We asked one of the largest economic consultancies in Europe to comment on recent debate around the profitability of the energy networks in Great Britain. Here, Frontier Economics sets out their findings and analysis.
by Frontier Economics
As an example, the recently published Common Wealth report “Hiding in Plain Sight” discussed the operating profit margin achieved by the sector, and used this to draw the conclusion that the profitability of the sector may be unduly high. We set out our key observations on this topic in this short article:
- Operating profit margin is the wrong measure to use in order to assess profitability and it is therefore wrong to draw a conclusion on profitability based on operating margin. The correct measure of profitability is returns.
- A reasonable level of return in a capital intensive industry can be expected to translate into a high operating margin. For example, a 3% return on assets translates to approximately 30% operating margin in the electricity transmission sector.
- The combination of high upfront costs and long-lived assets means that the energy network industry is by its nature highly capital intensive. A high operating margin should therefore be expected, but this alone does not allow us to infer anything about the level of allowed returns.
Attention should therefore not focus on the operating margin – which does not directly measure profitability – but instead on allowed returns. The sector regulator Ofgem has just set allowed returns at unprecedentedly low levels for the forthcoming regulatory period.
About Energy Networks Association
Energy Networks Association (ENA) is the industry body representing the companies which operate the electricity wires, gas pipes and energy system in the UK and Ireland.
ENA helps its members meet the challenge of delivering electricity and gas to communities across the UK and Ireland safely, sustainably and reliably.
Its members include every major electricity and gas network operator in the UK and Ireland, independent operators, National Grid ESO which operates the electricity system in Great Britain and National Grid Gas which operates the gas system in Great Britain. Its affiliate membership also includes companies with an interest in energy, including Heathrow Airport and Network Rail.
What are energy network operators?
Energy network operators manage and maintain the wires, pipes and other infrastructure which delivers electricity and gas to your home, business and community. They are private companies which are regulated by Ofgem and employ around 45,000 people in the UK and Ireland. They are represented by their industry body, Energy Networks Association (that's us).
Energy supplier or network operator? Energy network operators are entirely separate to your energy supplier, which is the company that bills you for using electricity and gas. Energy suppliers and generators are represented by Energy UK.