Evaluation of the Market in the UK Energy - Literature review Example

Macro and Micro- economics- The UK Energy market Lecturer’s Introduction The office of gas andelectricity market (OFGEM) is the regulator of natural gas and electricity in UK. It has powers of acting so from the government as well as from the community legislation. OFGEM acts as the regulator of the electricity and gas markets. The main goal is protecting the future and current electricity and gas consumer’s interests through competition promotion in an effort of regulating the monopoly of companies that run the trade networks (Warren 2014, p.942). While doing so, it is crucial to understand how the consumers engage with the electricity and gas markets and how further engagement can be supported further to ensure effectiveness in the market for the consumer interest (Sloman and Garratt, 2013, p.11). The essay main aims and objectives are discussing the finding of the OFGEM report in regards to the market energy situation in United Kingdom. The essay further seeks to discuss more on whether completion of the UK energy firms would be a benefit to the customers. The big six major firms in the UK have squeezed customers in all areas. Despite the rise of the inflation rates, the gas and petrol bills are on the rise, and there seems to be a never-ending cycle of the rise in prices unless further action is taken. The paper evaluates the market in the UK energy industry and proposes reforms identified in the OFGEM report that will make the energy sector more beneficial to the customers. Analysis Six major suppliers namely Centrica, NPower, EDF, EON, SSE, and Scottish Power dominate the UK energy market share in the supply of electricity and fuel and their domestic share has remained between 10 and 30 percent throughout the period with NPower having the largest market share (Sloman and Garratt, 2013, p.8). From the results, it is profoundly clear that the fuel and electricity expenditure has been on the rise from 2002 until 2012. Over the period, an increase in the average UK household spending on energy has resulted. The domestic energy prices of gas and electricity have been on the rise for the period of 2011 and 2013. According to published records accounts, the average fuel bill has increased by 13 percent over the period (Allen et al. 2008, p.530). Increased cost over the period can be attributed to social and environmental mandates by the government that are paid indirectly through the customer bills as well as network charges. From the observation, there is an increase in the aggregate profits reported by the six large companies vertically integrated as illustrated by the split in generation and supply. The generation profits have fluctuated over the years that reflect the changes in the relative generational cost by the different technologies. There is a wide variation in the supply margins among the six suppliers with some making greater profits than the other. From the analysis, 2012 average domestic supply margin was greater in comparison to benchmarks. In conclusion based on the data available an indication exists that the major six energy suppliers in the UK may have had a very good opportunity of making good profits although further work is needed to establish this conclusively. In order to enhance completion, it is important to enhance the growth of small suppliers. In 2014, the domestic market share of the small suppliers was 5 percent in gas and electricity market share a very significant increase from 2 percent in the previous years (Adams et al. 2011, p.1219). The type of market structure best describing the UK energy industry The UK market structure is characterized by a weak competition. The rise and fall of prices by the six largest fuel and electricity suppliers tend to be always announced at the same time. The price differences between the standard fuel dual tariffs are also converging. Generally, the market has a weak competition among the suppliers that can be attributed to market segmentation as well as a possible tacit coordination (Sloman and Garratt, p.2013). It is impossible to have competitive pressures from new suppliers and consumers due to barriers to expansion and entry i.e. vertical integration as well as a weak pressure from the customers. All these factors combine leading to poor outcome delivery for the domestic consumers (Watson et al. 2008, p.3087). The type of market structure that best describes the UK energy situation is an oligopoly market. In this type of market structure, a small number of oligopolistic such as the six major companies that dominate the market share dominate the industry. In the market structure, there is reduced completion leading higher prices for the customers as illustrated in the UK energy situation described above. Major characteristics of this market structure includes ability to set prices, their main goal is profit maximization, a few firms or companies are in control, there is no product differentiation and there are barriers to entry and exit as illustrated. According to the OFGEM characteristics of the energy retail market, they facilitate tacit coordination due to the great level of market products concentration and relatively similar observable costs; thus, conditions are predictable. This can be further explained by the increased profitability of the large companies and the convergence of the domestic supply margins (Warren 2014, p.945). Circle illustration of an oligopolistic market structure