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?
In an apparent U-turn, the Chancellor, George Osborne, has decided to cap the interest rates and other charges on payday loans and other short-term credit. As we have seen in previous news items, the sky-high interest rates which some of the poorest people in the UK are being forced to pay on these loans have caused outrage in many quarters: see A payday enquiry and Kostas Economides and the Archbishop of Canterbury. Indeed, the payday loan industry has been referred by the OFT to the Competition Commission (CC). The CC is required to report by 26 June 2015, although it will aim to complete the investigation in a shorter period.
It was becoming increasingly clear, however, that the government would not wait until the CC reports. It has been under intense pressure to take action. But the announcement on 25 November 2013 that the government would cap the costs of payday loans took many people by surprise. In fact, the new body, the Financial Conduct Authority, which is due to start regulating the industry in April 2014, only a month ago said that capping was very intrusive, arguing that it could make it harder for many people to borrow and push them into the hands of loan sharks. According to paragraph 6.71 of its consultation paper, Detailed proposals for the FCA regime for consumer credit:
The benefits of a total cost of credit cap has been looked at by the Personal Finance Research Centre at the University of Bristol. This report highlighted that 17 EU member states have some form of price restriction. Their research was ambiguous, on the one hand suggesting possible improved lending criteria and risk assessments. On the other, prices may drift towards a cap, which could lead to prices increasing or lead to a significant reduction in lenders exercising forbearance. Neither of these latter outcomes would be beneficial for consumers. Clearly this is a very intrusive proposition and to ensure we fully understand the implications we have committed to undertake further research once we begin regulating credit firms and therefore have access to regulatory data.
The government announcement has raised questions of how imperfections in markets should be dealt with. Many on the centre right argue that price controls should not be used as they can further distort the market. 
Indeed, the Chancellor has criticised the Labour Party’s proposal to freeze gas and electricity prices for 20 months if it wins the next election, arguing that the energy companies will simply get around the freeze by substantially raising their prices before and after the 20 months.
Instead, those on the centre right argue that intervention should aim to make markets more competitive. In other words, you should attempt not to replace markets, but to make them work better.
So what is the reasoning of the government in capping payday loan charges? Does it feel that, in this case, there is no other way? Or is the reasoning political? Does it feel that this is the most electorally advantageous way of answering the critics of the payday loan industry?
Webcasts and podcasts
Payday Loans To Be Capped By Government Sky News (25/11/13)
New law to cap cost of payday loans BBC News, Robert Hall (25/11/13)
Osborne: ‘Overall cost’ of payday loans to be capped BBC Today Programme (25/11/13)
George Osborne announces cap on payday loan charges amid concerns ITV News (25/11/13)
Articles
UK to cap payday lenders’ interest charges Reuters, Steve Slater, Paul Sandle, Kate Holton and William James (25/11/13)
Capping payday loans: from light touch to strong arm Channel 4 News, Faisal Islam (25/11/13)
Payday loans: New law to cap costs BBC News (25/11/13)
Payday loan ‘risk to mortgage applications’ BBC News (26/11/13)
Q&A: Payday loans BBC News (25/11/13)
George Osborne is playing social democratic catch-up on payday loans The Guardian, Larry Elliott (25/11/13_
Payday loans cap: George Osborne caves in following intervention led by Archbishop of Canterbury Independent, Oliver Wright (25/11/13)
The principle, the practice and the politics of fixing payday loan prices: why? And why now? Conservative Home, Mark Wallace (25/11/13)
George Osborne and the risky politics of chutzpah New Statesman, Rafael Behr (26/11/13)
Chancellor too quick off the mark on payday lending cap The Telegraph, James Quinn (25/11/13)
Crap and courage of convictions: the political problem with Osborne’s payday loan plan Spectator, Isabel Hardman (26/11/13)
Payday loan calculator
Payday loan calculator: how monthly interest can spiral BBC Consumer (7/11/13)
Questions
- What types of market failing exist in the payday loan industry?
- What types of controls of the industry are being proposed by George Osborne?
- What is the experience of Australia in introducing such controls?
- What alternative forms of intervention could be used to tackle the market imperfections in the industry?
- What were the proposals of the FCA? (See paragraph 6.6 in its document, Detailed proposals for the FCA regime for consumer credit.)
- According to a representative example on Wonga’s website, a loan of £150 for 18 days would result in charges of £33.49 (interest of £27.99 and a fee of £5.50). This would equate to an annual APR of 5853%. Explain how this APR is calculated.
