Analysis of the UK Energy Sector - Coursework Example

ANALYSIS OF THE UK ENERGY SECTOR al Affiliation ANALYSIS OF THE UK ENERGY SECTOR Introduction In the last decade, the UK energy sector has attracted a lot attention after numerous energy regulation bodies identifies challenges prevailing in the market. OFGEM is one of the bodies that conducted a market research to identify the various challenges that have affected energy market in UK. Evidently, the UK energy market is constrained due to the rise of energy prices and lack of consumer consideration in price determination. Additionally, irregular market competition has provided opportunities for consumer exploitation. As the demand for energy grows, there is evidence that the dominant supplier is making more profit at the expense of the consumers. The objective of the essay is to identify the challenges that have punctuated the energy market, the nature of business competition and possible approaches to handling these problems. To achieve this, the essay will point the constraints that exist in the market and use a theoretical approach to examine possible causes for these challenges. This way, it will be possible to make recommendation on how market regulation and demand side management can be used to solve these problems. Analysis of the UK Energy Sector The UK energy sector has shown a dynamic trend in the last few years with changes in energy prices and consumer expenditure. The Office for National Statistics noted that there was consistent increase in prices of both electricity and gas within the country. Between the year 2011 and 2013, the percentage price changes of both electricity and gas exceeded 10% in the UK. This is contrary to the expectation of the consumer at a time when the government strategic goals were directed towards reduction in the cost energy (Foxon et al., 2000). The poorest households in the UK have been adversely affected by the rise in cost of energy in the UK. Statistics show that the rich household energy costs increased by 1% while the poor households experienced an increase of 3% in cost energy between 2002 and 2012. These changes have been criticized as oppressive and there appears need for change in policies to prevent further increase in the cost of Energy as part of the government’s manifesto to support equity and reduce poverty level. The UK Energy Market Firm market concentration statistics provides a possible explanation for the changes in energy demand and prices within the country. A Herfindal-Hirschman analysis shows that the index remained fairly constant between 2005 and 2008 but increased considerably between the year 2010 and 2013. An increase in the index shows that there is considerable decrease in the number of supplier firms that dominate the market. This illustrates that the energy sectors has been possessed by a few firms that have consistently launched strategies to exploit the consumers (Foxon et al., 2000). When there are few firms within the market, there is minimal competition, which in turn increases the supplier bargaining power. In short, the suppliers have the privilege to increase prices in a non-competitive market. This explains why the company profits have considerably increased over the years while the consumer expenditure continues to increase. The Office of National Statistics shows the relationship between demand and supply within the UK energy sector. It is apparent that the demand has consistently increased as the supply has considerably decreased. Just like in any other business market, such market trends e reduce the consumer bargaining power and awards sovereignty to the supplier in terms of quality, quantity and cost of supply (Foxon et al., 2000). From this perspective, the wrong market trends have contributed to consumer exploitation within the UK energy sector. Theoretical Analysis of the UK Energy Sector Market structure theories are crucial in understanding the nature of price, demand and supply mechanism with any market. The price structure theory will inform on the nature of market challenges in the UK market and the way that organizations control prices within specific market orientations. According to Deodhar (2013), price variation is dependent on the consumer and supplier bargaining power. In UK, it is apparent that suppliers have a high bargaining power and this has led to hike in energy prices. From this perspective, oligopoly market structure is the best description of the UK market energy sector. An oligopoly market structure is where organization where there exist a few suppliers who dominate the market shares. Evidently, the largest share of the UK energy sector is possessed by the British gas, EDF Energy, E.ON UK, RWE nPower and the SSE. As the OFGEN reports, low market competition has resulted to consumer exploitation. The diagram below illustrates the nature of an oligopoly market. Within an oligopolistic market, the main investors may collude to fix prices in such a way that they optimize their profits. This is the situation that the UK energy sector has experienced. As the Ofgem result shows, the energy suppliers in UK collude at specific times to increase the prices at the same time. This is in line with the price theory that states lack of supplier competition as the main cause for rise in prices. In addition, Warren (2014) notes that the energy regulation bodies have created barriers in market entry as potential investors face tough environmental laws within the market. The barriers in