UK Domestic Gas & Electricity markets: A Case Study based on Structure-Conduct-Performance model - Essay Example

? UK Domestic Gas & Electri markets: A Case Study based on ‘Structure-Conduct-Performance’ model Introduction: The United Kingdom gas and electricity industry is known to have its own Big Six or major suppliers. The constant rise of gas and electricity costs despite news about prices in global market to decrease have placed many end consumers restless and doubtful about fair market practise of suppliers or firms, most specifically the Big Six. In addition, the regulating offices Competition Commission and Office of Gas and Electricity Markets have performed below consumer satisfaction. This paper will try to demonstrate the dominant role of the gas and electricity firm in the market despite presence of regulating bodies as a result of their collusive behaviour based on the structure-conduct performance (SCP) model. Industry characteristics: The SCP Model The structure-conduct performance model refers to the industry’s performance based on the behaviour of the firms also dependent on structure (Scherer and Ross, 1990) or factors of competitiveness in the market. The structure is defined by the number and size distribution of buyers and sellers, entry and exit conditions, product differentiation, vertical integration, diversification. The firms’ conducts is composed of the business objectives, pricing policies, product design and branding, advertising and marketing, research and development, collusion and merger. The performance includes profitability, growth, quality of products and service, technological progress, productive efficiency, and allocative efficiency (Scherer and Ross, 1990). Collusive & Oligopolistic There are six major electricity suppliers in the United Kingdom, mainly: BritishGas, EDF, e-on, NPower, ScottishPower, and SSE which is seen as oligopolistic for their dominant nature. From the Gas Act 1948 as a nationalised UK gas, these firms or the industry became privatised in 1986 (Wright, 1987). Based on SCP model, the UK gas and electricity industry is collusive and oligopolistic where prices are controlled by the Big Six or a limited number of firm performing with the resultant low efficiency due to the greater market power they yield. The UK gas and electricity price index have continuously risen and more so recently. In a consultation conducted by OFGEM (Office of Gas and Electricity Markets, 2008), it was suggested that “…wholesale costs have fallen for some months, the majority of the period is characterised by rising prices and costs,” (p174) as illustrated in accompanying graph covering and 8-year period: Source: OFGEM, 2008 The report observed that energy bills of consumers compose of 50-70% wholesales costs although described to be “smoother” when compared to wholesale prices. This is due to the fact that commodity-based retail markets’ suppliers cannot change retail prices frequently die to customer preferences for stable prices and additional costs incurred when changing retail prices that include re-calibration of prepaid meters, notification letters about the increase, and re-programming of the billing systems (OFGEM, 2008). Price Control The graph immediately shows that there was consistent higher and rising retail cost which diving wholesale costs could not dent. In addition, it should be noted that firms buy a large percentage of their energy on forward markets so that their costs have been smoothed out on certainty over future costs (OFGEM, 2008). The hedging strategies applied by firms of which OFGEM (2008) reported to buy up a year or up to 18 months prior to delivery indicate that immediate rises to cost of wholesale gas and electricity should not be an immediate cause to increase rates as claimed in their news releases, “steep rises in wholesale costs, which have increased 30% since last winter because of a higher global demand for gas, driven by increased consumption in Asia and the impact on supply of unrest in the Middle East and north Africa,” (King, 2011, P11). More supplier costs are incurred as much as any other business in all industries. As already suggested in other cases in Europe, “prices are too high because of the control that a few large companies maintain over the distribution networks” (The Independent, 2008, P6) prompting rise during that period in the UK to go as high as 40%. Barriers to Entry The industry structure is characterised by major players already called the big six and some minor suppliers which meant there is seller concentration. The barriers to entry include cases of which suppliers may already have monopoly on pipe ownership such as that of E-on and another European firm on a pipe with gas coming from Russia (The Independent, 2008). Impact on collusion: In a Structure Conduct Performance, the components are basic conditions such as consumer demand and production, elasticity of demand, substitutes, raw materials, rate of growth, location, and scale of economies, among others. In this model, there is a relation between market performance, market conduct, and market structure. It was suggested that performance is low in a greater market power. The UK gas and electricity demand and production which showed the following trend dictated a great market power due to steady climb of demand: Source: Parliamentary Office of Science and Technology, 2004, p2. The Competition Commission and OFGEM are regulating bodies in the United Kingdom that safeguard the consumers and smaller business interests to ensure healthy competition. The CC is under the Department for Business, Innovation and Skills created by the Competition Act of 1998 and governed by the Enterprise Act 2002. It is empowered to decide on inquiries and investigations as well as responsible in remedies or appropriate measures after an inquiry and identification of competition problems. Remedies may include prevention of merger, requiring firms to sell off part of its business or other possible solutions to improve competition (CC, 2012). If OFGEM abide by its mandate, an October 2008 report provided contrasting scenarios. One statement suggested that “Overall, the transition from monopoly gas and electricity supply ten years ago to competitive markets is well advanced and continuing to develop. Many consumers have benefited from lower prices, better service and a wider range of deals on offer,” (p 1). On another, the report stated that the “Probe has been undertaken against the background of unprecedented increases in world fuel prices which have flowed into record increased in wholesale and retail gas and electricity prices. A typical household’s energy bills have more than doubled since early 2004 and many households are now struggling to pay their bills,” (p 3). The probe (OFGEM, 2008) invoking the Enterprise Act of 2002 that enabled it access to documents from the firms failed to indicate actual suppliers’ expenditures for the period being investigated and instead relied on various mathematical assumptions to arrive at their safe estimations that suggested the market was favourable to the consumer. It also suggested that “The market shares of these Big 6 suppliers in their monopoly markets continue to fall year-on-year (at a rate of around 4 per cent per year for gas and 2 per cent per year for electricity) as they penetrate further into each other’s markets,” (OFGEM, 2008, p 8). Despite their findings, many consumers and even market watchdog such as Consumer Focus, Which? and uSwitch.com are worried about the continuing rise of energy prices, of which an 18% increase in gas and 16% increase in electricity prices commenced only after eight months when British Gas increased last (King, 2011). Conclusion: It is difficult to assume that regulators themselves are protecting the same limited firms viewed as oligopolistic that they should be investigating as it was not clear as of this writing if OFGEM recommended an investigation to the Competition Commission about the industry’s firms’ behaviours. Their clout is apparent in this regard as it extends to government agencies, characteristic of oligopolistic cases. The continuing rise of prices of gas and electricity and the equivalent increased net profits of these firms equate to the continuing power they yield in the UK market. Despite these trends, the regulating bodies have not arrived at actual solutions that indeed benefited the consumers. Reference: Competition Commission (2012). Policy. Accessed 2012 from http://www.competition-commission.org.uk/policy-and-international King, Mark. (2011). British Gas raises gas and electricity prices. Guardian. July 8. Accessed 2012 from http://www.guardian.co.uk/money/2011/jul/08/british-gas-raises-gas-electricity-prices OFGEM (2008). Energy Supply Probe – Initial Findings Report. Consultation. October. Scherer, Frederic M. and David Ross (1990). Industrial Market Structure and Economic Performance, 3rd ed. Wright, Mike. (1987). Government divestments and the regulation of natural monopolies in the UK: The case of Britishgas. Energy Policy, vol 15, Issue 3, June, Pages 193–216. Read More