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
- Describe the structure of the UK energy industry.
- What are the barriers to the entry of new energy suppliers and generators in the UK?
- To what extent is vertical integration in the electricity generation and supply industry in the interests of consumers?
- To what extent is horizontal integration in the electricity and gas markets in the interests of consumers?
- How will requiring the six largest energy suppliers to post their wholesale prices for the next 24 months increase competition in the energy market?
- Is greater transparency about the revenues, costs and profits of energy suppliers likely to make the market more competitive?
- Identify and discuss other measures which Ofgem could introduce to make the energy market more competitive.
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
- What are the characteristics of an oligopoly?
- Explain the reason why the vertically integrated nature of the big six energy companies creates a barrier to the entry of new firms.
- What are the barriers to entry in (a) the electricity supply market and (b) the electricity generating market?
- What action has Ofgem suggested to increase competition in the market? How effective are the proposals likely to be/
- Why is there a concern about liquidity in the market?
- If barriers to entry are reduced, how will this affect competition in the market? How will consumers be affected?
- Why are there suggestions that Ofgem’s proposals don’t go far enough?
Finance ministers and central bank officials of the G20 countries are meeting in Sydney from 20 to 23 February. Business leaders from these countries are also attending and have separate meetings.
Amongst the usual discussions at such meetings about how to achieve greater global economic stability and faster and sustained economic growth, there are other more specific agenda issues. At the Sydney meeting these include a roundtable discussion to identify practical solutions to lift infrastructure investment. They also include discussions on how to clamp down on tax avoidance through means such as transfer pricing.
The G20 meetings of finance and business leaders take place annually. There are also annual summits of heads of government (the next being in Brisbane in November 2014).
The G20 was formed in 1999 to extend the work of the G8 developed countries to include other major developed and developing countries plus the EU. In 2008/9 it played a significant role in helping devise policies to tackle the banking crisis and combat the subsequent recession. At the time there was a common purpose, which made devising common policies easier.
Since then, the importance of the G20 has waned. Partly this is because of the divergent problems and issues between members and hence the difficulty of reaching agreements. Partly it is because, to be effective, it needs to remain small but, to be inclusive, it needs to extend beyond the current 20 members. Indeed there has been considerable resentment from many countries outside the G20 that their views are not being represented. Some representatives from non-G20 countries attend meetings on an informal basis.
The following articles discuss the role of the G20 and whether it is fit for purpose.
Articles
Janet Yellen vs. the world: The issues at the G20 finance summit Globe and Mail (Canada), Iain Marlow (20/2/14)
Turning ideas into action at the G20 Business Spectator (Australia), Mike Callaghan (21/2/14)
Boosting infrastructure investment can prove G20’s value to the world The Conversation, Andrew Elek (20/2/14)
Can the G20 ever realise its potential? The Conversation, Mark Beeson (21/2/14)
G20 has failed to fulfil its promise of collaboration amid hostility The Guardian, Larry Elliott (20/2/14)
Official G20 site
G20 Priorities G20
Australia 2014 G20
News G20
Questions
- Which countries are members of the G20? Compile a list of those countries you feel ought to be members of such an organisation.
- What are the arguments for and against increasing the membership of the G20 (or decreasing it)?
- Why is Janet Yellen, Chair of the US Federal Reserve, likely to be at odds with leaders from other G20 countries, especially those from developing countries?
- Why have the tensions between G20 members increased in recent months?
- Discuss possible reforms to the IMF and the G20’s role in promoting such reforms.
- What insights can game theory provide in understanding the difficulties in reaching binding agreements at G20 meetings? Are these difficulties greater at G20 than at G8 meetings?
- Should the G20 be scrapped?
Facebook has announced that it’s purchasing the messaging company WhatsApp. It is paying $19 billion in cash and shares, a sum that dwarfs other acquisitions of start-up companies in the app market. But what are the reasons for the acquisition and how will it affect users?
WhatsApp was founded less than five years ago and has seen massive growth and now has some 450 million active users, 70% of whom use it daily. This compares with Twitter’s 240 million users. An average of one million new users are signing up to WhatsApp each day. As the Wall Street Journal article, linked below, states:
Even by the get-big-fast standards of Silicon Valley, WhatsApp’s story is remarkable. The company, founded in 2009 by Ukrainian Jan Koum and American Brian Acton, reached 450 million users faster than any company in history, wrote Jim Goetz, a partner at investor Sequoia Capital.