market entry have fuelled the problem, paving way for investors to optimize profits within a low market completion environment. The Ofgem report provides possible approaches that can be used to streamline the UK energy market and to reduce oligopolistic competition. To begin with, Ofgem suggests that there is need for demand management at the customers end to ensure that there are alternative sources of energy. Warren (2014) supports this idea and advocates for demand side management within the UK to reduce energy cost in the country. To do this, the government should provide alternatives such as solar panels to reduce demand for electricity. Reduction in demand will result to price reduction as suppliers strive to compete for the low demand. Secondly, Ofgem suggests that there is need to foster competition within the market to provide consumers with a higher bargaining power. Allen, Hammond and McManus (2008) cite market barriers such as policy as the result of the challenges within the UK energy sector. Regulatory bodies should reduce market barriers within the industry to provide for a healthy competition. As price theory indicates, an increase in the number of competitors within the energy will automatically lower the price of energy. The result is that customers will buy energy at lower prices and the companies will adhere to a sense of quality and quantity while offering services. Another suggestion by the Ofgem is provision of rules to enforce fair treatment towards constructing trust in the market. This implies that the body institutes an enforceable act that will regulate the conduct of market players to ensure that they prevent exploitation for instance. For instance, regulations can prevent firms from raising product prices by setting and revising maximum and minimum energy prices on behalf of the firms. However, it is clear that the standard of conduct since its establishment in 2013 has not yet improved the situation. The fuel prices remain high and the consumers have to use the large part of their earning in paying energy bills. Another reform that Ofgem (2014) puts forward is the use of technology in measuring energy consumption within the UK homes. The government has initiated the smart metering project and it is expected that all members of public should have smart meters by the end of 2015. Smart metering is directed towards effective control of consumption patterns and to ensure that the public are aware of their consumption patterns. Therefore, they can control their power usage, reduce losses, and take advantage of time of use tariffs. From a keen observation, consumer engagement will be handy in controlling demand, and this will help in transforming the UK energy sector. Conclusion In brief, the findings of the Ofgem report shows that prevalence of the oligopolistic competition underpins the consistent rise in the cost of energy within domestic setting. Furthermore, barriers of market entry have helped to reduce competition within the industry, leading to increase in supplier bargaining power. As the demand for energy grows, the five main suppliers in the UK take advantage to increase their profit margins. To this extent, I agree that breeding healthy competition within the industry would result to increase in energy prices and equity within the country. The Ofgem has a role to encourage independent investors to enter the market to foster fair competition. As competition increases, the customers are bound to benefit from low prices and quality supply. Besides, suing regulations to control prices would be crucial to protect the consumer. Ofgem also suggests that using technology would be an effective strategy in demand side management, which is crucial in controlling energy demand. On this basis, I feel that the UK energy sector requires strict regulation to foster fair trade and to reduce the cost of energy within the country. References Allen, S., Hammond, G., and McManus, 2008, ‘Prospects for and barriers to domestic micro-generation: A United Kingdom Perspective,’ Applied Energy, 85, pp. 528-544 Deodhar, Y, 2013, Why I am Paying More: Price Theory and Market Structure Made Simple. London: Random House Media. Foxon, T. J., Gross, R., Chase, A., Howes, J., Arnall, A., & Anderson, D. 2000, UK innovation systems for new and renewable energy technologies: drivers, barriers and systems failures. Energy policy, 33(16), 2123-2137. OFGEM, 2014, ‘Consultation on a proposal to make a market investigation reference in respect of the supply and acquisition of energy in Britain. Available from :< https://www.ofgem.gov.uk/ofgem-publications/86807/consultationpublish.pdf> Warren, P, 2014, ‘A Review of Demand-Side Management Policy in the UK,’Renewable and Sustainable Energy Reviews, 29, pp.941 – 951. Top of Form Bottom of Form Bottom of Form Bar, Christian von, Ulrich Drobnig, and Guido Alpa. The Interaction of Contract Law and Tort and Property Law in Europe A Comparative Study. München: Sellier, 2004. Bar, Christian von, Ulrich Drobnig, and Guido Alpa. The Interaction of Contract Law and Tort and Property Law in Europe A Comparative Study. München: Sellier, 2004. Bar, Christian von, Ulrich Drobnig, and Guido Alpa. The Interaction of Contract Law and Tort and Property Law in Europe A Comparative Study. München: Sellier, 2004. Bar, Christian von, Ulrich Drobnig, and Guido Alpa. The Interaction of Contract Law and Tort and Property Law in Europe A Comparative Study. München: Sellier, 2004. Bottom of Form Bottom of Form Read More