The Electricity and Gas Market of the UK - Example

Macro & Micro Economics Introduction Office of Gas and Electri Markets (OFGEM) was set up to promote competition in the energy sector of Great Britain mainly by protecting the interest of the consumers. The organization mainly works to provide remedy to the current issues faced in the energy market of the country. Despite the presence of OFGEM, the U.K. energy sector is characterized by a large number of inefficiencies most of which emanates from the lack of competition. It has been found the electricity and the gas industry in the market is characterized by few major firms which has eliminated the competition from the market. The purpose of this essay is to analyze the main findings of the latest report of OFGEM to understand the extent of competitiveness in the energy sector of the country. This will be linked to the basic economic theory of market competition to capture the overall scenario of the energy sector of the U.K. The U.K. energy sector The energy sector of UK is responsible for supplying electricity and gas to more than 50 million households and organisations. This sector possesses almost 90% shares of domestic consumers. Over a period of time the energy sector of UK has transformed their monopolistic business structure by introducing several private organisations. The current energy supply procedure in UK involves three major steps such as purchasing of the wholesale power or gas by different business entity, paying all the government policy as well as network costs and charging a certain price from the consumers as per their usage of these supplies. The presence of a number of privet organisations has increased the competition in the present market (Department of Energy and Climate Change, 2013). On the other hand, UK energy sector has demonstrated few weaknesses which are hampering the competitive advantages of the top energy suppliers. The major players of UK energy sector are British Gas, EDF Energy, E.ON UK, National Power, Scottish Power and Scottish and South eastern electrics (SSE). The market also consists of few smaller energy suppliers such as OVO Energy, Good Energy and Ecotricity. As per the recent data the major players of the energy sector of UK have accrued 92.4% share in the current market where British Gas holds the 30% part of the share. E.ON UK, Scottish Power and SSE hold approximately 14%, 11% and 15% market share respectively (Office for National Statistics, 2014). The profit ratio of the top players of energy sector has witnessed decline over the year of 2010 to 2013. On the other hand these organisations have increased their profit margin in terms of their domestic energy supply. This situation has resulted in the increase of the prices of domestic gas and electricity within the period of 2011 to 2013 (Office for National Statistics, 2014). According to different researches, the electricity and gas prices are rising near about eight times higher than the increase in the average income of the population. The domestic price of electricity has shown a sharp increase of 10% where the price of gas has demonstrated an approximate increase of 15% (Office for National Statistics, 2014). The rise in the price of gas and electricity is hugely affecting the spending pattern of household disposable income of the consumers. The utility expenses of the poorest fifth household have increased to 11% in the year of 2011 in comparison to 8% in the year of 2002. In contrary, the energy expenses of richest fifth household have increased by 3% only in comparison to 2% in 2002 (OFGEM, 2014). The problems that have been identified by the OFGEM report are not relatively new but the organization has found out that the problems have aggravated over the past four years which is particularly unacceptable (OFGEM, 2014). The overall findings from the report clearly suggest that the existing state of competition in the market is highly unimpressive which needs to be changed immediately. Application of Economic Theory Economists define an oligopoly market structure as one which falls within the spectrum of monopoly and perfect competition. It is characterized by imperfect competition as there are only a handful of firms that governs the market. In an oligopolistic market structure there are only a small number of sellers (Sloman, Norris and Garrett, 2013). The number of buyers are however large and this gives the sellers enough power to control the market. The products sold by the oligopolistic market players can either be similar or slightly different depending on the industry they are operating in. The U.K. electricity and gas market is one where the four players control the entire market and they have the power to regulate the price that is being charged in the market (Sloman, Norris and Garrett, 2013). The limited number of options in the oligopolistic market makes the buyers highly indifferent in an oligopolistic setting. This characteristic can be found strongly entrenched in the U.K. electricity market as consumers hardly changed their current suppliers because it is a difficult process. Another dominant characteristic of an oligopolistic market structure is that it is very difficult for new entrants to enter the market. Same has been found in case of the U.K. energy and gas industry as the four dominant players have created a situation which makes it very difficult for new players to enter the market (Sloman, Norris and Garrett, 2013). Figure 1: Oligopoly market structure (Source: Author’s creation) The graph in the above figure represents the conditions in an oligopolistic market structure. The figure depicts that the demand curve is broken