The UK electricity supply market is an oligopoly. Over 95% of the market is supplied by the ‘big six’: British Gas (Centrica), EDF Energy, E.ON, npower (RWE), Scottish Power (Iberdrola) and SSE. The big six also generate much of the electricity they supply; they are vertically integrated companies. Between them they generate nearly 80% of the country’s electricity. There are a further two large generators, Drax Power Limited and GDF Suez Energy UK, making the generation industry an oligopoly of eight key players.
Ofgem, the energy market regulator, has just published a report on the wholesale electricity market, arguing that it is insufficiently liquid. This, argues the report, acts as a barrier to entry to competitor suppliers. It thus proposes measures to increase liquidity and thereby increase effective competition. Liquidity, according to the report, is:
… the ability to quickly buy or sell a commodity without causing a significant change in its price and without incurring significant transaction costs. It is a key feature of a well-functioning market. A liquid market can also be thought of as a ‘deep’ market where there are a number of prices quoted at which firms are prepared to trade a product. This gives firms confidence that they can trade when needed and will not move the price substantially when they do so.
A liquid wholesale electricity market ensures that electricity products are available to trade, and that their prices are robust. These products and price signals are important for electricity generators and suppliers, who need to trade to manage their risks. Liquidity in the wholesale electricity mark et therefore supports competition in generation and supply, which has benefits for consumers in terms of downward pressure on bills, better service and greater choice.
So how can liquidity be increased? Ofgem is proposing that the big six publish prices for two years ahead at which they are contracting to purchase electricity from generators in long-term contracts. These bilateral deals with generators are often with their own company’s generating arm. Publishing prices in this way will allow smaller suppliers to be able to seek out market opportunities. The generating companies will not be allowed to refuse to contract to supply smaller companies at the prices they are being forced to publish.
In addition, Ofgem is proposing that generators would have to sell 20% of output in the open market instead of through bilateral deals. As it is, however, some 30% of output is currently auctioned on the wholesale spot market (i.e. the market for immediate use).
But it is pricing transparency plus small suppliers being able to gain access to longer-term contracts that are the two key elements of the proposed reform.
Articles
UK utilities face having to disclose long-term deals Reuters, Karolin Schaps and Rosalba O’Brien (12/6/13)
Ofgem set to ‘break stranglehold’ in the energy market BBC News, John Moylan (12/6/13)
Ofgem plan ‘to end energy stranglehold’ BBC Today Programme, John Moylan and Ian Marlee (12/6/13)
Ofgem outlines proposals to ‘break stranglehold’ of big six energy suppliers on electricity market The Telegraph (12/6/13)
Ofgem widens investigation into alleged rigging of gas and power markets The Guardian, Terry Macalister (6/6/13)
Ofgem moves to break stranglehold of ‘big six’ energy suppliers Financial Times, Guy Chazan (12/6/13)
Ofgem to crackdown on Big Six energy suppliers in bid to cut electricity prices Independent, Simon Read (12/6/13)
Reports and data
Opening up Electricity Market to Effective Competition Ofgem Press Release (12/6/13)
Wholesale power market liquidity: final proposals for a ‘Secure and Promote’ licence condition – Draft Impact Assessment Ofgem (12/6/13)
Electricity statistics Department of Energy & Climate Change
The Dirty Half Dozen Friends of the Earth (Oct 2011)
Questions
- What barriers to entry exist in (a) the wholesale and (b) the retail market for electricity?
- Distinguish between spot and forward markets. Why is competition in forward markets particularly important for small suppliers of electricity?
- How will ‘liquidity’ be increased by the measures Ofgem is proposing?
- To what extent does vertical integration in the energy industry benefit consumers of electricity?
- What is a price reporting agency (PRA)? What anti-competitive activities have been taking place in the short-term energy market and why may PRAs not be ‘fit for purpose’?
- Do you think that the measures Ofgem is proposing will ensure that the big generators trade fairly with small suppliers? Explain.
- What are the dangers in the proposals for the large generators?
How important are emotions when you go shopping? Many people go shopping when they ‘need’ to buy something, whether it be a new outfit, food/drink, a new DVD release, a gift, etc. Others, of course, simply go window shopping, often with no intention of buying. However, everyone at some point has made a so-called ‘impulse’ purchase.
There is only one article below, which is from the BBC and draws on data released from the National Employment Savings Trust’s survey. This report suggests that British people spend over £1 billion every year on impulse buys – purchases that are not needed, were not intended and are often regretted once the ‘high’ has worn off. Often, it is the way in which a product is advertised or positioned that leads to a spontaneous purchase – seeing chocolate bars/sweets at the tills; a product offered at a huge discount advertised in the window of a shop; 2 for 1 purchases; points for loyalty etc. All of these and more are simple techniques used by retailers to encourage the impulse buy. As consumer psychologist, Dr. James Intriligator says:
Retailers have clever ways of manipulating customers to spend more but if you stick to your plans you can avoid being affected by their tactics.
