividends to their owners between 2017 and 2021, with gas distribution networks distributing £2.4bn to theirs over the same period, according to a separate report by Common Wealth, a left-of-centre think-tank that has the Labour politician Ed Miliband on its board.
It argues that UK households are paying the price for these payouts to owners — which include private equity, infrastructure funds and individuals such as Hong Kong’s billionaire Li family, which is weighing a £15bn sale of UK Power Networks, the country’s largest electricity network provider.
There are now six big electricity distribution networks and four regional gas distribution companies after a wave of privatisations in the 1980s and 1990s. Many have complex, multi-layered ownership structures, some with offshore holding companies in the Cayman Islands or Jersey.
Average household bills will rise by 54 per cent in April to almost £2,000 a year for most households. By some forecasts they will increase again to roughly £3,000 a year in October, putting unbearable pressure on low-income families.
Although the rises are partly the result of soaring gas prices, exacerbated by Russia’s invasion of Ukraine, the high profit margins suggest British households are also paying the price of a fragmented system of private monopolies that delivers outsized returns for investors, Common Wealth said.
The average British customer paid £214.35 for gas and electricity distribution in the year leading up to March 2021, according to industry regulator Ofgem, which at the time accounted for roughly a fifth of a typical household’s energy bills.
Recent storms that disrupted power supplies have also shown that service levels are sometimes poor, with Ofgem recently chastising companies for “inadequate support” to thousands of households left without power in the wake of Storm Arwen in November.
Joseph Baines and Sandy Brian Hager, senior lecturers in international political economy at King’s College London and City, University of London respectively who authored the Common Wealth report, argue that their findings show that “the financial returns of these companies are being prioritised over the financial security of British households”.
However, John Griffin, analyst at IbisWorld, said that although the operating margins were noteworthy, there were flaws in using them as a metric as the high level of regulation in the sector made it “difficult to compare with industries which operate in a free market”.
“The high operating margins were allowed as part of regulator Ofgem’s price control framework to enable firms to invest in network expansions and upgrades, as well as providing a return to these companies and its shareholders,” he added.
The Energy Network Association, which represents the monopoly providers, said the Common Wealth analysis was an “unfair representation”.
“The UK’s distribution networks are set to invest and spend more than £33bn over the next five years. This expenditure and investment — alongside the 36,000 people employed by the sector — secures safe, sustainable, reliable networks to deliver the energy that communities need now and in the future.”
However, Common Wealth argues that much of the £33bn comes from customer bills and that the high returns are not justified given these companies’ monopoly status.
“Huge profit margins are usually seen as a reward for extraordinary performance, and dividends as a return for equity investors bearing risk, but neither the performance levels nor the risk exposures of these natural monopolies are that high,” said Baines.
Actual payouts to investors are much higher than the dividends alone suggest, according to Common Wealth, which found that the interest payments on the internal debt of the gas distribution networks amounted to £928mn from 2017 to 2021, and £842mn for the electricity providers over the same period.
Although calls for a windfall tax have been focused on oil producers operating in the North Sea, Common Wealth argues that electricity and gas distribution companies should also face greater scrutiny from policymakers.
Ofgem said in its state of the market report in 2019 that “the overall costs of the transmission and distribution networks to consumers . . . have turned out to be higher than they needed to be” and that “the majority of network companies are achieving profit margins towards the higher end of our expectations”.
However, it is planning to reduce returns to shareholders as part of its next review periods which start in 2023 for electricity and 2027 for gas.
“Ofgem’s network regulation has delivered significant benefits to consumers through higher quality services whilst attracting the investment needed to connect record levels of renewable power,” the regulator said in response to the Common Wealth report. “We are reducing the amount paid to shareholders so that they are closer to current market levels.”
Despite Ofgem’s willingness to cut returns, appetite for the monopolies, which offer guaranteed revenues, has remained strong. Macquarie and KKR have emerged as potential buyers for UK Power Networks, which was bought for £5.8bn in 2010 by Hong Kong billionaire Li Ka-shing’s CK Infrastructure Holdings.