17 February 2023

Beware the nonsense narratives about ‘obscene’ energy profits


Another day, another set of hysterical headlines about energy company profits.

This time Centrica plc, the £30bn owner of British Gas, has achieved record yet relatively unremarkable profits of £3.3bn – triple its results in 2021, but only around 10% of equivalent results for British fossil fuel majors.

Unite General Secretary Sharon Graham describes this as ‘obscene’ and ‘rampaging energy profiteering’. Her words are echoed by Mel Evans of Greenpeace, who along with others is calling for a ‘proper windfall tax’. Some have also raised the recent story about a British Gas contractor’s unethical debt collection practices as evidence of Centrica’s malevolence and greed.

Nor is this confined to the usual leftwing talking heads. Even people with broadly free market instincts are using terms like ‘price gouge’ to describe profits from market prices.

This is all too typical of an era in which successive Conservative governments adopt Labour policies like price controls and windfall taxes in panicked reaction to the bad publicity. None of this is new, but it does show how badly the free market side of the debate is losing, and has been for 25 years – and that is both puzzling and dangerous if we want to keep the lights on.

Fundamentally, capitalists believe the pursuit of profit is a ‘deeply moral’ enterprise. It is the return on risks taking with your own resources, generates new resources, and in doing so changes the world for the better. Nowhere is that truer than in energy markets, where enormous risks are taken in the toughest climates and most ungovernable places on earth, with no guarantee of any return. The products of that enterprise have made us warmer, wealthier and much more resilient to the horrors of nature, including climate change.

When supply exceeds demand – as it did to an extreme degree during the pandemic – prices fall, firms make losses, and some go bust. When the reverse is true, as it is today, they make money, expand, and reinvest, often in the new sources of energy we need for our energy security. These are the blunt facts of supply and demand expressed through the price mechanism, and its impact on the bottom line and future spending plans.

Centrica’s results are an illustration of the absurdity of viewing this through the lens of moral posing. Nearly all their profit has come from two divisions, those engaged in trading and drilling. The former involves taking market positions on movements in the price of energy and providing security of supply through hedging strategies, for example in securing LNG cargoes for Europe years ahead or offsetting the intermittency of renewables. They had a great year, profits soared 1,900% from £70m to £1.4bn.

In the drilling (upstream) business, which includes a share of nuclear power projects, profits were up 170% from £663m to £1.8bn. Their service engineers lost money, the retail energy business was down, making less than £8 per customer, and they had limited success in business services and Ireland.

The fair tax on all of that (Centrica say they have paid £1bn) is whatever was legally due at the time. Trying to link the rate to the moral worth of each of those activities is impossible. The highly profitable trading activities helped keep the lights on, the gas extracted helped keep our homes warm. The losses in engineering do not make their debt collectors nicer people, Irish taxation is a matter for Ireland, and so it goes on. A deeper dive into the detail is provided by Kathryn Porter, who makes further excellent points about the impacts of trying to link these businesses together, for example by using gas profits to cross-subsidise bills. Were it even legal to do this, it would distort both markets for trivial benefits that are properly the purpose of the tax and welfare system.

If still confused about the morality of profit, consider the counterfactuals. Loss-making entities either go bust or must be bailed out, for example through our ‘supplier of last resort’ system. Taxpayer bailouts of failed enterprises in turn encourage reckless risk-taking, reward poor choices, and put the cost on everyone else.

Britain has the recent example of Bulb, alongside 28 smaller failures. The French have EDF, whose record losses last year will be passed on to the general public, without their consent. State control further means that future investment choices will meet political priorities such as jobs in battleground constituencies, rather than public preferences for affordable heat and power. The money for that investment will come from borrowing, raising taxes, or cutting spending elsewhere, rather than on the back of commercial success. These well understood problems are called ‘moral hazards’ in economics for a reason.

Today’s social democrats routinely claim that they do support markets, seek partnerships with business, and don’t want a return to state ownership, just a ‘kinder’ form of capitalism whose priorities are aligned to missions such as Net Zero. They support making money, just not ‘excessively’. That balancing act is simply not compatible with either the shrill outrage every time an energy company makes a profit, or the repeated advocacy of ‘Banana Republic tax policies.

Nor, crucially, can anyone plan a business based on second-guessing what a politician might consider to be ‘too much success’. If the UK is seen as a place of high, arbitrary taxes, applied retrospectively (which is what Labour say a ‘proper windfall tax’ means), investors will rightly see the country as a one-way losing bet. Our energy system will become more costly, less secure and we will be stuck with older, dirtier technologies.

Politicians who want to stop this happening don’t need to cheer corporate results or provide a running commentary. They do need to stand up for the principles of free market capitalism: profit, stable predictable taxes and proportionate regulation. Above all we need to stop these nonsense narratives of moral harm dominating the debate and leading to further absurd policies.

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Andy Mayer is Chief Operating Officer, Company Secretary and Energy Analyst at the Institute of Economic Affairs.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.