indicating that if the upper portion is highly elastic and the lower part of the curve is highly inelastic. The demand curve illustrates that if one firm increases the price then others in the market will not do the same but if it decides to reduce the market price then others follow (Sloman, Norris and Garrett, 2013). The U.K. energy and gas industry follows the strategy of tactit coordination which cannot be regarded as a real collusion because it is only a trick competition without any formal agreement. Here none of the firms enter into price wars by undercutting each other but there is an informal connection in their strategic responses. Figure 2: Behaviour of firms under competition (Source: Author’s creation) The figure above shows the behaviour of individual firms operating under the conditions of collusion. The equilibrium point is determined by the point where the marginal revenue of the firms in collusion intersects the marginal cost curve. Point d shows the equilibrium and profits of the firm is indicated by the rectangle bcaP0. The office of OFGEM has devised a few recommendations which can improve the competition in the energy market of the U.K. The first recommendation put up by the OFGEM is that the existing market structure should be simplified. The organization has introduced some of liquidity reforms which will provide suppliers and generators with greater access to the wholesale market (OFGEM, 2014). This recommendation is in line with the findings of Allen, Hammond and McManus (2008) who had asserted that micro-generation is likely to improve the current competitive structure of the market. The second recommendation provided by the committee is to monitor the conditions in the market and improve the transparency of reporting to the regulatory authorities. This is done to assess the efficiency of the plans. Researchers are of the notion that monitoring of an organization can help in improving the accountability and makes them more responsible towards the stakeholders. The third recommendation suggested by OFGEM is to remove the obstacles relating to the long delays in switching and improve the overall customer engagement in the energy sector (OFGEM, 2014). This recommendation of the report is in line with the findings of Cooke (2012) who was of the notion that enabling the power of consumes is one of the basic ways in which competition can be increased in the energy market. The final recommendation provided by OFGEM was that new entrants should enter the market in order to create a competitive environment (OFGEM, 2014). Economists like Varian (1994) have showed that entry of new firms in the market not only brings down the price but also reduces the overall cost of production. This is highly beneficial for the customers because they have a large number of options to choose from as overall output of the industry improves. Conclusion The electricity and gas market of the U.K. is facing a number of difficulties at present. The most important problem of the industry is that there is a lack of genuine competition which is hampering the overall efficiency of the market. The market structure of the U.K. electrical and gas market is oligopolistic in nature. Though apparently the four large firms seem to be engaged in a collusive behaviour but actually they practice tactit coordination which is particularly proving to be harmful to the consumers. The recommendations suggested by OFGEM shows that there are certain ways in which the competition in the market can be increased. They suggested that the first requirement would be to detangle the complex market structure and make it simpler. Reforms relating to easy availability of liquidity have been suggested. The second recommendation is to create a robust system of reporting which will help in observing any sort of abnormality in the market. This can be beneficial for taking corrective measures if there is any trace of corruption. The third recommendation was to improve the extent of customer engagement so that they are aware of the changes going in the industry and the final recommendation is to allow new firms to enter the market so that consumers have a greater number of options to choose from. Reference List Allen, S.R., Hammond, G.P. and McManus, M.C., 2008. Prospects for and barriers to domestic micro-generation: A United Kingdom perspective. Applied Energy, 85(6), pp.528-544. Cooke, D., 2011. Empowering customer choice in electricity markets. [pdf] OECD. Available at: [Accessed 31 January 2015]. OFGEM, 2014. Consultation on a proposal to make a market investigation reference in respect of the supply and acquisition of energy in Great Britain. [pdf] OFGEM. Available at: < https://www.ofgem.gov.uk/ofgem-publications/86807/cmamarketreference09072014.pdf> [Accessed 30 January 2015]. Sloman, J., Norris, K. and Garrett, D., 2013. Principles of economics. New Jersey: Pearson Higher Education. Varian, H.R., 1994. Entry and cost reduction. [pdf] University of Michigan. Available at: Warren, P., 2014. A review of demand-side management policy in the UK. Renewable and Sustainable Energy Reviews, 29, pp.941-951. Department of Energy and Climate Change, 2013. UK energy in brief. [pdf] Anational statistics publications. Available at [Accessed 30 January 2015]. Office for National Statistics, 2014. Full Report: Household Energy Spending in the UK. [online] Available at http://www.ons.gov.uk/ons/rel/household- [Accessed 30 January 2015]. Bibliography Jones, A. and Sufrin, B., 2014. EU competition law: Text, cases and materials. Oxford University Press. Strbac, G., 2008. Demand side management: Benefits and challenges. Energy Policy, 36, pp. 4419–26. Read More