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Posts Tagged ‘Ofgem’

Energising the energy market

In June 2014, the Gas and Electricity Markets Authority (which governs the energy regulator, Ofgem) referred Great Britain’s retail and wholesale gas and electricity markets to the Competition and Markets Authority (CMA). The market is dominated by the ‘big six‘ energy companies (British Gas, EDF, E.ON, npower, Scottish Power and SSE) and Ofgem suspected that this oligopoly was distorting competition and leading to higher prices.

The CMA presented its report on 10 March 2016. It confirmed its preliminary findings of July and December 2015 “that there are features of the markets for the supply of energy in Great Britain that result in an adverse effect on competition”. It concludes that “the average customer could save over £300 by switching to a cheaper deal” and that “customers could have been paying about £1.7 billion a year more than they would in a competitive market”.

It made various recommendations to address the problem. These include “requiring the largest suppliers to provide fuller information on their financial performance” and strengthening the role of Ofgem.

Also the CMA wants to encourage more people to switch to cheaper suppliers. At present, some 70% of the customers of the big six are on default standard variable tariffs, which are more expensive than other tariffs available. To address this problem, the CMA proposes the setting up of “an Ofgem-controlled database which will allow rival suppliers to contact domestic and microbusiness customers who have been stuck on their supplier’s default tariff for 3 years or more with better deals.”

Another area of concern for the CMA is the 4 million people (16% of customers) forced to have pre-payment meters. These tend to be customers with poor credit records, who also tend to be on low incomes. Such customers are paying more for their gas and electricity and yet have little opportunity to switch to cheaper alternatives. For these customers the CMA proposed imposing transitional price controls from no later than April 2017 until 2020. These would cut typical bills by some £80 to £90 per year. In the meantime, the CMA would seek to remove “restrictions on the ability of new suppliers to compete for prepayment customers and reduce barriers such as debt issues that make it difficult for such customers to switch”.

Despite trying to address the problem of lack of competition, consumer inertia and barriers to entry, the CMA has been criticised for not going further. It has also been criticised for the method it has chosen to help consumers switch to cheaper alternative suppliers and tariffs. The articles below look at these criticisms.

Podcast
Competition and Markets Authority Energy Report BBC You and Yours (10/3/16)

Articles
Millions could see cut in energy bills BBC News (10/3/16)
Shake-up of energy market could save customers millions, watchdog says The Telegraph, Jillian Ambrose (10/3/16)
UK watchdog divided over energy market reforms Financial Times, Kiran Stacey (10/3/16)
How the CMA energy inquiry affects you Which? (10/3/16)
UK watchdog accused of bowing to pressure from ‘big six’ energy suppliers The Guardian, Terry Macalister (10/3/16)

CMA documents
CMA sets out energy market changes CMA press release (10/3/16)
Energy Market Investigation: Summary of provisional remedies Competition and Markets Authority (10/3/16)

Questions

  1. Find out the market share of the ‘big six’ and whether this has changed over the past few years.
  2. What, if any, are the barriers to entry in the gas and electricity retail markets?
  3. Why are the big six able to charge customers some £300 per household more than would be the case if they were on the cheapest deal?
  4. What criticisms have been made of the CMA’s proposals?
  5. Discuss alternative proposals to those of the CMA for dealing with the problem of excessive prices of gas and electricity.
  6. Should Ofgem or another independent not-for-profit body be allowed to run its own price comparison and switching service? Would this be better than the CMA’s proposal for allowing competitors access to people’s energy usage after 3 years of being with the same company on its standard tariff and allowing them to contact these people?
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A windfall for electricity producers?

When an industry produces positive externalities, there is an argument for granting subsidies. To achieve the socially efficient output in an otherwise competitive market, the marginal subsidy should be equal to the marginal externality. This is the main argument for subsidising wind power. It helps in the switch to renewable energy away from fossil fuels. There is also the secondary argument that subsidies help encourage the development of technologies that would be too uncertain to fund at market rates.

If subsidies are to be granted, it is important that they are carefully designed. Not only does their rate need to reflect the size of the positive externalities, but also they should not entail any perverse incentive effects. But this is the claim about subsidies given to wind turbines: that they create an undesirable side effect.

