It may be a new year, but the energy debate has picked up where it left off in 2013. Yesterday, the Labour party accused the ‘big six’ energy companies of overcharging their customers by a total of £4 billion.

Labour’s announcement was met with consternation by the energy industry, however. Industry group, Energy UK, says companies pay “the most competitive price they can” for electricity, and the party’s numbers don’t paint a “true picture” of the cost of energy. But market regulator, Ofgem, says it can’t scrutinise Labour’s claims because it doesn’t have access to data companies say is too commercially sensitive to share.

So how did Labour conclude households are being ripped off? We delve into its data to try and shed some light on a notoriously opaque issue.

Breaking down the £4 billion

Labour says the big six energy companies are paying considerably more for electricity than their smaller competitors, and passing that cost on to consumers.

The party backs this up by comparing the wholesale cost of electricity – which the big six pay to generators before selling on to households – with the price small suppliers pay. As the wholesale cost of electricity makes up about 60 per cent of an average household’s bill, it’s important that suppliers are getting the best deal they can.

Labour has compared the figures the big six give to Ofgem, with prices given to Labour by small supplier First Utility:

Source: Labour party figures, table by Carbon Brief

Assuming the difference in the wholesale cost is passed on to consumers, Labour says the big six’s markups mean an average household could be spending £48 more per year on electricity than they should be. That estimate is based on Ofgem estimates which suggest an average UK household uses 3,800 kilowatt hours of electricity each year.

And it could mean the big six are overcharging a lot of households, Labour argues. It says the big six supply 98 per cent of Britain’s households – around 26.7 million. If all of those 26.7 million households have been paying £48 more than they needed to, for 3 years, the total cost comes to £3.84 billion – or nearly £4 billion.

Where it gets complicated

The energy market isn’t very transparent, so working out how much companies actually pay for electricity – and what represents a ‘real market price’ – is very difficult. This is where Labour’s analysis hits a few stumbling blocks.

1. Comparing different things

For starters, industry body Energy UK says it’s not fair to compare the big six’s prices with First Utility’s.

The big six figures Labour uses are for the weighted average cost of fuel. This includes the wholesale cost of electricity, but also other costs which the companies incur as they trade. As such, Energy UK says the big six’s prices are bound to be different to those First Utility gave Labour.

Labour acknowledges that this difference could account for up to 10 per cent of the markup. Nonetheless, that would still mean households supplied by the big six were overcharged by £43 per year, on average.

2. There’s no such thing as one ‘market price’ for wholesale electricity

Different companies pay different amounts for electricity because there’s not one wholesale market, there’s several. Companies can buy electricity a day, weeks, months, or years ahead. Each company buys a different amount of electricity from each of these markets as it attempts to get the best deal.

First Utility’s ‘market price’ was for the year-ahead market. It’s hard to know how that compares to the price the big six pay because they don’t have to disclose those figures to Ofgem. As such, Labour has taken a single price from First Utility and tried to compare it to a large range of prices from the big six without really knowing what the complete picture looks like.

Nonetheless, Labour says that if the big six are consistently paying more than First Utility’s year ahead prices, maybe they should be forced to reconsider how they go about buying electricity, and whether or not they really are getting a good deal for consumers.

Market reform

Labour’s main objection is that the big six are ‘vertically integrated’, meaning they generate electricity as well as supplying it. Labour argues this system is bad for consumers as the big six could be manipulating the wholesale cost of electricity without anyone knowing.

That’s why it called for all electricity to be sold on the open market in its 10-point energy plan, launched in November. Labour argues that would stop companies trading with themselves, and prevent them artificially pushing up the price.

It also recommends separating the two parts of the businesses.That would force the big six to report how much profit each part of the business made separately, making the market easier to analyse.

Transparency

Labour, Ofgem, and the energy industry are all calling for greater transparency in the energy market. Until that happens, politicians and commentators are forced to make do with the data available to them – as Labour has this week – to try and work out whether consumers are getting value for money.

As such, it seems unlikely the big six are overcharging consumers by precisely £4 billion as there are too many unknown factors. But Labour’s analysis highlights just how hard it is to know whether consumers are getting a good deal in the current energy market.