In other cases, it’s simply the frame of mind of the consumer that can lead to such purchases, such as being hungry when you’re food shopping or having an event to attend the next day and deciding to go window shopping, despite already having something to wear! Dr. Intriligator continues, saying:
Your ability to resist and make rational choices is diminished when your glucose levels are down … When you get irrational, you fall back on trusted brands, which often leads you to spend more money … Later in the shop, you’re more tired and less likely to resist [impulse buys]
But are such purchases irrational? One of the key assumptions made by economists (at least in traditional economics) is that consumers are rational. This implies that consumers weigh up marginal costs and benefits when making a decision, such as deciding whether or not to purchase a product. But, do impulse buys move away from this rational consumer approach? Is buying something because it makes you happy in the short term a rational decision? Behavioural economics is a relatively new ‘branch’ of economics that takes a closer look at the decisions of consumers and what’s behind their behaviour. The following article from the BBC considers the impulse buy and leaves you to consider the question of irrational consumers.
Article
How to stop buying on impulse BBC Consumer (30/5/13)
Questions
- If the marginal benefit of purchasing a television outweighs the marginal cost, what is the rational response?
- Using the concept of marginal cost and benefit, illustrate them on a diagram and explain how equilibrium should be reached.
- What is behavioural economics?
- What are the key factors that can be used to explain impulse buys?
- How can framing help to explain irrational purchases?
- If a product is advertised at a significant discount, what figure for elasticity is it likely to have to encourage further purchases in-store?
- Is bulk-buying always a bad thing?
The Clean Energy Bill has been on the agenda for some time and not just in the UK. With climate change an ever growing global concern, investment in other cleaner energy sources has been essential. However, when it comes to investment in wind farms, developers have faced significant opposition. The balancing act for the government appears to be generating sufficient investment in wind farms, while minimising the negative externalities.
The phrase often thrown around with regards to wind farms, seems to be ‘not in my backyard’. That is, people recognise the need for them, but don’t want them to be built in the local areas. The reason is to do with the negative externalities. Not only are the wind farms several metres high and wide, creating a blight on the landscape, but they also create a noise, both of which impose a third party effect on the local communities. These factors, amongst others, have led to numerous protests whenever a new wind farm is suggested. The problem has been that with such challenging targets for energy, wind farms are essential and thus government regulation has been able to over-ride the protests of local communities.
However, planning guidance in the UK will now be changed to give local opposition the ability to override national energy targets. In some sense, more weight is being given to the negative externalities associated with a new wind farm. This doesn’t mean that the government is unwilling to let investment in wind farms stop. Instead, incentives are being used to try to encourage local communities to accept new wind farms. While acknowledging the existence of negative externalities, the government is perhaps trying to put a value on them. The benefits offered to local communities by developers will increase by a factor of five, thus aiming to compensate those affected accordingly. Unsurprisingly, there have been mixed opinions, summed up by Maria McCaffery, the Chief Executive of trade association RenewableUK:
Maria McCaffery, chief executive of trade association RenewableUK, said the proposals would signal the end of many planned developments and that was “disappointing”.
Developing wind farms requires a significant amount of investment to be made upfront. Adding to this cost, by following the government’s advice that we should pay substantially more into community funds for future projects, will unfortunately make some planned wind energy developments uneconomic in England.
That said, we recognise the need to ensure good practice across the industry and will continue to work with government and local authorities to benefit communities right across the country which are hosting our clean energy future.
The improved benefits package by the energy industry is expected to be in place towards the end of the year. The idea is that with greater use of wind farms, energy bills can be subsidised, thereby reducing the cost of living. Investment in wind farms (on-shore and off-shore) is essential. Current energy sources are non-renewable and as such new energy sources must be developed. However, many are focused on the short term cost and not the long term benefit that such investment will bring. The public appears to be in favour of investment in new energy sources, especially with the prospect of subsidised energy bills – but this positive outlook soon turns into protest when the developers pick ‘your back yard’ as the next site. The following articles consider this issue.
Residents to get more say over wind farms The Guardian, Fiona Harvey and Peter Walker (6/6/13)
Local communities offered more say over wind farms BBC News (6/6/13)
Locals to get veto power over wind farms The Telegraph, Robert Winnett (6/6/13)
Wind farms are a ‘complete scam’, claims the Environment Secretary who says turbines are causing ‘huge unhappiness’ Mail Online, Matt Chorley (7/6/13)
New planning guidance will make it harder to build wind farms Financial Times, Jim Pickard, Pilita Clark and Elizabeth Rigby (6/6/13)
Will more power to nimbys be the death of wind farms? Channel 4 News (6/6/13)
Locals given more ground to block wind farms Independent, Tom Bawden (6/6/13)
Questions
- What are the negative externalities associated with wind farms?