Small-scale operators are encouraged to build small turbines by offering them a higher subsidy per kilowatt generated (through higher ‘feed-in’ tariffs). But according to a report by the Institute for Public Policy Research (IPPR), this is encouraging builders and operators of large turbines to ‘derate’ them. This involves operating them below capacity in order to get the higher tariff. As the IPPR overview states:

The scheme is designed to support small-scale providers, but the practice of under-reporting or ‘derating’ turbines’ generating capacity to earn a higher subsidy is costing the taxpayer dearly and undermining the competitiveness of Britain’s clean energy sector.

The loophole sees developers installing ‘derated’ turbines – that is, turbines which are ‘capped’ so that they generate less energy. Turbines are derated in this way so that developers and investors are able to qualify for the more generous subsidy offered to lower-capacity turbines, generating 100–500kW. By installing derated turbines, developers are making larger profits off a feature of the scheme that was designed to support small-scale projects. Currently, the rating of a turbine is declared by the manufacturer and installer, resulting in a lack of external scrutiny of the system.

The subsidies are funded by consumers through higher electricity prices. As much as £400 million could be paid in excess subsidies. The lack of scrutiny means that operators could be receiving as much as £100 000 per year per turbine in excess subsidies.

However, as the articles below make clear, the facts are disputed by the wind industry body, RenewableUK. Nevertheless, the report is likely to stimulate debate and hopefully a closing of the loophole.

Video
Turbine power: the cost of wind power to taxpayers Channel 4 News, Tom Clarke (10/2/15)

Articles
Wind subsidy loophole boosts spread of bigger turbines Financial Times, Pilita Clark (10/2/15)
Call to Close Wind Power ‘Loophole’ Herald Scotland, Emily Beament (10/2/15)
Wind farm developers hit back at ‘excessive subsidy’ claims Business Green, Will Nichols (10/2/15)
The £400million feed-in frenzy: Green energy firms accused of making wind turbines LESS efficient so they appear weak enough to win small business fund Mail Online, Ben Spencer (10/2/15)
Wind power subsidy ‘loophole’ identified by new report Engineering Technology Magazine, Jonathan Wilson (11/2/15)

Report
Feed-in Frenzy Institute for Public Policy Research, Joss Garman and Charles Ogilvie (February 2015)

Questions

  1. Draw a diagram to demonstrate the optimum marginal rate of a subsidy and the effect of the subsidy on output.
  2. Who should pay for subsidies: consumers, the government (i.e. taxpayers generally), electricity companies through taxes on profits made from electricity generation using fossil fuels, some other source? Explain your thinking.
  3. What is the argument for giving a higher subsidy to operators of small wind turbines?
  4. If wind power is to be subsidised, is it better to subsidise each unit of output of electricity, or the construction of wind turbines or both? Explain.
  5. What could Ofgem do (or the government require Ofgem to do) to improve the regulation of the wind turbine industry?
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Making UK energy supply more competitive (John’s post)

The UK energy industry (electricity and gas) is an oligopoly. There are six large suppliers: the ‘Big Six’. These are British Gas (Centrica, UK), EDF Energy (EDF, France), E.ON UK (E.ON, Germany), npower (RWE, Germany), Scottish Power (Iberdrola, Spain) and SSE (SSE Group, UK). The Big Six supply around 73% of the total UK market and around 90% of the domestic market.

Energy suppliers buy wholesale gas and electricity and sell it to customers. The industry has a considerable degree of vertical integration, with the energy suppliers also being involved in both generation and local distribution (long-distance distribution through the familiar pylons is by National Grid). There is also considerable horizontal integration, with energy suppliers supplying both electricity and gas and offering ‘dual-fuel’ deals, whereby customers get a discount by buying both fuels from the same supplier.

Smaller suppliers have complained about substantial barriers to entry in the industry. In particular, they normally have to buy wholesale from one of the Big Six. Lack of transparency concerning their costs and internal transfer prices by the Big Six has led to suspicions that they are charging more to independent suppliers than to themselves.

