Energy Market in the United Kingdom and European Union - Research Paper Example

? Analyzing Case Study Introduction The essay will discuss the energy market in European Union especially in the United Kingdom. The essay will describe the formation of the imperfect market structures such as monopolistic and oligopolistic markets with attention to gas and electricity markets. The essay will analyze the reasons behind collusion of firms in the same industry and formation of cartels. The impact of existence of oligopolistic markets in an economy will be discussed in regards to its effects to the consumers. The analysis of the British Gas will help in identifying various issues relating to the behavior of the company and the industry in which the company operates. The analysis will take into consideration the actions and decisions of the energy industry regulators to promote competition in the industry. United Kingdom Energy Markets As demonstrated by the actions of British Gas and the Scottish and Southern Energy, the energy market in U.K is characterized by collusion and cartels. These oligopolistic market structures enable the six larger firms in this industry to regulate the market by determining the prices and supply of energy products. An oligopoly is a market structure, which is controlled by few producers, and each of the producers has control over the market. The extent to which an industry or a market is dominated by a few leading firms is determined by the concentration ratio. It is an industry where the level of market concentration is high. In most circumstances, an oligopoly exists when there are five large firms, and the demand or sales of their products account for 60 percent of the total market. There is no specified theory that explains how firms determine the output and price under the conditions of oligopoly. If there are price wars in the industry the oligopolistic firms will produce and price their products as perfect competitive industry, at other times they will behave like a pure monopoly. The following are the characteristics of oligopoly market structure; these characteristics are also displayed by the UK energy market. First, product branding; this feature is seen when every firm in the market is selling differentiated (branded) products. For example, British Gas, EDF, E.ON, Scottish Power, Npower, and SSE firms among other small firms in the energy industry sell differentiated products in the UK energy markets. Second, entry barriers; considerable entry barriers into the industry market prevents other firms to enter the market thus enabling dominant firms to maintain supernormal profits. Various small firms may operate on the edge of an oligopolistic market, but these firms are not large enough to have a considerable effect on the market output and prices. In July 2011, the British Gas announced an increase in electricity and gas prices by 16 percent and 18 percent respectively just eight months after it increased its prices. British Gas managing director defended the increase in prices saying that the market rates for energy has increased in the global energy market, which increased the wholesale costs of the firm by 30 percent for the last one year (King 2011). While reacting to this increase in energy prices energy minister, Chris Huhne demanded change in the UK electricity market. Energy secretary Chris Huhne, held a meeting with small energy suppliers, with an objective of finding ways of breaking the dominance of the large six electricity and gas companies and help in keeping energy prices down. The plan of the minister was to abolish the entry barriers in the energy market to allow competition between small and large firms in the energy industry (King 2011). The actions of Chris clearly show that there are entry barriers in the UK energy market. Third, interdependent decision making; in oligopolistic market firms take into consideration the possible responses of their competitors to any change in output, price or forms of non-price competition. Increase of gas and electricity prices by British Gas came one month after Scottish Power increased their prices by 21 percent. These companies display a possible scenario of interdependence in decision making. Fourth, non-price competition; oligopolistic firms employ non-price competition strategies in marketing their products and/or services. Free deliveries and installation, heavy spending on marketing and advertising and branding of products, diversification of product range and expansion into new market, and extensive after-sales service are some of the examples of non-price competition. For example, SSE engaged in doorstep sales activities, in Great Britain where it was persuading potential consumers to switch to their products. Later the firm suspended these activities after it was proved guilty of misleading prospective customers. The firm noted that doorstep selling was no longer an effective method of gaining new long term customers (King 2011). Energy suppliers should focus on providing better value products and services, instead of hard selling. Impact of Collusion Collusion is the desire by firms in an industry to realize joint-earnings maximization within a market or prevent revenue and price instability in an industry. Price fixing symbolizes an endeavor by suppliers to control supply and fix the price level close to the price level we would expect in monopoly. Fixing of prices by firms in the oligopolistic market facilitates the formation of cartels. Collusion affects the supply and prices of services and products in the market. Cartels are illegal, but large energy suppliers in UK increase prices in almost the same manner and the same period, exhibiting a collusion behavior. As King (2011) notes increase of electricity and gas prices by British Gas and Scottish Power adversely affected nine million consumers in UK among other customers in EU. The increase in price raised the average annual fuel bill from ?1,096 to ?1,288. As the Consumer Focus director, Mike O’Connor noted, the price rise had a severe impact to consumers; it increased pressure on sternly stretched households’ budgets and led to inadequate fuel supplies to numerous households. Ann Robinson-uSwitch.com noted that, the other four giant energy suppliers in UK could possibly follow suit, by increasing prices of their products further increasing the households’ energy bills. Conclusion According to the above analysis it is true that the energy market in UK exhibits oligopoly market characteristics. In order to guard the concerns of the consumers, the UK and EU Competition Commissions need to play their role in ensuring that, the small suppliers are allowed to compete with the six large energy firms. Eliminating the entry barriers in the energy market will promote free and fair competition and this will help in bringing the energy prices down. Competition will ensure a stable supply of gas and electricity to UK households, at relatively stable prices thus protecting consumers from behaviors of oligopolistic energy firms in UK. References List King, M, 2011, British Gas raises gas and electricity prices, The Guardian, viewed 18 March 2012, < http://www.guardian.co.uk/money/2011/jul/08/british-gas-raises-gas-electricity-prices> Read More