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
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.
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.
I certainly agree with the main thrust of this post, namely that competition in the energy market is simply not working well. This is nothing new; it was already the case nearly four years ago when the Business & enterprise Select Committee reported on it.
http://news.bbc.co.uk/1/hi/business/7526048.stm
So it remains an open question what to do about it. Of the various possibilities I agree that the existing policy that suppliers offer tariffs reflective of their costs is a non-starter. It has already failed and moreover, just as work expands to fit the time available, so costs increase to eat up the revenue.
The best plan is surely to limit each of the suppliers to just two tariffs (actually two per county because distribution costs vary substantially). This would massively reduce the confusion marketing going on at the public’s expense and force the companies to be a whole lot more transparent. It’s funny how right wing ideologues somehow ‘forget’ that for markets to work properly both parties must have good information and limiting the number of tariffs is the only way to achieve some rough parity in this respect.
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?
The Government is the referee on the playing field. It’s clear that the energy supply market is not working, because it is dominated by too few companies. The solution is to split up the companies, like the US did to the telephone company Ma Bell. Too few competitors is why the retail bank sector does not work either in the UK. They should be broken up as well. The Government had the courage to do it to BAA and although it took a long time, more organisations now run airports than before.
Thanks for your comments everyone.
Tim Leunig – ‘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.’… The energy bill is made of lots of different costs for the suppliers – wholesale makes up about 50% of the bill, transmission and distribution makes about 20%, then there is metering, environmental policies, grid balancing and more. Given there are all these other costs it gives a distorted picture to look at differences in operating costs as a proportion of the overall bill. Total operating costs per customer vary by over 100% between the most and least efficient suppliers – that is not insignificant.
It is very possible there are differences in the suppliers other controllable costs (which would include wholesale, metering, environmental policies) that would mean the spread between the least and most efficient is even bigger than that showed just by looking at the operational costs. It’s very possible – but the information is simply not available to prove it.
Liberal eye – we’re interested in the idea of limiting the overall number of tariffs a supplier can offer. We didn’t specify a number but each would definitely have to offer a standard credit, direct debit and prepayment meter tariff. then they would be able to use the rest of their ‘quota’ to offer which ever tariffs they want – be it fixed term, or non-fixed termm, green, standard. Whatever. Ofgem has proposed major changes to tariffs that are likely to make the market more complex for consumers while also restricting the ability of suppliers to innovate in standard tariffs. I think our solution could be better at improving simplicity and maintaining innovation potential.
Jenny – we’re turning our attention to issues in electricity generation next.
The standard neoliberal narrative is that more choices equals more competition equals a Good Thing. I disagree. More choices actually results in confusion marketing and a diversion of attention away fromthe main event. Against the full time experts none of us amateurs, even those of us with a strong commercial background, has a chance so many/most will end up paying too much and the companies can cherry pick the ‘best’ (ie most credit worthy, largest or otherwise desirable customers) by finely segmenting their offering while less favoured customers pay more to balance things up.
So what I am proposing is a counter-intuitive solution where each company has to offer its BEST shot because it is its ONLY shot (or very nearly only). That implies hard choices for suppliers because nothing is ‘ruled out’ (per Tim Leunig) and there is no ‘each would definitely have to offer…’ (per Reg Platt). So, for instance, in a largely rural county supplier A might choose to offer no dual fuel because a high proportion of customers have no gas. But that then leaves them exposed to supplier B that is a new entrant and decides to offer a dual fuel discount or green power and to supplier C that simply offers a lower price. Inter alia it would make it much harder for the big 6 to dominate supply and because suppliers would have to upgrade customers on old tariffs they would immediately loose the benfit of the stickiness of many customers.
Of course the proposed limit of two tariffs is arbitrary but I’m fairly sure that the smaller the number the healthier the competition and this could be tested by setting up a business game where participants act out the various parties involved over several periods.
Ultimately, it’s the difference between a ‘free market’ (meaning in practice one where the dominant players set the rules to suit themselves almost invariably runnign rings round the regulators) and an ‘open market’ where the rule-setting power of the state is used to prevent bad practice for the benefit of citizens and facilitate challenge to incumbents for the benefit of a long term reduction in price and the promotion of good innovation. Administrative intervention (a.k.a. regulation) is then much less necessary because genuine competition between companies does the job.
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?