Under new regulations announced by Ofgem, the industry regulator, the Big Six will have to post the prices at which they will trade wholesale power two years in advance and must trade fairly with independent suppliers or face financial penalties. In addition, ‘a range of measures will make the annual statements of the large companies more robust, useful and accessible.’ According to the Ofgem Press Release:

From 31 March new rules come into force meaning the six largest suppliers and the largest independent generators will have to trade fairly with independent suppliers in the wholesale market, or face financial penalties. The six largest suppliers will also have to publish the price at which they will trade wholesale power up to two years in advance. These prices must be published daily in two one-hour windows, giving independent suppliers and generators the opportunity and products they need to trade and compete effectively.

But will these measures be enough to break down the barriers to entry in the industry and make the market genuinely competitive? The following articles look at the issue.

Articles
Boost for small energy firms as Big Six are ordered to trade fairly on wholesale markets or face multi-million pound fines This is Money, Rachel Rickard Straus (26/2/14)
Energy firms told to trade fairly with smaller rivals BBC News, Rachel Fletcher (26/2/14)
Ofgem ramps up scrutiny of Big Six accounts The Telegraph, Denise Roland (26/2/14)
‘Big six’ told to trade fairly – will it make a difference? Channel 4 News, Emma Maxwell (26/2/14)
Energy regulator Ofgem forces trading rules on ‘big six’ suppliers Financial Times, Andy Sharman (26/2/14)

Information
Ofgem tears down barriers to competition to bear down as hard as possible on energy prices Ofgem Press Release (26/2/14)
The energy market explained Energy UK
Gas Ofgem
Electricity Ofgem
Energy in the United Kingdom Wikipedia
Big Six Energy Suppliers (UK) Wikipedia

Questions

  1. Describe the structure of the UK energy industry.
  2. What are the barriers to the entry of new energy suppliers and generators in the UK?
  3. To what extent is vertical integration in the electricity generation and supply industry in the interests of consumers?
  4. To what extent is horizontal integration in the electricity and gas markets in the interests of consumers?
  5. How will requiring the six largest energy suppliers to post their wholesale prices for the next 24 months increase competition in the energy market?
  6. Is greater transparency about the revenues, costs and profits of energy suppliers likely to make the market more competitive?
  7. Identify and discuss other measures which Ofgem could introduce to make the energy market more competitive.
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The Big Six: for how much longer? (Elizabeth’s post)

The energy market is complex and is a prime example of an oligopoly: a few dominant firms in the market and interdependence between the suppliers. Over 95% of the market is supplied by the so-called ‘big six’ and collectively they generate 80% of the country’s electricity. There are two further large generators (Drax Power Limited and GDF Suez Energy UK), meaning the electricity generation is also an oligopoly.

This sector has seen media attention for some years, with criticisms about the high profits made by suppliers, the high prices they charge and the lack of competition. Numerous investigations have taken place by Ofgem, the energy market regulator, and the latest development builds on a simple concept that has been a known problem for decades: barriers to entry. It is very difficult for new firms to enter this market, in particular because of the vertically integrated nature of the big six. Not only are they the suppliers of the energy, but they are also the energy generators. It is therefore very difficult for new suppliers to enter the market and access the energy that is generated.

Ofgem’s new plans will aim to reduce the barriers to entry in the market and thus make it easier for new firms to enter and act as effective competitors. The big six energy generators are vertically integrated companies and thus effectively sell their energy to themselves, whereas other suppliers have to purchase their energy before they can sell it. The regulator’s plans aim to improve transparency by ensuring that wholesale power prices are published two years in advance, thus making it easier for smaller companies to buy energy and then re-sell it. Andrew Wright, the Chief Executive of Ofgem, said:

These reforms give independent suppliers, generators and new entrants to the market, both the visibility of prices, and [the] opportunities to trade, [that] they need to compete with the largest energy suppliers…Almost two million customers are with independent suppliers, and we expect these reforms to help these suppliers and any new entrants to grow.

Although such reforms will reduce the barriers to entry in the market and thus should aim to increase competition and hence benefit consumers, many argue that the reforms don’t go far enough and will have only minor effects on the competitiveness in the market. There are still calls for further reforms in the market and a more in-depth investigation to ensure that consumers are really getting the best deal. The following articles consider this ongoing saga and this highly complex market.

