The voice of the energy industry

SMI: outdated, statistically biased & inaccurate

Estimates of how much money energy companies might make have been wildly exaggerated in recent years. New, independent research from NERA has found Ofgem estimates have been consistently out over the last four years by as much as 200 per cent. This is despite Ofgem revising its methodology in recent months.

The report highlights that the SMI:

  • consistently overstated profits;
  • is statistically biased - resulting from mistaken assumptions around revenues and costs;
  • overestimates average consumption levels; and
  • used outdated and hypothetical information to calculate hedging strategies.

Commenting on NERA’s assessment of flaws in the regulator’s own model Lawrence Slade, chief executive of Energy UK, said:

“NERA’s research shows that Ofgem’s SMI reports, time and again, have proven to be unreliable. The report shows that the SMI takes no account of what energy companies have to pay out in financing costs, interest or tax but gives the misleading impression that there are massive profits to be made. Ofgem’s Dermot Nolan admitted the SMI was no predictor of future profits but Ofgem still risks misleading customers by publishing these inaccurate figures every month. It’s high time the SMI was abandoned.”

Mr Slade said that the energy industry is committed to working with Ofgem and to greater transparency with customers based on rigorous and accurate information. He pointed out that all the major companies annually publish full breakdowns of earnings and costs in their Consolidated Segmental Statements (CSS). These are audited by Ofgem which has acknowledged they are a better indicator of earnings before interest and tax as they are based on actual historical data.  

Ends

Notes to Editors

Key information from NERA report:

  • Ofgem’s methodology clearly states that the “SMI cannot and does not seek to provide a forecast of company profits” (Executive Summary) and that “a reliable indicator of profitability (before interest and taxes) is provided in the individual companies’ Consolidated Segmental Statements (CSS)” (2.1, Page 3).
  • The SMI has consistently overstated profits. (2.1, Page 3)
    • For the last four years Ofgem has overestimated profits for gas, electricity and dual fuel.
    • Ofgem has given the impression that profits per customer were between 50-200% higher than the actual figures.
  • The SMI is biased: the bias results from assumptions around revenues and costs. (2.3 Page 5)
    • The revenue assumptions are based on simplified consumption estimates.
    • The wholesale costs do not take into account different hedging strategies.
    • Ofgem assumes operating costs per customer rise with inflation. In practice, as small suppliers gain market share, operating costs per customer for larger companies are likely to increase.
    • The network costs assume a standard level of consumption and ignore 5 million customers on Economy 7 meters.
    • Ofgem assumes that the costs of social policies remain flat where as in practice they tends to rise over time.
  • Ofgem overestimates the average consumption levels (Appendix A, Page 7 & 8)
    • Consumption levels directly impact on the revenue (bill)
    • The blend of tariffs places too much weight on more expensive deals
  • Ofgem use hedging strategies based on 2008 information. (Appendix 3, Page 10)
    • Ofgem uses a hypothetical hedging strategy based on the 2008 Energy Supply Probe while the energy market has evolved since then
    • It is not clear that an 18 month buying strategy is at all representative of an average of individual buying strategies.
  • Fixed costs per customers may rise as large suppliers’ market shares fall ( Appendix 4, Page 14)
  • Ofgem simply assumes that indirect costs rise with inflation (Appendix 4, Page 14)

The NERA report can be read in full online.

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