The True Cost of Energy: why Ed Davey must act
A poll out yesterday showed that action to address high energy bills is now the top priority for voters, so Energy and Climate Change Secretary Ed Davey has a political interest in new research on the True Cost of Energy published by IPPR. The report argues that competition in the energy market is not working and that some consumers are paying higher prices as a result.
IPPR has analysed how much it costs energy companies to supply electricity and gas to UK consumers, finding strong evidence that competition in the market is not in good health.
The UK energy market is dominated by six companies, who provide energy to 99% of all consumers. We have found that the least efficient of the Big Six spends 113%, or over £50, more on their operations per year for each customer than the most efficient, a significant amount when compared to the average energy bill of around £1,255 a year. As price is overwhelmingly what matters to consumers when they buy energy, it is surprising that such a big difference exists. In a competitive market inefficient companies should be priced out of the market. What is striking is that the difference between the most and least efficient company in terms of how much they spend on their operations per customer has grown since 2007, when we would expect to see the reverse. This is strong evidence that competition is not driving efficiency savings as it should be.
The role of the energy markets regulator, Ofgem, is key. It publishes regular estimates of energy companies’ costs and how these relate to the average energy bill, but Ofgem’s evidence shows no sign that energy bills have been affected by the efficiency savings the companies have achieved in their operations. As a result some consumers are likely to be paying more for their energy than they should. Ofgem has launched a major package of reforms, the Retail Market Review, aimed at improving competition in the energy market. But the previous package of reforms failed to improve conditions and, according to Ofgem’s own research, on some measures conditions have actually deteriorated.UK consumers cannot afford for these new reforms to go the same way.
Ed Davey should therefore ensure that Ofgem enforce its existing policy that the suppliers must offer tariffs that are reflective of their costs. IPPR analysed the tariffs offered by suppliers and found that several did not appear to be complying with the policy. In fact, Ofgem has launched an investigation into one of the suppliers, Scottish Power, but over a year later they have yet to provide any update on progress. On the face of it, it looks like Ofgem needs to act faster. Alternatively, it may be that the policy is very hard to implement, in which case Ofgem should say so and look for alternatives. What is clear is that the current approach does not appear to be working.
He should also ensure that Ofgem examine loss leading: where suppliers subsidise big discounts for some customers by overcharging others. IPPR found that some suppliers charge some customers over £330 a year more for using the same amount of energy than others and we estimated that 5 million people could be being overcharged through this practise. This also limits competition because small suppliers cannot match the discounts offered by some of the Big Six suppliers. Another area ripe for reform is the number of tariffs that suppliers can offer. Reducing the number of these would immediately simplify the market, making switching easier, while still enabling energy companies to offer innovative tariffs.
So while reforming the industry is a great policy challenge, it is also a great political opportunity. As a former minister for consumer affairs, Ed Davey is fully aware of the difference that relatively small changes to energy bills can make when people are on tight budgets. If he could deliver decisive reform of the energy market the political dividend could be substantial.