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The row over energy prices heats up…

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So, why exactly can’t I pick up a newspaper without looking at a stock image of an ignited gas ring?

It’s a valid question. After a long hot summer, the belated autumn has turned the nation’s attention to energy – namely the pricing strategies employed by the so-called ‘Big Six’ energy providers (namely, British Gas, EDF, Scottish Power, npower, e-on, and SSE). The whole furore kicked off in earnest on September 24th at the Labour party conference, where Ed Miliband, fresh from his tiff with Paul Dacre and The Daily Mail, announced that upon their election Labour would fix energy prices for twenty months. Free-marketeers baulked,  the coalition government recommended thicker jumpers*, and British Gas announced a 10% price hike. Even The Archbishop of Canterbury had a say, branding price rises as ‘inexplicable’.

What are politicians actually suggesting (assuming knitwear isn’t actually part of official government policy)?

Beyond his proposed price freeze, Ed Miliband has also suggested the abolition of the energy watchdog Ofgem, to be replaced with something more consumer friendly. The Lib Dem energy secretary Ed Davey called for more profit transparency from energy companies, and everybody agrees that tariffs need to be made clearer to consumers. Sir John Major surprised his own party on Tuesday and came out of hiding to suggest a one-off windfall tax on energy company’s ‘excess profits’, sensibly suggesting that a choice between keeping warm and eating isn’t especially acceptable. No one in power has embraced this suggestion.

So how do we decide who’s right?

‘Right’ is a strong word, though we can gain some insight with a little economic analysis. From an academic viewpoint, the energy market is absolutely littered with market failures (the factors that prevent free markets from working with full efficiency) and it’s only by analysing these in turn that we can start to decide whether policies mooted by MPs across the political spectrum are likely to be effective or worthwhile.

Let’s start with something almost everyone’s able to agree on: the problem of competition and market concentration. It doesn’t take a PhD from the LSE to see that having 96% of the UK’s energy supplied by only six companies is far from ideal. The market is vulnerable to tacit collusion, where all companies simultaneously raise prices above what they should in a competitive oligopolistic market. On Monday, npower was the third of the big six to announce inflation-beating price rises to come into effect by December, and e-on is tipped to do likewise in the next few days. Add to which the largely inelastic demand schedule for energy, and firms seem to be able to raise prices with complete impunity.

Any economist’s natural solution, of course, would be to have more suppliers in order to decrease market concentration of the incumbents, likely forcing a reduction in prices. The barriers to entry in any given utilities market, however, are notoriously high. Fixed entry costs for energy firms are huge – the new nuclear power plant at Hinkley Point in Somerset is set to cost an EDF-led consortium £16bn. Without the economies of scale achieved though being big (a la British Gas et al) it’s not obvious that any new firm could even overcome their marginal costs.

If we’re stuck with just six companies for now, are they at least trying to justify their price rises?

They’re certainly offering explanations, blaming (amongst other things) hefty ‘green’ taxes levied upon them by Westminster. This brings us on to the next market failure: negative externalities, pollution being the oldest example in the book. Energy production in its current CO2-belching form is certainly untenable, but the search for cleaner, greener methods is expensive. Much has also been made of the Energy Company Obligation (ECO), a government home insulation initiative, which British Gas claimed added £40 to the average household fuel bill (a figure that would account for the majority of their own price rise, but one that simply doesn’t ‘add up’, according to Ed Davey).

Energy companies, somewhat unsurprisingly, didn’t much care for Ed Miliband’s price freeze proposal, projected to cost them anywhere between £4.5-7bn, depending on whose figures you believe. This, so the big six claim, is money that won’t be invested in improving energy production, resulting in a higher long term cost to consumers – precisely what Mr Miliband is trying to avoid. Even without capped prices, utilities don’t boast glamorous margins (‘4-5% at best’) and our existing per kWh electricity prices are below the EU27 average, Germany’s being over 50% higher than those in the UK.

To conclude?

This is such a multifaceted issue, it shouldn’t come as a surprise that there’s no clear-cut conclusion. It’s politically difficult to side with energy companies whilst they’re slapping beefy charges on consumers during these times of economic distress. But with climate change threatening our planet more fundamentally than any stock market crash ever could, now is not the time to curtail investment in new energies. Ed Miliband’s price freeze policy, moreover, reeks of a short-termism that merely treats the symptoms of a broken system (it would, as he has since suggested, require significant regulatory change simply to prevent a spike in prices after his prospective twenty months of flat prices are up).

Even if the government stays as relatively quiet as it’s done up until this point, don’t expect the energy debate to abate any time soon. There are still three big energy companies to declare their pricing intentions, and Labour wont allow it to die down as long as there’s a perceived living standards squeeze.

We can only hope, as Sir John Major reluctantly expects courtesy of ‘sod’s law’, that the winter weather is not too severe, and that people aren’t genuinely forced to choose between food and heat.

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*It’s worth noting that Ed Davey’s somewhat woolly suggestion wasn’t the only bit of misguided PR this week – on the day its price rise was announced, British Gas conducted a Twitter Q&A with the hashtag ‘askbg’. It went as well as could be expected, and a social media manager vacancy was advertised on the Centrica careers page by the end of the day.

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2 thoughts on “What a Gas…

  1. What people seem to be missing, and is in my opinion a key issue in this sphere is with regard to the reasons behind price rises. All 3 companies so far have sited the main reason behind a hike as the increase in gas prices, both at home and abroad.

    People have, however, jumped to seemingly the opposite conclusion. that we are spending too much on subsidising expensive renewable energy, and need to get back to cheap fossil fuels.

    These two positions are directly at odds. Once up and running renewables are cheaper and don’t leave us at the mercy of volatile gas prices. What we are seeing is an increase in the price of fossil fuels because of a raise in demand for energy which is increasing globally faster than supplys of fossil fuels. The solution is to substitute away to a cheaper alternative. The trouble is green energy has high start up costs, but low marginal costs,

  2. You’re entirely right. Another quirk of the solar power industry (ironically to its detriment) is the fast pace of innovation. Because the efficiency of solar panels is being improved so quickly, there’s a reluctance to invest in existing products, since more efficient models are almost certain to be available in the near future.

    To break free of fuel import price volatility would be ideal, to that end the announcement of a new nuclear plant and (to a more controversial extent) the various fracking proposals are certainly welcome.

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