Ofgem ramps up scrutiny of Big six accounts Telegraph, Denise Roland (27/2/14)
Energy firms told to trade fairly with smaller rivals BBC News (26/2/14)
Energy regulator Ofgem force trading rules on ‘big six’ suppliers Financial Times, Andy Sharman (26/2/14)
Ed Davey calls on Ofgem to investigate energy firms’ gas profits The Guardian, Sean Farrell and Jennifer Rankin (10/2/14)
UK forces big power companies to reveal wholesale prices Reuters (26/2/14)
Watchdog unveils new rules on Big six energy prices Independent, Tom Bawden (26/2/14)
Energy Bills: New rules to boost competition Sky News, (26/2/14)

Questions

  1. What are the characteristics of an oligopoly?
  2. Explain the reason why the vertically integrated nature of the big six energy companies creates a barrier to the entry of new firms.
  3. What are the barriers to entry in (a) the electricity supply market and (b) the electricity generating market?
  4. What action has Ofgem suggested to increase competition in the market? How effective are the proposals likely to be/
  5. Why is there a concern about liquidity in the market?
  6. If barriers to entry are reduced, how will this affect competition in the market? How will consumers be affected?
  7. Why are there suggestions that Ofgem’s proposals don’t go far enough?
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An energy cartel?

As Elizabeth noted in Fuelling the Political Playing Field, there has been much debate recently about energy prices in the UK. Four of the ‘Big Six’ energy companies have now announced price rises. They average 9.1% – way above the rate of consumer price inflation and even further above the average rate of wage increases. What is more, they are considerably above the rate of increase in wholesale energy prices, which, according to Ofgem, have risen by just 1.7% in the past year.

The bosses of the energy companies have appeared before the House of Commons Energy and Climate Change Select Committee to answer for their large price increases. The energy companies claim that the increases are necessary to cover not only rising wholesale prices, but also green levies by the government and ‘network charges’ for investments in infrastructure. However, it is hard to see how, even taking into account all three of these possible sources of cost increases, the scale of price increases can be justified.

Another possible explanation for the price hikes is that they are partly the result of a system of transfer pricing (see). The energy industry is vertically integrated. Energy companies are not only retailers to customers, but also generators of electricity and wholesale shippers of gas. It is possible that, by the producing/shipping arms of these companies charging higher prices to their retailing arms, the retailers’ costs do indeed go up more than the wholesale market cost. The result, however, is higher profits for the producing arms of these businesses. In other words, a higher transfer price allows profits to be diverted from each company’s retailing arm to its producing arm.

This is an argument for making the wholesale market more competitive and for stopping the by-passing of this market by producing arms of companies selling directly to their retailing arms. What the companies are being accused of is an abuse of market power and possibly of colluding with each other, at least tacitly, to support the continuation of such a practice.

So is the answer a price freeze, as proposed by the Labour Party? Is it an investigation of the energy market by the Competition Commission? Or is it, at least as a first step, much more openness by the energy companies and transparency about their pricing practices? Or is it to encourage consumers to switch between energy companies, including the smaller ones, which at present account for less than 5% of energy supply? The videos, podcasts and articles consider these issues.

Webcasts and Podcasts
Energy bosses blame high bills on wholesale prices Channel 4 News, Gary Gibbon (29/10/13)
Why are energy bosses being questioned? BBC News, Stephanie McGovern (29/10/13)
Key questions Big Six energy companies must answer The Telegraph, Ann Robinson (29/10/13)
Energy bosses offer excuses for prices rises The Telegraph (29/10/13)
Energy bosses face MPs over price rises BBC News, John Moylan (29/10/13)
Energy boss ‘can’t explain’ competitors’ price hikes The Telegraph (29/10/13)
Ovo boss: Competition Commission would take too long BBC News (30/10/13)
Dale Vince: Energy market is ‘dysfunctional’ BBC Today Programme (30/10/13)
Tony Cocker: Public mistrust energy industry BBC Today Programme (30/10/13)
Ed Davey: Energy deals not just for ‘internet savvy’ BBC Today Programme (31/10/13)

