Election 2015: How to regulate the big six energy suppliers?

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As the election is coming up I thought it would be interesting to look at each of the main parties’ proposals for regulating retail energy markets in the UK. I will focus particularly on markets for electricity, but many of the same issues will also apply to gas.

Conservatives & Liberal Democrats

Not surprisingly, given the two parties have been in coalition for five years and that the Lib Dems have had a major role in shaping energy policy, there is relatively little difference in their approaches to retail markets for electricity. Both are promoting switching for consumers  by reducing switching times to one day and both are pledging to bring forward the roll-out of smart meters. The Lib Dems also include a proposal to allow people to form energy cooperatives so they can benefit from group discounts and cut their bills.

Labour

The Labour party is proposing to freeze energy bills up to January 2017. They say that it’s not good that energy companies are vertically integrated, but offer no solution to this. They will replace OFGEM with a new tougher regulator with the power to force energy companies to cut their prices when wholesale energy prices fall.

We will fix the broken energy market, increasing competition and transparency so that it works for consumers. This will include introducing a simple new tariff structure so that people can compare prices in place of the complex and confusing system that exists today.

The policies above don’t give much indication at all of what they would actually do to fix the energy market or increase competition. They suggest introducing a simple new tariff structure but give no indication of what that might be. There is also notably no mention of a roll out of smart meters, something that even the environmentally sceptic conservatives have included.

Analysis: market or price regulation

The two policy programs present contrasting views of the role that consumers and regulators should play in the energy market. The platform offered by the Conservatives and the Liberal Democrats is based on a basic belief in market forces, that by making it easier for consumers to swap suppliers they will be all forced to lower prices and offer better customer service. They propose a host of mechanisms to support this, all based around making switching easier for consumers. The evidence on switching rates in the UK broadly supports this stance, with increasing numbers of consumers switching to smaller suppliers who are offering lower prices than the big six. There are also a huge number of small suppliers who can offer far better customer service and innovative products to consumers. The emergence of price comparison websites as a way to encourage consumer switching has also been significant and will help to ensure that there is competition for the big six. The Labour party’s proposals are precisely the opposite of the market based approach. Where they do offer any detail on the policies they would implement, they rely on what is effectively price regulation. They also want a new regulator, which looks essentially the same as OFGEM only with a new website and name.

The Labour party’s proposals for the electricity market are a big bag of pain for consumers and the independent retailers who are driving down electricity prices at the moment. Just to get this off my chest as well, in their manifesto they include the line “businesses say energy is the biggest cost they face”. Clearly they must have only been talking to aluminium refineries as this really isn’t the case for the vast majority of businesses. The commitment to ‘simplify electricity tariffs’ is particularly worrying, given that suppliers are already limited to offering just four products. Any further reduction would only serve to reduce consumer choice. There can be no further simplification of the tariffs themselves without the removal of the standing charge, something that is likely to have significant opposition from energy companies and the regulator.

Why a price freeze isn’t the solution

Currently it is the responsibility of consumers to choose their own electricity supplier. If they think they are being ripped off by the big six, they are free to move towards a smaller supplier who can offer lower prices. The Labour Party’s price freeze shifts the responsibility away from consumers and towards politicians and the regulator. It sets a precedent that high energy prices are something that the government should ‘fix’, instead of something that consumers should react to by switching.

A price freeze would reduce incentives for consumers to switch energy providers and allow the big six energy suppliers to continue offering products that are bad for the environment and offer terrible customer service. When energy prices rise, so do the number of consumers switching. In Q4 of 2013, when there was a particularly cold winter and bills rose, the number of households switching their electricity supplier almost doubled (696,000 in Q3 to 1,304,000 in Q4, OFGEM transfer statistics). If prices were to be frozen the incentives for consumers to switch would be reduced and the monopoly of the big six would continue.

As consumers, we should be thinking more about our energy usage and the responsibility to look for the most suitable tariff should fall with ourselves. When consumers switch it is one of the rare opportunities they have to consider their energy usage, to look at alternatives and to take an interest in sustainability issues such as energy efficiency. A price freeze would take the responsibility out of the hands of individuals and people would continue to let their direct debit do the work. That would be bad for consumers and the environment in the long run.