Facebook had fewer than 150 million users after its fourth year, one third that of WhatsApp in the same time period.
Yet, despite its large user base, WhatsApp has just 55 employees, including 32 engineers.
For the user, WhatsApp offers a cheap service (free for the first year and just a 99¢ annual fee thereafter). 
There are no charges for sending or receiving text, pictures and videos. It operates on all mobile systems and carries no ads. It also offers privacy – once sent, messages are deleted from the company’s servers and are thus not available to government and other agencies trying to track people.
With 450 million current active users, this means that revenue next year will not be much in excess of $450 million. Thus it would seem that unless Facebook changes WhatsApp’s charging system or allows advertising (which it says it won’t) or sees massive further growth, there must have been reasons other than simple extra revenue for the acquisition.
Other possible reasons are investigated in the videos and articles below. One is to restrict competition which threatens Facebook’s own share of the messaging market: competition that has seen young people move away from Facebook, which they see is becoming more of a social media platform for families and all generations, not just for the young.
Videos and podcasts
Facebook pays billions for WhatsApp Messenger smartphone service Deutsche Welle, Manuel Özcerkes (19/2/14)
Facebook’s WhatsApp buy no bargain Reuters, Peter Thal Larsen (20/2/14)
Facebook Agrees To Buy WhatsApp For $19bn Sky News, Greg Milam (20/2/14)
Facebook Eliminates Competitor With WhatsApp Bloomberg TV, Om Malik, David Kirkpatrick and Paul Kedrosky (20/2/14)
Why WhatsApp Makes Perfect Sense for Facebook Bloomberg TV, Om Malik, David Kirkpatrick and Paul Kedrosky (20/2/14)
Facebook buying WhatsApp for $19bn BBC News, Mike Butcher (20/2/14)
Is Facebook’s acquisition of WhatsApp a desperate move? CNBC News, Rob Enderle (19/2/14)
Facebook’s $19bn WhatsApp deal ‘unjustifiable’ BBC Today Programme, Larry Magid (20/2/14)
Articles
Facebook to buy WhatsApp for $19 billion in deal shocker ReutersGerry Shih and Sarah McBride (20/2/14)
Facebook to Pay $19 Billion for WhatsApp Wall Street Journal, Reed Albergotti, Douglas MacMillan and Evelyn M. Rusli (19/2/14)
Facebook to buy WhatsApp for $19bn The Telegraph, Katherine Rushton (19/2/14)
Facebook buys WhatsApp: Mark Zuckerberg explains why The Telegraph (19/2/14)
WhatsApp deal: for Mark Zuckerberg $19bn is cheap to nullify the threat posed by messaging application The Telegraph, Katherine Rushton (20/2/14)
Why did Facebook buy WhatsApp? TechRadar, Matt Swider (20/2/14)
What is WhatsApp? What has Facebook got for $19bn? The Guardian, Alex Hern (20/2/14)
Facebook to buy messaging app WhatsApp for $19bn BBC News (20/2/14)
WhatsApp – is it worth it? BBC News, Rory Cellan-Jones (20/2/14)
Facebook buys WhatsApp: what the analysts say The Telegraph (19/2/14)
Facebook ‘dead and buried’ as teenagers switch to WhatsApp and Snapchat – because they don’t want mum and dad to see their embarrassing pictures Mail Online (27/12/13)
Facebook and WhatsApp: Getting the messages The Economist (22/2/14)
Questions
- Are Facebook and WhatsApp substitutes or complements, or neither?
- What does Facebook stand to gain from the acquisition of WhatsApp? Is the deal a largely defensive one for Facebook?
- Has Facebook paid too much for WhatsApp? What information would help you answer this question?
- Would it be a good idea for Facebook to build in the WhatsApp functionality into the main Facebook platform or would it be better to keep the two products separate by keeping WhatsApp as a self contained company?
- What effects will the acquisition have on competition in the social media and messaging market? Is this good for the user?
- Will the deal attract the attention of Federal competition regulators in the USA? If so, why; if not, why not?
- What are the implications for Google and Twitter?
- Find out and explain what happened to the Facebook share price after the acquisition was announced.
