Competition in the energy market

Energy bills generate newspaper headlines and are something every household in the UK has to grapple with. Manifesto commitments to fix energy prices were featured by different parties in the 2015 and 2017 election campaigns, and in the meantime the Competition and Markets Authority (CMA) completed a major inquiry on how the market works.

Prices are rising…

Energy bills have several component parts – a supplier pulls these parts together and this is hidden from the end customer. For example, the actual generating cost of the energy supplied is normally less than half of the bill (43% of a typical dual fuel bill in 2015). Next up is the cost of getting the energy to consumers’ homes, via pipes and power cables (around 24% in 2015).

Environmental policies made up 7% of costs, while supplier operating costs (metering, IT, service) made up 16%. Supplier retail profits were around 4% of the bill – although some think this should be lower (profits for some big suppliers also come from other sources).

The profits of suppliers have been under increasing scrutiny for some years. All but one of the ‘big six’ have raised prices in recent months, giving rise to debate over whether the rise was justified.

Ofgem data shows that suppliers are facing cost pressures, mainly due to rising wholesale energy costs, but also higher costs from government renewable and low-carbon electricity generation schemes. But costs are complex; Ofgem recently told a Commons committee that the need to pass cost increases on to customers depends on the company’s cost base, and overall energy costs are similar to three years ago.

Is competition working?

When energy markets were liberalised, customers remained with their ‘regional’ company for electricity and national company for gas, but consumers were supposed to switch to save money and a competitive market would be established. As predicted, the number of major suppliers (now known as the ‘big six’) consolidated. Most consumers don’t switch suppliers regularly and therefore don’t get the best deals.

Concerns over the level of competition in the market led to a major CMA investigation from 2014 to 2016. It found that around two-thirds of the big six’s domestic customers were still on an expensive ‘default’ standard variable tariff (SVT), and said consumers could be £1.4 billion a year better off overall. The investigation proposed reforms to support competition – for example, a database of consumers who hadn’t switched and changes to price comparison websites.

But there are signs that the market may be getting more competitive – the number of active suppliers is rising rapidly, from 27 at the end of 2015 to 52 at the end of 2016.

The problem of standard variable tariffs

Consumers who haven’t changed supplier at all, or at least not recently, are likely to be on SVTs. The chart shows the significant gaps in annual cost between a ‘big six’ SVT and the lowest price in the market. At the end of March 2016 the average ‘big six’ dual fuel customer could save £150 by switching to the cheapest ‘big six’ tariff on offer; or £250 by switching to the cheapest tariff on the marketplace.

Annual duel-fuel energy bills

So if prices are fixed, what might happen?

In the 2017 election the Conservatives pledged to introduce a “safeguard tariff cap” that would cap high SVTs, but would support initiatives around switching at the same time. It was suggested the cap may save consumers on these tariffs £100 a year. Labour proposed to implement an ‘emergency price cap’ to keep average dual fuel bills below £1,000 before other reforms took place.

Fixing prices is not unheard of – Ofgem set a three-year cap for pre-payment meters in 2017 following the CMA investigation. However, capping standard prices could be seen as admitting the market may not be able to operate efficiently.

Intervening in the energy market is not popular with energy companies or with those who think competition should be left to work without intervention. One criticism of price controls is that it encourages people not to seek a better deal; another is that consumers who do switch will see higher rates, as suppliers seek to protect their overall profits by putting other prices up.

A key question for the next Parliament will be how to make consumer markets such as energy work effectively – can consumers be encouraged to find the best deal or does Government need to be more active?

This article is part of Key Issues 2017 – a series of briefings on the topics that will take centre stage in UK and international politics in the new Parliament. More Key Issues posts will be published on this blog throughout June, subscribe via the homepage to get instant alerts

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Improving energy efficiency can reduce energy bills but also has high up-front costs. Policies promoting household energy efficiency measures, together with the improved standards for appliances, lights and boilers also reduce consumption and climate change impacts.

The smart meter rollout – due for completion by 2020 – is expected to increase awareness among home owners about their energy usage, and encourage the take-up of efficiency measures. This, combined with a more efficient grid, should result in cost reductions in the longer term.