- The proposal is to allow a relatively large upfront fee and to cap interest rates at a relatively low level, such as 4% per month, as is the case in Australia. Explain the following comment about this in the Faisal Islam article above: “The upfront fee, in theory, should change the behavioural finance of consumers around taking the loan in the first place (there are ways around this though). So this is an intervention based not on lack of competition, but asymmetries of information in consumer finance.”
- Comment on the following statement by Mark Wallace in the Conservative Home article above: “If overpriced payday loans should be capped, why not overpriced DVDs, sandwiches or, er, energy bills?”
- Compare the relative advantages and disadvantages of George Osborne’s proposal with that of Justin Welby, the Archbishop of Canterbury (see the news item, Kostas Economides and the Archbishop of Canterbury).
No matter the product or service, price is always a key factor and never more so than in tough economic times. In most cases, prices are allowed to be determined by the forces of demand and supply, which gives the equilibrium price. However, in some cases, the government may choose to intervene with a price control, for example rent controls and the national minimum wage. Another market where there is also regulation is the airline industry and the Civil Aviation Authority have recently been criticized by Heathrow Airport for its price control plan.
Whenever we go on holiday, the price we pay for an airline ticket will depend in part on the airport we are taking off from and landing at, as they will charge the airline for landing fees, security, terminals etc. 
Heathrow airport had proposed that annual rises to its tariffs charged to airlines would increase by 4.6% above RPI inflation. However, this plan has been rejected by the CAA, which has said that the annual tariff rise between 2014 and 2018 should not be above the RPI. Though Heathrow are criticizing the CAA about this restriction, it is an improvement from the initial proposal which would have capped price rises at the RPI minus 1.3%.
Controversy has naturally been created, with the CAA arguing that such price controls are needed to keep prices down and thus benefit consumers and retain the competitiveness of Heathrow airport. But, in contrast, Heathrow has argued that such a cap will put its competitive position under pressure and will risk future investment in the UK. But this isn’t the only criticism of the CAA. Airlines aren’t happy with the ruling either, arguing that the CAA has bowed to the pressure of Heathrow. The contrasting positions of the CAA, Heathrow and airlines are evident in the following quotes, firstly from the Chairwoman of the CAA:
The proposals will put an end to over a decade of prices rising faster than inflation at Heathrow. Tackling the upward drift in Heathrow’s prices is essential to safeguard its globally competitive position. The challenge for Heathrow is to maintain high levels of customer service while reducing costs. We are confident this is possible and that our proposals create a positive climate for further capital investment, in the passenger interest.
Secondly, from Heathrow’s Chief Executive:
This proposal is the toughest Heathrow has ever faced. The CAA’s settlement could have serious and far-reaching consequences for passengers and airlines at Heathrow … We want to continue to improve Heathrow for passengers. Instead, the CAA’s proposals risk not only Heathrow’s competitive position but the attractiveness of the UK as a centre for international investment. We will now carefully consider our investment plans before responding fully to the CAA.
And finally from the IAG Chief Executive, who said:
[The CAA] neglected its new primary statutory duty to further the interests of passengers by endorsing a settlement that allows the UK’s monopoly hub to ignore its inefficiencies and over-reward investors by imposing excessive charges … It is a bad day for customers who have been let down by the CAA.
Any price rise from the airports will be passed on to airlines and these in turn will translate into higher prices for customers. However, is there any truth to Heathrow’s claims that investment will be adversely impacted? As costs rise, profit margins and profit will fall, unless the revenue generated can increase. Price controls restrict the amount that prices can rise and thus unless demand increases by a significant margin, profits will decline. With lower profits, there will be less money for investment and arguably the service that customers face will also decline. However, the CAA suggests that Heathrow will be able to cut its costs and thus protect investment into the future, while retaining its competitive position globally by charging lower prices to airlines. This is unlikely to be the end of the journey, but for the moment, the CAA appears to have put its foot down. The following articles consider the battleground between the CAA and Heathrow.
Regulation in the passenger’s interest, support investment and driving competition The Civil Aviation Authority (3/10/13)
Passengers at Heathrow ‘face £1bn fares hike’ Independent, Matthew Beard (4/10/13)
Heathrow airport attacks regulator’s price control plan BBC News (3/10/13)
CAA proposed Heathrow charges rise in line with inflation The Telegraph, Rebecca Clancy (13/10/13)
Passengers face fare increases as Heathrow and Gatwick are allowed to up landing fees Mail Online (3/10/13)
Heathrow and airlines enraged by CAA price proposals The Telegraph, Alistair Osborne (3/10/13)
Heathrow attacks Civil Aviation Authority over airport charges Financial Times, Andrew Parker (3/10/13)
BAA considers life outside Heathrow as CAA backtracks on charges The Guardian, Gwyn Topham (3/10/13)
Heathrow charge plan disappoints all round Wall Street Journal, Peter Evans (3/10/13)
Questions
- What is the role of a regulator?