Articles
Energy giants ‘charge as much as they can get away with’ The Telegraph, Peter Dominiczak (29/10/13)
UK energy markets need perestroika Financial Times (27/10/13)
Britain’s energy utilities must embrace glasnost Reuters, John Kemp (29/10/13)
Small energy firms ‘escape levies’ BBC News (30/10/13)
Is the energy market structurally flawed? BBC news, Robert Peston (30/10/13)
The energy market needs a Competition Commission investigation Fingleton Associates, John Fingleton (12/10/13)
Energy firms raised prices despite drop in wholesale costs The Guardian, Rowena Mason (29/10/13)
Only full-scale reform of our energy market will prevent endless price rises The Observer, Phillip Lee (26/10/13)
Energy Giants Blame Rising Bills On Green ‘Stealth Taxes’ Huffington Post, Asa Bennett (29/10/13)
Big Six energy firms ‘like cartel’ Belfast Telegraph (30/10/13)
Energy boss says he hasn’t done sums on green levies The Telegraph, Georgia Graham (30/10/13)
Graphic: How your energy bills have soared in ten years The Telegraph, Matthew Holehouse (30/10/13)
British energy suppliers’ explanations for price hikes just don’t add up The Guardian, Larry Elliott (31/10/13)
The 18th energy market investigation since 2001: Will this one be different? The Carbon Brief, Ros Donald (31/10/13)
Energy: Is there enough competition in the market? BBC News, Hugh Pym (26/11/13)

Information and Reports
Wholesale [electricity] market Ofgem
Wholesale [gas] market Ofgem
Response on wholesale energy costs Ofgem Press Release (29/10/13)
Response to Government’s Annual Energy Statement Ofgem Press Release (31/10/13)
Real Energy Market Reform The Labour Party

Questions

  1. Why may the costs of energy paid by the energy retailers to energy producers/shippers have risen more than the wholesale price?
  2. Explain what is meant by transfer pricing. How could transfer pricing be used to divert profits between the different divisions of a business?
  3. How can transfer pricing be designed by multinational companies to help them minimise their tax bills?
  4. Why is policing transfer pricing arrangements notoriously difficult?
  5. What evidence is there to show that switching between retailers by customers can help to drive retail energy prices down?
  6. How did the old electricity pool system differ from the current wholesale system?
  7. Should electricity companies be forced to pool the electricity they generate and not sell it to themselves through bilateral deals?
  8. Comment on the following: “The current electricity trading arrangements ‘create the very special incentive for the oligopolists. …The best of all possible worlds is where nobody invests. As supply and demand close up, the price spikes upwards, and supernormal profits result.’”
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Energising the debate

The energy sector has a history of criticism with regards to prices and practices. In the past, Ofgem have tried to make the sector more competitive, by ensuring that price comparisons are easier. At the beginning of this year, many of the big six providers announced price cuts, but within the next few weeks, we will see the reverse occurring, as energy prices begin to rise.

British Gas has announced price rises of 6% from 16th November that will affect over 8 million customers by adding approximately £80 per year to the annual dual fuel bill. Npower will also put its prices up 10 days later (8.8% for gas and 9.1% for electricity), creating higher bills for 3 million people.

In January of this year, when we saw energy prices fall, it was not solely due to Ofgem’s findings. We had a relatively mild winter, which reduced the demand for energy and this fed into lower prices. As the winter now approaches once more, demand for energy will begin to increase, feeding into prices that are now higher.

Furthermore, the energy companies have said that a range of external factors are also adding to their costs and putting increasing pressure on them to increase their charges. Npower’s Chief Commercial Officer said:

“There is never a good time to increase energy bills, particularly when so many people are working hard to make ends meet…But the costs of new statutory schemes, increases in distribution charges and the price of gas for the coming winter are all being driven up by external factors, for example government policy”

Significant investment is needed in the energy sector. Energy companies are required to set aside money for maintaining and improving the national grid and investing in renewable energy, such as wind and solar power. In order for the energy companies to fund these investments, more money must be raised and the logical method is to put up prices. However, critics are simply blaming ‘these very big lazy companies’ who are passing ‘above-inflation price rises’ onto already squeezed households.

Part of this is undoubtedly to do with the market structure of this sector. A typical oligopoly creates a market which, under certain circumstances, can be highly competitive, but because of barriers to entry that prevent new firms from entering the market may charge higher prices and be inefficient. Indeed, Ofgem has plans to reduce the power of the main energy providers by forcing them to auction off some of the electricity they generate. The aim of this is to free up the market and make it more competitive.

