Analysis of the United Kingdom Energy Market - Example

United Kingdom Energy Market Affiliation United Kingdom energy market Introduction The office of Gas and Electricity Markets (OFGEM) is the biggest government regulators for downstream, natural gas and electricity markets in Great Britain. The Main objective of OFGEM is to protect the interest of the customers where possible by ensuring that they promote competition. Moreover, they protect future and existing consumer’s interest in relation to the gas that is conveyed via pipes and electricity that is conveyed by distribution or transmission systems. The duties and powers of OFGEM are provided for under statute such as the Electricity Act 1989, the Gas Act 1986 and the Utilities Act 2000 and Energy Act 2010 among others. Through the statutes, OFGEM manages to ensure that the suppliers provides the consumers with gas and electricity at reasonable prices. The essay main goal and objective is to discuss the findings of the OFGEM report in relation to the energy market situation in the U.K. Additionally, the essay seeks to establish whether the big six U.K firms may contribute any benefits to the United Kingdom consumers. The expected findings in this essay is to understand the reason for the increased prices of gas and electricity on the part of the consumer even though the United Kingdom energy market is oligopolistic. This will be undertaken by evaluating the U.K energy market and proposing reforms as indicated in the OFGEM report that will ensure that energy sector is more beneficial to the consumers. Analysis of the United Kingdom Energy market Market review has indicated that urgent action is needed to ensure that energy retail markets in the U.K work in the interests of the customers. This is because customers are at risk because of a number if features found in the market that serve to decrease the effectiveness of competition. For example, the high number of sticky customers and pricing information is of major concern because many consumers find it difficult to make informed decisions when it comes to the choice of supplier (OFGEM, 2011, p. 5). According to the state of market analysis that was done by OFGEM it was established that the average dual fuels prices increased by 24% between the year 2009 and 2013. This relates to a consumer price index inflation rate that was established at 13.8% in that period (OFGEM, 2014, p. 5). This in turn led to the energy consumption to decrease, which meant that the consumer bills increased less than the prices. Moreover, the average dual fuel bill increased by 13% between the year 2009 and 2012, which was slightly above the CPI inflation rate of 11% within that period. Therefore, OFGEM estimated a further increase in the average bills at 6% in 2013. The increased cost of households fuels has been contributed over the years by environmental and social mandates by the government institution, which have been left to the consumer to pay indirect through their network charges and consumer bills. Lack of competition in the energy market has attributed greatly in the increased inflation in the energy industry. Figure 1: Average dual fuel household bills 2009-2012 Source: Consolidated Segmental Statements (OFGEM, 2014, p. 5) However, the recent progression of smaller suppliers has been an encouraging development because as per January 2014 the small suppliers domestic share was above 5% in both gas and electricity. This has been an increase of over 2% points compared to 2013. This has established that there is a possibility to enter in the energy and compete with the big six firms of energy suppliers. There are some fears however, on whether any single supplier will manage to achieve a sufficient scale to be close to disrupting the constraint on the six energy firms across the market (Adams et al. 2011, p. 1220). Additionally, the lack of wholesale market and products has also contributed to the frustration. This is because the trading activities of non-vertically incorporated suppliers may be protecting any advantaged positions of the big six (OFGEM, 2014, p. 11). This means that even though the smaller suppliers want to ease the competition from the big six energy suppliers they need more power as the big six are at an advantaged position. The market structure best describing the United Kingdom Energy Industry The incumbent suppliers have rendered the United Kingdom market to have a weak competition, which has in turn lead to market segmentation and weak competition. Furthermore, it has been expected to be new competitive pressure from new suppliers and consumers, but barriers have been set by the big six firms such as vertical integration. This in turn has led to poor delivery of services to the consumers as the big six have allowed market segmentation (OFGEM, 2014, p. 12). It has been established that the six biggest suppliers have disproportionately retained a high number of consumers that are located in incumbent regions and for Centrica high number of gas customers. Therefore, the best type of market describing the United Kingdom energy industry is oligopolistic market. An oligopoly comprises of many companies selling the same product where consumers can substitute products, but only one organizations’ offerings for another. In the case of the energy market in the UK, it is an oligopoly, because a small number of oligopolies that is the big six dominate the energy market share (OFGEM, 2014, p. 13). In the United Kingdom, the six energy firms have taken over the market where they have reduced the chances of competition even from smaller firms. The