- Conduct a cost-benefit analysis as to whether a wind farm should be constructed in your local area. Which factors have you given greatest weight to?
- In question 2 above, were you concerned about the Pareto criterion or the Hicks-Kaldor criterion?
- If local communities can be compensated sufficiently, should wind farms go ahead?
- If the added cost to the development of wind farms means that some will no longer go ahead, is this efficient?
- Why is there a need to invest in new energy sources?
- To what extent is climate change a global problem requiring international (and not national) solution?
Since coming to office in December 2012, Shinzo Abe’s government has been determined to revive the Japanese economy. For the past 20 years, Japan’s growth has averaged only 0.8% per annum. This compares with 1.3% for Germany, 2.3% for the UK, 2.6% for the USA, 4.9% for South Korea and 10.4% for China.
Japanese real GDP per capita was only 14.5% higher in 2012 than 20 years earlier. This compares with figures for Germany, the UK, the USA, South Korea and China of 27%, 45%, 34%, 126% and 497% respectively.
So what has the Japanese government done to boost both short-term and long-term growth after years of stagnation? There are ‘three arrows’ to the policy, targeted at reviving and sustaining economic growth.
The first arrow is monetary policy. The Bank of Japan has engaged in extensive quantitative easing through bond purchases in order to drive down the exchange rate (see A J-curve for Japan?), stimulate expenditure and increase the rate of inflation. A target inflation rate of 2% has been set by the Bank of Japan. Part of the problem for the Japanese economy over the years has been stagnant or falling prices. Japanese consumers have got used to waiting to spend in the hope of being able to buy at lower prices. Similarly, Japanese businesses have often delayed stock purchase. By committing to bond purchases of whatever amount is necessary to achieve the 2% inflation target, the central bank hopes to break this cycle and encourage people to buy now rather than later.
The second arrow is fiscal policy. Despite having the highest debt to GDP ratio in the developed world, Japan is embarking on a large-scale programme of infrastructure investment and other public works. The package is worth over $100bn. The expansionary fiscal policy is accompanied by a longer-term plan for fiscal consolidation as economic growth picks up. In the short term, Japan should have no difficulty in financing the higher deficit, given that most of the borrowing is internal and denominated in yen.
The third arrow is supply-side policy. On 5 June, Shinzo Abe unveiled a series of goals his government would like to achieve in order to boost capacity and productivity. These include increasing private-sector investment (both domestic and inward), infrastructure expenditure (both private and public), increasing farmland, encouraging more women to work by improving day-care facilities for children, and deregulation of both goods, capital and labour markets. The prime minister, however, did not give details of the measures that would be introduced to achieve these objectives. More details will be announced in mid-June.
The following videos and articles look at the three arrows of Abenomics and the effects they are having on confidence and attitudes as well as on expenditure, output and the exchange rate. They also look at the crucial third arrow: at whether supply-side reforms will be enough to achieve a sustained increase in economic growth.
Videos
Abenomics an uncertain future for most Financial Times on YouTube, Ben McLannahan (30/5/13)
Assessing Abenomics NHK World (3/6/13)
Adam Posen on Abenomics NHK World (30/5/13)
Japanese concerned over ‘Abenomics’ AlJazeera on YouTube (30/5/13)
Abenomics – the cure for deflation? BBC News, Rupert Wingfield-Hayes (10/5/13)
Japan PM’s economic speech ‘short on detail’ BBC News, Rupert Wingfield Hayes (5/6/13)
Pretty Positive on Abenomics Bloomberg, Jan Hatzius, Goldman Sachs (5/6/13)
Why Abenomics is Bonkers: Pro CNBC, Graeme Maxton, (27/5/13)
‘Abe’nomics Not About BOJ Printing Money Bloomberg, Derek Halpenny (31/5/13)
Abenomics Aims `Third Arrow’ at Business Rules Bloomberg, Willie Pesek (5/6/13)
Analysis on Abe’s Growth Plan NHK World (5/6/13)
Articles
Will three arrows find their target? On Line Opinion, Andrew Leigh (6/6/13)
Japan Fires ‘Third Arrow,’ but Will It Work? CNBC, Dhara Ranasinghe (5/6/13)
Japan’s ‘3 Arrows’ May Run Into German Wall CNBC, Michael Ivanovitch (19/5/13)
Japan’s recovery – the power of Abe’s three arrows Commonwealth Bank, Australia, Melanie Timbrell (31/5/13)
So Far, the Battery Charger Is Working in Japan The New York Times, Jeff Sommer (18/5/13)
Abenomics Could Light A Fire Under The Japan Trade Again Business Insider, Matthew Boesler (4/6/13)
Japan’s New Prime Minister Unveils The ‘Most Important’ Plank Of Abenomics Business Insider (5/6/13)
Japan PM pledges to boost incomes by 30% Channel NewsAsia (5/6/13)
Abe’s growth strategy disappoints economists, investors The Asahi Shimbun (6/6/13)
Abenomics Won’t Be ’Magic Bullet’ for Japan, Says Johnson of MIT Bloomberg, Cordell Eddings (5/6/13)
Too soon to call time on Abenomics BBC News, Stephanie Flanders (19/6/13)
Abenomics: The objectives and the risks BBC News, Puneet Pal Singh (19/7/13)
Data
World Economic Outlook Database IMF
Bank of Japan Statistics Bank of Japan
Economic Outlook Annex Tables OECD
Country statistical profile: Japan 2013 OECD
Questions
- Demonstrate on (a) an aggregate demand and supply diagram and (b) a Keynesian 45° line diagram the effects of the three arrows (assuming they are successful) in meeting their objectives.
