The True Cost of Energy: why Ed Davey must act

A poll out yesterday showed that action to address high energy bills is now the top priority for voters, so Energy and Climate Change Secretary Ed Davey has a political interest in new research on the True Cost of Energy published by IPPR. The report argues that competition in the energy market is not working and that some consumers are paying higher prices as a result.

IPPR has analysed how much it costs energy companies to supply electricity and gas to UK consumers, finding strong evidence that competition in the market is not in good health.

The UK energy market is dominated by six companies, who provide energy to 99% of all consumers. We have found that the least efficient of the Big Six spends 113%, or over £50, more on their operations per year for each customer than the most efficient, a significant amount when compared to the average energy bill of around £1,255 a year. As price is overwhelmingly what matters to consumers when they buy energy, it is surprising that such a big difference exists. In a competitive market inefficient companies should be priced out of the market. What is striking is that the difference between the most and least efficient company in terms of how much they spend on their operations per customer has grown since 2007, when we would expect to see the reverse. This is strong evidence that competition is not driving efficiency savings as it should be.

The role of the energy markets regulator, Ofgem, is key. It publishes regular estimates of energy companies’ costs and how these relate to the average energy bill, but Ofgem’s evidence shows no sign that energy bills have been affected by the efficiency savings the companies have achieved in their operations. As a result some consumers are likely to be paying more for their energy than they should. Ofgem has launched a major package of reforms, the Retail Market Review, aimed at improving competition in the energy market. But the previous package of reforms failed to improve conditions and, according to Ofgem’s own research, on some measures conditions have actually deteriorated.UK consumers cannot afford for these new reforms to go the same way.

Ed Davey should therefore ensure that Ofgem enforce its existing policy that the suppliers must offer tariffs that are reflective of their costs. IPPR analysed the tariffs offered by suppliers and found that several did not appear to be complying with the policy. In fact, Ofgem has launched an investigation into one of the suppliers, Scottish Power, but over a year later they have yet to provide any update on progress. On the face of it, it looks like Ofgem needs to act faster. Alternatively, it may be that the policy is very hard to implement, in which case Ofgem should say so and look for alternatives. What is clear is that the current approach does not appear to be working.

He should also ensure that Ofgem examine loss leading: where suppliers subsidise big discounts for some customers by overcharging others. IPPR found that some suppliers charge some customers over £330 a year more for using the same amount of energy than others and we estimated that 5 million people could be being overcharged through this practise. This also limits competition because small suppliers cannot match the discounts offered by some of the Big Six suppliers. Another area ripe for reform is the number of tariffs that suppliers can offer. Reducing the number of these would immediately simplify the market, making switching easier, while still enabling energy companies to offer innovative tariffs.

So while reforming the industry is a great policy challenge, it is also a great political opportunity. As a former minister for consumer affairs, Ed Davey is fully aware of the difference that relatively small changes to energy bills can make when people are on tight budgets. If he could deliver decisive reform of the energy market the political dividend could be substantial.

* Reg Platt is a Research Fellow at the Institute for Public Policy Research, specialising in energy and climate change policy.

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9 Comments

  • John Richardson 1st May '12 - 1:13pm

    British Gas are cutting 600 UK jobs in an effort to become more efficient.

    One thing I would like to see reformed is the time it takes to switch. I recently changed my gas from SSE to nPower. It took 69 days – over 9 weeks. The least time I’ve ever had it take is over 4 weeks. IMO this should be reduced to a maximum of 7 days for people not on deals. This would allow consumers to respond in good time to a changing market.

  • There are big issues in the market – CentreForum will publish a paper on this later in the year – but if the gap between the most and least efficient companies is only 4% of average bills then this must be about the tightest cost spread in any sector.

  • jenny barnes 1st May '12 - 2:44pm

    Most of the cost of domestic energy, though, relates directly to the wholesale price of gas – an internationally traded commodity. And that’s not going to get any cheaper.
    Insulation, renewables, nuclear.
    Trying to get the big 6 companies to change their charging policies? not so much. The Coalition seems to be entranced by the idea of markets – if so, let the markets work. That’ll be gas fired electricity then, until the gas gets too dear, and then prices will go up a lot.

  • 2 per county? Which are ruled out:
    discounts for dual fuel?
    discounts for reading your own meter?
    discounts for paying by direct debit?
    discounts for paying monthly?

  • Richard Dean 2nd May '12 - 6:44pm

    I wonder of this industry is suffering from some conflicting ideas and objectives? The cost differential quoted as £50 per £1255 is 4%, which is astonishly small. Doesnlt it suggest either that companies collude to equalise the costs they allow Ofgem to see (which siggests Ofgem is not doing its job), or that they are all being as efficient as they possibly can?

    Proper competition in principle should keep margins low and industries efficient, which is presumably good for consumers as well as the country as a whole (though John Richardson;s news about BG shows it is not good for workers!). If companies compete on price, someone somewhere is going to be paying more than someone somewhere else, maybe even next door, otherwise no company would have a competititive advantage and there would be no competition!. If companies compete on service, someone somewhere is going to be getting a better service than someone somewhere else. So if we want the thing that is good for everyone on average, then we more or less have to accept that some consumers will be worse off than others.

    Are consumers up in arms about this? If so, there should be business opportunities for intermediarties to buy gas and services from the best source and pass on some of the cost savings to consumers. There could also be a role for a government agency to provide advice to consumers. If these opportunities don’t exist, then is the problem really felt? Is the problem really one that has been fabricated by politicians for political objectives?

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