Figure 1: Percentage market share by UK Energy Firms – December 2014-Current Data retrieved from http://www.cornwallenergy.com Proposed reforms, identified in the OFGEM report to make the UK energy market beneficial to the consumers Improvement of the tariff compatibility - This is an effort of making it easier for the domestic consumers to compare the prices of the energy products and, make a decision on the best deal. By improving, the compatibility of the tariff confusion in the domestic market will be addressed by restricting tariffs. Consumers will have the ability of determining at a glance whether they will save money by switching from one supplier to another (IPSOS MORI 2012, p. 24). Enhancing liquidity - This will improve access to the market products for new entries and independent generators and suppliers. This will enhance completion in the industry, as other participants need to compete against the existing players for the benefit of the consumers. This will be attained through proposing a new license requiring the big six companies to make 10 to 20 percent of their power generation market share to be available through a regulatory mandatory action. Thus, other potential players will be able to enter into the industry (OFGEM 2012, p.12-16). Establishment of a mandatory market making arrangement - Proposing a new license condition requiring for the establishment of a mandatory market making arrangements is essential. This will help in ensuring that the market participants can trade continuously and have the ability of mitigating the imbalance risk involved. This will be very beneficial to the customers who have problems in assessing the present market and enhance competition in the industry (Sloman and Garratt, 2013, p.21). Strengthening the probe remedies - This is in an effort of making sure that existing remedies are enforced where necessary so that they achieve their stated objectives. This will provide suppliers with less freedom on how they interpret their obligations. Actions under this proposal include strengthening the existing authorities in an effort to ensuring that the customers receive clear transparent information as well as providing advice regarding the switching process (Suganthi & Samuel 2012, p.1236). Enforcement actions and enhanced monitoring of the supplier activities can also be achieved by this proposal. Improving on the reporting transparency- According to the 2008 probe, reporting of separate financial information is essential to control supply and generation. This is crucial in enhancing the consumer’s transparency as well as for the potential competitors, and it will be easier to control the pricing of the energy products (Warren 2014, p.948). Conclusion The energy industry in the UK has been dominated by an oligopoly of energy supplier over decade comprising of the big six companies. All together, they provide around 98 percent of the UK household energy. A surprising matter is that the share of the market of each of these companies has been static with every major market supplier dominating a specific area. As a result, the energy prices are high as there is no completion in the industry. The market has a weak competition among the suppliers that can be attributed to the segmentation of the market, as well as a possible tacit coordination. It is impossible to have competitive pressures from new suppliers and consumers due to barriers to expansion and entry i.e. vertical integration as well as a weak pressure from the customers. Therefore, enactment of the proposed reforms, identified in the OFGEM report is essential to make the energy sector to be beneficial to the consumers. This includes improving the reporting transparency, strengthening the probe remedies, establishment of a mandatory market making arrangement, improvement of the tariff compatibility and enhancing liquidity. References Adams, P.W. et al., 2011. Barriers to and drivers for UK bioenergy development. Renewable and Sustainable Energy Reviews, 15, pp.1217–1227. http://www.sciencedirect.com/science/article/pii/S1364032110003266 Allen, S.R., Hammond, G.P. & McManus, M.C., 2008. Prospects for and barriers to domestic micro-generation: A United Kingdom perspective. Applied Energy, 85, pp.528–544. http://www.sciencedirect.com/science/article/pii/S0306261907001481 Ipsos MORI, 2012. Consumer Experiences Of Time of Use Tariffs: Report prepared for Consumer Focus, Retrieved from: https://www.ipsos-mori.com/Assets/Docs/Publications/Ipsos-MORI-report-on-Consumer-Experiences-Of-Time-Of-Use-Tariffs.pdf OFGEM, 2012, Retail Market Review: Intervention to enhance liquidity in the GB power market. OFGEM Retrieved from https://www.ofgem.gov.uk/ofgem-publications/39643/liquidity-feb-condoc.pdf Sloman, J., & Garratt, D. (2013). Essentials of economics. New York, Prentice Hall/ Pearson. https://books.google.com/books?isbn=0273783793 Suganthi, L. & Samuel, A.A., 2012. Energy models for demand forecasting—A review. Renewable and Sustainable Energy Reviews, 16, pp.1223–1240. http://www.sciencedirect.com/science/article/pii/S1364032111004242 Warren, P., 2014. A review of demand-side management policy in the UK. Renewable and Sustainable Energy Reviews, 29, pp.941–951. http://www.sciencedirect.com/science/article/pii/S1364032113006680 Watson, J. et al., 2008. Domestic micro-generation: Economic, regulatory and policy issues for the UK. Energy Policy, 36, pp.3085–3096. http://www.sciencedirect.com/science/article/pii/S0301421508002218 Read More