While only three providers have announced price rises, it is inevitable that the other three will follow. The relative increases will create incentives for consumers to switch providers, but crucial to this is an ability to understand the different tariffs on offer and lack of clarity on this has been a big criticism previously levelled at the energy sector. Indeed, half of UK customers have never switched energy providers. Perhaps this is the time to think about it, firstly as a means of saving money and secondly as a means of putting the energy companies in competition with each other. The following articles consider this market.

Energy price rises: how to switch, save and safeguard your supply The Guardian, Mark King (12/10/12)
Npower and British Gas raise energy prices (including video) BBC News (12/10/12)
Energy price rises? We’re like turkeys voting for Christmas The Telegraph, Rosie Murray-West (12/10/12)
British Gas and Npower to raise prices fuelling fears of a ‘long, cold winter’ for more households Independent
, Graeme Evans
(12/10/12)Wholesale prices rise as energy costs jump Wall Street Journal, Sarah Portlock and Jeffrey Sparshott (12/10/12)
British Gas raises gas and electricity prices by 6pc The Telegraph (12/10/12)
Osborne warns energy firms over price hikes Reuters (12/10/12)
Energy price hikes to take effect from next week Independent, Simon Read(13/10/12)

Questions

  1. What are the main reasons influencing the recent price rises? In each case, explain whether it is a demand- or supply-side factor.
  2. Using your answer from question 1, illustrate the effect of it on a demand and supply diagram.
  3. Which features of an oligopolistic market are relevant to the energy sector. How can we use them to explain these higher prices.
  4. How has government policy affected the energy sector and energy prices?
  5. Why are customers reluctant to change energy providers? Does this further the energy company’s ability to raise prices?
  6. Are there any government policies that could be implemented to reduce the power of the energy companies?
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A shock for energy provision

EU environmental legislation is beginning to cause problems in the UK. As it prohibits coal-fired power plants from generating power, they will be forced to close. This means that the UK will be forced to rely more on imported energy, which could lead to price rises, as energy shortages emerge.

Ofgem, the energy regulator has said that the risk of a gas shortage is likely to be at its highest in about 3 years time, as the amount of spare capacity is expected to fall from its current 14% to just 4%. Energy shortages have been a concern for some time, but the report from Ofgem indicates that the predicted time frame for these energy shortages will now be sooner than expected. Ofgem has said that the probability of a black-out has increased from 1 in 3,300 years now to 1 in 12 years by 2015.

The government, however, has said that its Energy Bill soon to be published will set out plans that will secure power supply for the UK. Part of this will be through investment, leading to new methods of generating energy. The Chief Executive of Ofgem, Alistair Buchanan said:

‘The unprecedented challenges in facing Britain’s energy industry … to attract the investment to deliver secure, sustainable and affordable energy supplies for consumers, still remain.’

One particular area that will see growth is wind-farms: a controversial method of power supply, due to the eye-sore they present (to some eyes, at least) and the noise pollution they generate. But with spare capacity predicted to fall to 4%, they will be a much needed investment.

Perhaps of more concern for the everyday household will be the impact on energy prices. As we know, when anything is scarce, the price begins to rise. As energy shortages become more of a concern, the market mechanism will begin to push up prices. With other bills already at record highs and incomes remaining low, the average household is likely to feel the squeeze. The following articles and the Ofgem report considers this issue.

Report
Electricity Capacity Assessment Ofgem Report to Government, Ofgem (5/12/12)

Articles
Power shortage risks by 2015, Ofgem warns BBC News (5/10/12)
Britain faces risk of blackout The Telegraph (5/10/12)
Ofgem estimates tightening margins for electricity generation Reuters (5/10/12)
Electricity shortages are ‘risk’ by 2015 Sky News (5/10/12)
Future energy bills could give customers a nasty shock ITV News, Chris Choi (5/10/12)