- Explain how the price control outlined by the CAA will affect Heathrow.
- If Heathrow is unable to cut costs, what is the likely effect? Using a diagram illustrate the impact on profitability if costs (a) can be reduced and (b) cannot be reduced.
- Why are the CAA being criticised by airlines and airports?
- How will customers be affected by Heathrow’s planned price rises and the CAA’s proposal?
- ‘Regulation in the airlines industry is essential to retain competitiveness.’ Evaluate the validity of this statement.
When people take out loans they typically do so to spend and with the UK economy in its current state, many would argue that this is a good thing. The ‘payday loan’ industry took advantage of the weak economy and the squeezed households in the UK and for the past few years, we have seen constant adverts that will appeal to many households. But, is the industry as competitive as the adverts would have us believe?
An inquiry into this industry has been on-going for some time, and it has now been referred to the Competition Commission, due to ‘deep-rooted problems with the way competition works’. For some, a payday loan is a short term form of finance, but for others it has become a way of living that has led to a debt spiral. Frank McKillop, policy manager at Abcul said:
There is a clear demand for instant credit and across the country we are increasingly seeing members who have debts with multiple payday lenders and a record of rolling over debts, or going to one payday lender to clear the debt to another.
One problem identified by the OFT is that customers have found it difficult to compare costs and this has led, in some cases, to customers paying back significantly more than they originally thought. Customers being unable to repay loans will ring warning bells for many people, with no-one wanting a return to the height of the credit crunch.
The OFT has criticized payday loan companies for competing not on costs, but on the speed of approval and using certain unapproved tactics as part of their advertising. The selling point of such companies is that you can have the money in a very short time period. However, the criticism is that this leads to loans being given to those who are unable to afford them. Key credit checks are not being done and with late night texts being sent to often financially vulnerable people, it is no wonder that complaints have been received. In a statement, the OFT said:
The competitive pressure to approve loans quickly may give firms an incentive to skimp on the affordability assessment which is designed to prevent irresponsible lending and protect consumers.
[the business models of companies were] predicated on making loans which are unaffordable, leading to borrowers paying far more than expected through rollovers, additional interest and other charges.
While payday loans are legal and there are many companies offering them, it is what they are competing over, which seems to be in question. The industry itself has begun to change its practices, providing more information to customers, only allowing loans to be rolled over three times and the potential to freeze repayments if the customer gets into financial difficulty. If more stringent checks are completed and hence timing does not become the only grounds for competition, then the problems above may become less significant. With the ongoing OFT inquiry into the practices of the payday loan industry and the continuing demand for such financing, it is likely that we will see much more of both the good and the bad that it has to offer. The following articles consider the investigation.
Webcasts
Balls warns against payday loans ‘blank cheque’ BBC News (27/6/13)
Payday lender investigation could be delayed by bureaucracy Telegraph, Steve Hawkes (27/6/13)
Payday lenders to face ‘tougher restrictions’ on advertising BBC News, Simon Gompertz (1/7/13)
Payday lending rates BBC News, Julio Martino and Stella Creasy (2/7/13)
Articles
Regulator to investigate payday loan industry Financial Times, Elaine Moore and Robert Cookson (27/6/13)
Q&A: Payday loans BBC News (31/5/13)
Payday loans: reining in an industry that is a law unto itself Guardian (27/6/13)
Payday loans industry to face competition inquiry BBC News (27/6/13)
Payday loans firms face competition inquiry Sky News (27/6/13)
Payday loans market faces competition inquiry Guardian, Hilary Osborne (27/6/13)
OFT refers payday loans to Competition Commission Scotsman, Jane Bradley (27/6/13)
Five reasons why we all need to worry about payday lenders Telegraph, Emma Simon (27/6/13)
OFT documents
Payday lending compliance review Office of Fair Trading (27/6/13)
Questions
- Into which market structure would you place the payday loans industry? Make sure you justify your answer.
- What is the role of the (a) the OFT and (b) the Competition Commission? Do these authorities overlap?
- What part does advertising play in this industry?
- To what extent is the payday loan industry a possible cause of another credit crunch?
- Why has the OFT referred this industry to the Competition Commission?
- To what extent are payday loans an essential part of an economy?