Britain has faced some its worst ever weather, with thousands of homes flooded once again, though the total number of flooded households has fallen compared to previous floods. However, for many households, it is just more of the same – if you’ve been flooded once, you’re likely to be flooded again and hence insurance against flooding is essential. But, if you’re an insurance company, do you really want to provide cover to a house that you can almost guarantee will flood?
The government has pledged thousands to help households and businesses recover from the damage left by the floods and David Cameron’s latest step has been to urge insurance companies to deal with claims for flood damage as fast as possible. He has not, however, said anything regarding ‘premium holidays’ for flood victims.
The problem is that the premium you are charged depends on many factors and one key aspect is the likelihood of making a claim. The more likely the claim, the higher the premium. If a household has previous experience of flooding, the insurance company will know that there is a greater likelihood of flooding occurring again and thus the premium will be increased to reflect this greater risk. There have been concerns that some particularly vulnerable home-owners will be unable to find or afford home insurance.
The key thing with insurance is that in order for it to be provided privately, certain conditions must hold. The probability of the event occurring must be less than 1 – insurance companies will not insure against certainty. The probability of the event must be known on aggregate to allow insurance companies to calculate premiums. Probabilities must be independent – if one person makes a claim, it should not increase the likelihood of others making claims.
Finally, there should be no adverse selection or moral hazard, both of which derive from asymmetric information. The former occurs where the person taking out the insurance can hide information from the company (i.e. that they are a bad risk) and the latter occurs when the person taking out insurance changes their behaviour once they are insured. Only if these conditions hold or there are easy solutions will the private market provide insurance.
On the demand-side, consumers must be willing to pay for insurance, which provides them with protection against certain contingencies: in this case against the cost of flood damage. Given the choice, rational consumers will only take out an insurance policy if they believe that the value they get from the certainty of knowing they are covered exceeds the cost of paying the insurance premium. However, if the private market fails to offer insurance, because of failures on the supply-side, there will be major gaps in coverage.
Furthermore, even if insurance policies are offered to those at most risk of flooding, the premiums charged by the insurance companies must be high enough to cover the cost of flood damage. For some homeowners, these premiums may be unaffordable, again leading to gaps in coverage.
Perhaps here there is a growing role for the government and we have seen proposals for a government-backed flood insurance scheme for high-risk properties due to start in 2015. However, a loop hole may mean that wealthy homeowners pay a levy for it, but are not able to benefit from the cheaper premiums, as they are deemed to be able to afford higher premiums. This could see many homes in the Somerset Levels being left out of this scheme, despite households being underwater for months. There is also a further role for government here and that is more investment in flood defences. If that occurs though, where will the money come from? The following articles consider flooding and the problem of insurance.
Articles
Insurers urged to process flood claims quickly BBC News (17/2/14)
Flood area defences put on hold by government funding cuts The Guardian, Damian Carrington and Rajeev Syal (17/2/14)
Flooding: 200,000 houses at risk of being uninsurable The Telegraph (31/1/12)
Govt flood insurance plan ‘will not work’ Sky News (14/2/14)
Have we learned our lessons on flooding? BBC News, Roger Harrabin (14/2/14)
ABI refuses to renew statement of principles for flood insurance Insurance Age, Emmanuel Kenning (31/1/12)
Wealthy will have to pay more for flood insurance but won’t be covered because their houses are too expensive Mail Online, James Chapman (7/2/14)
Buyers need ‘flood ratings’ on all houses, Aviva Chief warns The Telegraph, James Quinn (15/2/14)
Wealthy homeowners won’t be helped by flood insurance scheme The Telegraph(11/2/14)
Costly insurance ‘will create flood-risk ghettos and £4.3tn fall in house values’ The Guardian, Patrick Wintour (12/2/14)
Leashold homes face flood insurance risk Financial Times, Alistair Gray (10/2/14)
Questions
- Consider the market for insurance against flood damage. Are risks less than one? Explain your answer.
- Explain whether or not the risk of flooding is independent.
- Are the problems of moral hazard and adverse selection relevant in the case of home insurance against flood damage?
- To what extent is the proposed government-backed flood insurance an equitable scheme? Should the government be stepping in to provide insurance itself?
- Should there be greater regulation when houses are sold to provide better information about the risk of flooding?
- Why if the concept of opportunity cost relevant here?
- How might household values be affected by recent floods, in light of the issues with insurance?