Questions

  1. What is the role of Ofgem in the UK?
  2. Explain the way in which prices adjust as resources become more or less scarce. Use a demand and supply diagram to illustrate your answer.
  3. To what extent do you think the UK should be forced to close down its coal-fired plants, as a part of EU environmental legislation?
  4. Are there any market failures associated with the use of wind farms? Where possible, use a diagram to illustrate your answer.
  5. Explain why an energy shortage will lead to an increase in imports and how this in turn will affect energy prices.
  6. What are the government’s plans to secure energy provision in the UK? Do you think they are likely to be effective?
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Abuse of power

EDF, one of the big six energy retailers in the UK, has agreed to pay out a record £4.5m. £1m of this will go to funding an energy advice centre; the rest will go to providing £50 each to 70,000 ‘vulnerable customers’ who struggle to pay their bills and who receive the government’s warm home discount.

The agreement was made with Ofgem after an investigation into mis-selling, both on the doorstep and over the phone. Customers were persuaded to switch energy suppliers with the promise of savings on their bills. As the FT articles states:

Ofgem found that EDF’s sales force did not always provide complete information to customers on some contract terms, or on the way in which their monthly direct debits had been calculated. In some cases, telesales agents claimed savings without knowing whether they were accurate for the specific customer on the call, the regulator said.

Ofgem did not accuse the company of directly sanctioning such practices, but rather of weak monitoring and control of its sales force’s actions.

The £4.5m payment is in lieu of a fine. Consumer groups have welcomed this, preferring the company to pay compensation to a fine, which would have simply increased Treasury funding.

It is the first settlement in a broader investigation into mis-selling, involving four of the six major suppliers.

Articles
EDF to pay out £4.5m in mis-selling case Financial Times, Guy Chazan and Hannah Kuchler (9/3/12)
EDF agrees to pay £4.5m misleading sales ‘fine’ Guardian, Lisa Bachelor (9/3/12)
Is it a fine? Is it a penalty? No, it’s EDF’s mystery Ofgem payment Management Today, Rebecca Burn-Callander (9/3/12)
‘Misleading claims’ cost EDF a £4.5m payout from watchdog , Independent, Tom Bawden (10/3/12)
EDF Energy agrees to pay a £4.5m ‘fine’ BBC News (9/3/12)
EDF Energy agrees to pay a £4.5m ‘fine’ BBC News, John Moylan (9/3/12)
More energy payouts could follow EDF’s £4.5m The Telegraph, Kara Gammell (9/3/12)

Ofgem ruling
EDF energy agrees to invest £4.5 million to help vulnerable customers following Ofgem investigation Ofgem

Questions

  1. What types of market failure are present in the energy supply industry?
  2. What are the arguments for and against fines being paid directly to victims of crime rather than to the government?
  3. In what ways could the energy industry be made more competitive?
  4. Why do the utilities, such as gas, electricity and water, require their own regulator rather than simply being subject to competition law?
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An energetic price war

In an earlier blog Energy profits margins up by over 700% we analysed the increasing pressure on many households as they saw their energy bills increase in price year on year. This helped the big six energy companies achieve a 700% rise in their profits.

However, it also sparked interest by the regulator Ofgem, which was looking to ensure that consumers found it easier to make price comparisons and create a more competitive market. One issue that Ofgem were looking into was how to make the energy sector more open to competition, given that the big six companies own the power stations and hence this acts as a barrier to the entry of new firms.

The latest announcements from some of the big energy companies will therefore come as a pleasant turn of events for Ofgem. On Wednesday January 11th 2012, EDF announced that it would be cutting its energy prices by 5% from 7th February in response to a fall in wholesale costs. Only a day later, Npower announced its plans to cut its tariffs by 5% from 1st February. British Gas cut its prices by 5% with immediate effect and SSE will reduce its gas prices by 4.5% from March 26th.

Is this a sign that the market is becoming more competitive thanks to Ofgem or is there another explanation? For the past 2 winters, temperatures have been consistently below freezing and hence demand for gas/electricity was at an all time high, speaking concerns of gas shortages. However, with the mild winter we are currently experiencing (I hope I haven’t jinxed it!) demand for heating etc has been significantly lower, which has reduced wholesale costs and the big six companies have begun to pass these savings on to their customers. Yet, despite this seemingly good news, are they being as ‘kind’ as we think? Most of the companies are cutting their prices by about 5%, yet wholesale prices fell by significantly more than that. Furthermore, over the past few years, customers have seen their tariffs increase significantly – by a lot more than 5%. To some extent, this confirms the criticism levelled at the energy sector – when costs rise, they are quick to pass on the full costs to their customers. But, when costs fall, they are slow to pass on only a fraction of their cost savings. The following articles consider this issue.