main aim of this kind of market is to ensure that they get profits from their consumer; they have control over the prices and most of all tactic coordination where the big firms work together when it comes to setting the market prices. Additionally, an oligopolistic market has the attribute of segmenting their customer base. In that, they charge different consumers different prices for the same product (OFGEM, 2014, p. 11). This has been a major characteristic of the big six energy firms where most of the consumers have been unable to switch from their gas and electricity supplier because of market liberization. For that reason, the sticky consumers have been charged more the use of energy indicating that there are more likely to be on increased priced single fuel tariffs. Market segmentation has allowed the suppliers to use their power over the incumbent customers, as they do not have the incentive to switch from their supplier. Another indicator that the market is oligopolistic is the tacit coordination in the sense that, in case, the market is stable enough and the rival firm manage to interact repeatedly in relation to price announcement (Great Britain, 2005). The firms can anticipate what the other firm is planning for the future making them to establish a well-coordinated course of action without them having to communicate directly (OFGEM, 2014, p. 12). Such actions have been found to make competition less effective making the prices of energy to go up than they would in markets that were competitive. OFGEM observed that many characteristics could facilitate to tacit coordination in the energy retail market. This is because there is high levels of concentration in the market in relation to the company structure, costs, and products as they are relatively similar (Allen, Hammond & McManus, 2008, p. 540). Moreover, the prices of energy are observable making the demand conditions predictable. For that reason, the six firms have had power over the prices making it hard for the consumers to get adequate energy without having to pay more than required. Proposed reforms as identified in the OFGEM report in order to make the UK energy market beneficial to the consumers. Various reforms were proposed to benefit the consumers from having to more than what is expected of them when it comes to energy. They include enhancing liquidity, which will turn allow access to new entries in the energy market by independent suppliers and generators. By so doing, it will increase competition, which will allow the energy prices to go down for the consumers. This will be achieved by proposing a new license that mandates the big six firms to make 10 to 20% of their power generation market share. Secondly, there is the improvement of the tariff compatibility, which is an effort to make it easier for the domestic customers to compare the prices of energy product allowing them to make sound decisions on what to buy. This will prevent market segmentation; hence, allowing the consumers to move from one buyer to the other. Thirdly, there should be improvement on reporting transparency because it will allow control in the generation and supply of energy. Furthermore, by ensuring that there is consumer transparency it will allow potential consumers into the market; thus, controlling the pricing of energy products in the United Kingdom, which will be beneficial for the consumers. Lastly, strengthening probe remedies that will ensure that the existing remedies are enforced in order to achieve the goals and objectives that have been stated by OFGEM. Moreover, it will give the suppliers less freedom to interpret their obligation in the market; hence, strengthening the existing authorities into ensuring that the consumers are protected from the suppliers who are motivated by financial gain. Conclusion It is clear that the energy sector in the United Kingdom is dominated by suppliers whose sole interest is to ensure that they gain financially. The six major suppliers in the energy market have ensured that smaller suppliers cannot get through the market; hence, weakening competition. This has largely affected negatively on the consumers because they have had to suffer because of the increased prices of household energy. The six-energy company provide an average of 98 % of energy in UK meaning that they have the power to control prices without any questions asked. However, through the help of OFGEM the government has shown an initiative to allow the smaller suppliers to penetrate the market, which will ensure that the big six do not have control over the market. Additionally, the proposed reforms will come along way because the consumers will have the choice to decide on which supplier they want to rely on when it comes to be given sufficient household energy. The government actions will help the consumers, as they will move away from suppliers who only think of their own interests. References Adams, P.W. et al., 2011. Barriers to and drivers for UK bioenergy development. Renewable and Sustainable Energy Reviews, 15, pp.1217–1227. 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. Great Britain. (2005). Ofgem, the social action plan and the energy efficiency commitment: thirteenth report of session 2004-05. London, Stationery Office. OFGEM. (2011, March 21). The Retail Market Review. Retrieved February 4, 2015, from https://www.ofgem.gov.uk/ofgem-publications/39708/rmrfinal.pdf. Pp. 1-81 OFGEM. (2014, March 12). State of the Market Assessment. Retrieved February 4, 2015, from https://www.ofgem.gov.uk/ofgempublications/86804/assessmentdocumentpublished.pdf. Pp. 1-120 Read More