The problems with the big six energy suppliers go beyond just the prices they charge. They routinely rank at the bottom of customer service polls and are almost universally beaten by smaller independent suppliers. They offer no green tariffs so consumers wouldn’t have the opportunity to support the environment through their electricity usage when they switch.  Price regulation would do nothing to help these problems, and if anything would make them worse. There are innovative products such as the flow boiler that wouldn’t be possible if consumers stopped switching. The only way to remedy these issues would be to encourage people to switch away from the big six.

As energy consumers our best hope is that Ed Miliband is simply electioneering and just saying this to win over voters who like the sound of lower bills. Hopefully if he does get into number 10 then this policy will be a one off and would not harm the competitive retail electricity market in the UK too much.

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Election 2015: How to regulate the big six energy suppliers?

2 thoughts on “Election 2015: How to regulate the big six energy suppliers?

  1. Danny says:

    Interesting arguments. On the price freeze, your arguments seem to be:
    1. Consumers should take responsibility, not (just?) regulators
    2. Price freezes reduce the incentives to switch.
    3. Switching is a positive thing, because individuals can create a more tailored tarriff due to informational asymmetry
    4. Price is not the only important issue, we should also consider service provided.

    But:
    1. I guess so – I’m more concerned about outcome than process here
    2. Price freezes create an upper bound for the price, not a lower bound – there can still be price competition and so still a disparity between providers and by extension incentives for consumers to switch. But you suggest that consumers switch providers in response only to price increases and not to price decreases. So your argument presumeably is that we should *encourage* energy providers to raise prices *in order to provoke switching*. But this is a very large claim. I’m not sure the numbers of consumers who switch in response to a price rise (i.e. the welfare gain from switching) is greater than the welfare loss to those who still don’t switch. Indeed, I’m fairly sure you can prove it’s not greater – if it were, then there’d never be a profitable price rise!
    3. I guess so. But tarrifs aren’t that tailored – in practise, you’re choosing between higher fixed costs or higher variable costs. I’m not sure this argument says more than “you can get a better deal if you think about it”. Which is true, but not independantly related to price switching
    4. Suppose so. But if consumers are so apathetic that they are prepared to accept lousy service and also price differentials, I think we should prioritise protecting them from price rises.

    I’ve heard a lot of peculiar arguments against price freezes, including increased possibility of collusion, reduced incentives to lower prices, and the necessity of having high prices in order to encourage investment. I’m not particularly convinced by any of them.

    One separate electoral issue is the Conservative commitment to implement whatever changes the CMA suggest in their ongoing market investigation. We obviously don’t know what these changes are going to be, so it’s counter-democratic for Parliament to delegate making these policy decisions to an independant body (a little bit like the decision to delegate setting interest rates to the Bank of England; or the independance ambassadors have when building binational relations; or the judiciary). I’m not sure the Conservatives have justified why ‘energy policy’ is in the set of issues which don’t fall under direct democratic mandate.

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    1. Those are some interesting points, especially on whether it’s right to delegate these decisions to the CMA. Just on those four issues:

      1. The responsibility for energy supplies does matter even if you’re interested in outcomes. Part of the reason why people are so bad at implementing energy efficiency measures for example is because they don’t feel that energy usage is something they really have much input into. It may also be that there is some path dependency in this sort of policy, that in the future it becomes the government’s responsibility in the same way that fuel prices seem to be.

      2. It’s fair to say that I think higher energy prices in the short run might lead to a more competitive market in the long run. In order for consumers to have sufficient motive to switch the big six need to be left to charge high prices and offer poor customer service. When consumers become suitably disgruntled then hopefully there will be a larger shift to smaller suppliers offering lower prices. The reason that hasn’t happened so far is because consumer switching is still relatively low, likely due to complex tariffs and long switching times. If a 24 hour switching time was introduced, and perhaps communities were able to bargain collectively, then this may actually happen. If switching rates do always stay low then you would be correct.

      3. You’re probably right there. I am clearly biased here because of my research interest in green tariffs, but switching to these sort of electricity products would also be more likely given higher prices charged by the big six.

      4. The correct response to consumer apathy may be to try and fix the market rather than fix the prices. The research on what triggers switching does tend to suggest that the two big factors are price rises and poor experience with customer service, if that’s not disallowed then eventually the market will correct itself.

      I think what’s more worrying about the Labour party’s manifesto is that aside from the price freeze and replacing ofgem, there isn’t a great deal of detail concerning what they would actually do.

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