Npower will cut gas prices by 5% BBC News (13/1/12)
EDF cuts gas price by 5% Reuters, Karolin Schaps and Henning Gloystein (11/1/12)
British Gas readies push to promote price cut MarketingWeek, Lara O’Reilly (13/1/12)
British Gas cuts prices by 5% Independent (13/1/12)
Energy suppliers do battle in the war of modest price cuts The Telegraph, Emily Godsen (13/1/12)
British Gas and SSE follow EDF Energy price cut Financial Times, Guy Chazan and Sylvia Pfeifer (11/1/12)
British Gas cuts electricity prices, but keeps gas on hold Guardian, Hillary Osborne (12/1/12)
British gas and SSE announce price cuts (including video) BBC News (12/1/12)
More power firms cut energy tariffs The Press Association (12/1/12)

Questions

  1. In which market structure would you place the energy sector? Explain your answer.
  2. What is the role of Ofgem? What powers does it (and the other regulators have)?
  3. Using a demand and supply diagram to help you, explain why wholesale costs have fallen.
  4. Why have the energy companies only passed on about 5% of cost savings to their customers, despite falls in wholesale costs of significantly more than that?
  5. Do you think price wars are likely to break out in this sector? Are they in the interests of consumers?
  6. Why did energy prices increase so quickly last year and the year before? Use a diagram to help you.
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Energy profit margins up by over 700%

Families in the UK seemed to have been squeezed in all areas. With incomes flat, inflation rising, petrol and bills high, there seems to be a never ending cycle of price rises without the corresponding increase in incomes. This has been confirmed by the latest figures released from the big six energy companies, whose profit margins have risen from £15 per customer in June to £125 per customer per year. This is assuming that prices remain the same for the coming year.

The regulator, Ofgem has said that profit margins will fall by next year and that they are ensuring that price comparisons between the big energy companies become much easier to allow consumers to shop around. It is a competitive market and yet due to tariffs being so complicated to understand, many consumers are simply unable to determine which company is offering them the best deal. There is certainly not perfect knowledge in this market. Tim Yeo, the Chair of the Energy and Climate Change Committee said the profit margins were:

‘Evidence of absolutely crass behaviour by the energy companies, with a jump in prices announced in the last few months ahead of what will be a winter in which most families face their highest ever electricity and gas bills’

Ofgem will publish proposals later this year with suggestions of how to make the market more competitive. We have already seen in the blog “An energetic escape?” how Ofgem is hoping to reduce the power of the big six by forcing them to auction off some of the electricity they generate. The aim is to free up the market and allow more firms to enter. With the winter fast approaching and based on the past 2 years of snow and cold weather, it is no wonder that households are concerned with finding the best deals in a bid to reduce just one of their bills. The following articles consider this issue.

Energy price hikes see profits soar The Press Association (14/10/11)
Energy suppliers’ profit margins eight times higher, says regulator Ofgem Telegraph (14/10/11)
Energy firms’ profit margins soar, Ofgem says BBC News (14/10/11)
Energy firms’ profits per customer rise 733%, says Ofgem Guardian, Dan Milmo and Lisa Bachelor (14/10/11)
Regulator proposes radical change to energy market Associated Press (14/10/11)
Energy bills face overhaul in first wave of reform Reuters, Paul Hoskins (14/10/11)
Ofgem tells energy companies to simplify tariffs Financial Times, Michael Kavanagh (14/10/11)
You can’t shop around in an oligopoly Financial Times, William Murray (13/10/11)

Questions

  1. What type of market structure best describes the energy market?
  2. Of the actions being taken by Ofgem, which do you think will have the largest effect on competition in the market?
  3. Are there any other reforms you think would be beneficial for competition?
  4. Why is transparency so important in a market?
  5. What barriers to entry are there for potential competitors in the energy market?
  6. Why do you think profit margins are so high in this sector?
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