- What will determine the effectiveness of the first two arrows in boosting short-term economic growth?
- Would you characterise the policies of the third arrow as interventionist or market-orientated, or as a mixture? Explain.
- What are the dangers in ‘Abenomics’?
- Find out what has been happening to Japanese bond rates. What are the implications of this for monetary policy?
- What are the ‘markets telling Abe’?
- In what ways will expectations influence the effectiveness of Abenomics?
Here are a series of videos examining the case for and against austerity policy. Is such policy necessary to re-balance countries’ economies and retain or regain the confidence of investors? Or does such policy harm not just short-run growth but long-run growth too? Does it reduce investment and thereby aggregate supply?
These videos follow on from the news item Keynes versus the Classics: a new version of an old story. In the first video, Mark Blyth, author of Austerity: the History of a Dangerous Idea, argues that austerity policy has not worked and never can. George Osborne, by contrast, argues that although it has been a ‘hard road to recovery’, austerity policy is working.
International bodies take a more nuanced stand. The IMF, while supporting the objective of reducing the government deficit, argues that the pace of the cuts in the UK should be slowed until more robust growth returns. The OECD, in examining the global economy, is more supportive of countries maintaining the pace of deficit reduction, but argues that the ECB needs to take stronger monetary measures to boost bank lending in the eurozone.
With austerity having increasingly alarming effects on unemployment and social cohesion, especially within certain eurozone countries, such as Greece, Portugal and Spain, it is not surprising that there are growing demands for rethinking macroeconomic policy.
There is general agreement that more needs to be done to promote economic growth, and a growing consensus that an increase in infrastructure expenditure is desirable. But whether such expenditure should be financed by increased borrowing (with the extra deficit being reduced subsequently as a result of the extra growth), or whether it should be financed by reductions in expenditure elsewhere, is a continuing focus of debate.
Austerity: the History of a Dangerous Idea The Guardian, Mark Blyth (27/5/13) (see also)
IMF: UK austerity will be a ‘drag on growth’ BBC News. Hugh Pym (22/5/13)
George Osborne: ‘Hard road to recovery for UK economy’ BBC News (22/5/13)
Economy and austerity BBC News, Sajid Javid and Stephen Timms (1/5/13)
IMF’s Olivier Blanchard urges UK austerity rethink BBC News (16/4/13)
OECD ‘supportive of Osborne austerity plans’ BBC news (29/5/13)
Stimulus vs. austerity measures in EU CNN, Mohamed El-Erian (29/5/13)
‘No time to wobble’ on deficit reduction YouTube, Sir Roger Carr (CBI president) (16/5/13)
Deficit-Cutting: Not If, But When Wall Street Journal Live, David Wessel (8/5/13)
Questions
- What are the arguments for maintaining a policy of deficit reduction through tight fiscal policy?
- What are the three principles put forward by Mark Blyth for designing an appropriate macroeconomic policy?
- How does the fallacy of composition relate to the effects of all countries pursuing austerity policy simultaneously?
- Is the IMF for or against austerity? Explain.
- Assess the policies advocated by the OECD to stimulate economic growth in the eurozone.
The UK electricity supply market is an oligopoly. Over 95% of the market is supplied by the ‘big six’: British Gas (Centrica), EDF Energy, E.ON, npower (RWE), Scottish Power (Iberdrola) and SSE. The big six also generate much of the electricity they supply; they are vertically integrated companies. Between them they generate nearly 80% of the country’s electricity. There are a further two large generators, Drax Power Limited and GDF Suez Energy UK, making the generation industry an oligopoly of eight key players.
