Why Energy Prices Are Higher & Why The "People Before Profit" Slogan Understands Neither People Nor Profit

 

People habitually talk about the right quantity of things - they are always going on about whether there is too much of something or too little - not enough being done to tackle climate change, too much sugar in our diets, not enough taxation of the rich, too much currency in circulation - the list goes on. It must be tiring always trying to attribute the proper quantities of everything in life.

The one doing the rounds at the moment is that there is too much profit being made by big energy companies - often accompanied by the misguided "People before profits" slogan. To see why the "People before profits" slogan is misjudged, you first have to see that, imprudent political meddling aside, a business can only survive in the free market if it is profitable. And a business can only be profitable if it can sell its goods or services at a higher rate than the cost of producing them. Businesses that can do this provide not just benefits for its owners, shareholders and workforce, but primarily for society too, by providing value to consumers at prices they are willing to pay. That is, the businesses have taken raw material (human talents and ideas, labour and material resources) and transposed them in a way that makes them more beneficial and valuable to society. It requires abject foolishness to utter the words "People before profits", because profits are about people, where, in terms of value, the one is not distinguishable from the other.

In a competitive market, without government impediments, profits can keep increasing only up to a point, after which they become exhausted, because new competition emerges to ensure that, by and large, the prices are charged in line with supply and demand and consumer preference. If an industry contains diminishing profits, then it is becoming inefficient - and everyone can understand this. But if an industry contains so-called 'excessive' profits (short-term shocks aside), many people become habitually myopic to the opposite truth; that the industry probably has too few providers, and there are likely potential suppliers who can compete in the sector and make smaller profits but still thrive.

Of course, the relationship between proper quantities, proper prices and proper profits is hamstrung by government price fixing, taxes and subsidies, but we'll return to that in a moment. What conditions the analysis is whether or not the good or service is a fungible one – by which we mean whether or not that good or service is easily replaceable in competition. The trouble with energy is that it is not a fungible good in the same way that beer, food, clothes or cars are. If you need to heat your home, you can't suddenly decide to substitute the narrow range of options and the relatively small range of providers able to produce the infrastructure to enable you to stay warm. Whereas, if you're thirsty, and you find that beer is too expensive, you can buy some other drinks instead. Similarly, if the price or BMWs or leather jackets became undesirable, there are plenty of other alternatives you can seek, like Fords, Vauxhalls, wool or denim. The only competition for your energy is from a very small range of big firms offering other tariffs. A small range of big firms that provides a service (like energy to millions of people) is a very hard group to break into, as competition for such a service is hard to generate. It's very costly to start up a rival firm to provide energy to millions of people.

It's true that energy companies are currently making big profits, but the picture the 'windfall tax' proponents are trying to create is inadequate, over-simplistic and misleading. In the first place, these profits must be offset against huge industry setbacks during the pandemic, in which the sector saw huge losses as the price of energy slumped when most people weren't travelling or and trading as much. If you think the huge surge in profits is simply down to greed, then you ought to wonder why the energy firms weren't greedier before the pandemic. If there are shortages in energy (Ukraine conflict, pandemic, etc), meaning that supplies might reduce and prices would go up, then wholesale prices are going to go up too, so one of the main reasons the energy companies are charging us more is because they are paying more.

But there's even more to it than that. Because of the volatility of the industry in recent times, many smaller energy firms have collapsed, which, of course, is a factor in increased profits for the bigger firms able to sweep up their custom. Part of the cause of their collapse was the government-imposed price cap, which meant they were not able to increase their prices in line with supply and demand. Furthermore, the profits of energy firms are not just made by the energy provided to consumers - the profits continued to soar despite a price cap that kept the price of energy below its marginal rate. Many of the profits we have been reading about have come from traders buying and selling commodities and seeing their value increase by the volatility of the market.

The upshot is, energy prices are caused by a number of complex factors - supply, demand, global (in)stabilities, future projections, and the minutia related to raw materials and provision of those materials in generating those supplies. People may bemoan what they think are high prices and excessive profits, but finding something hard to afford does not enable you to claim that it is too expensive. We can say why something is expensive, and we can acknowledge that the price is too high for some people to afford, but neither of those things means it's too expensive. A £5000 Porsche might be unaffordable to a jobless man, but that doesn't mean £5000 is too expensive for a Porsche.

Price caps, taxes and subsidies muddy the waters, because price caps mean goods and services are not sold in line with supply and demand's prices; taxes mean businesses are bearing more than the full production costs of their operation; and subsidies mean businesses are not bearing the full production costs of their operation. The plethora of articles that compare the relative prices and profits of energy in various countries, are fairly pointless, as they are oblivious to the complex distortionary effects created by respective price caps, taxes and subsidies in the respective nation's economy.

Further reading on this subject: 

On The Economics Of High Oil Prices (And Why They Can Be Good)