Price Regulation is Not the Solution to Unaffordable Energy Prices

(by Catherine Waddams)  At the Labour party conference, Ed Miliband said he would freeze energy prices until 2017.  Miliband’s frozen energy prices might lead to frozen homes as well.  Interventions in energy markets do not have a happy history, either in California or the UK, and those who remember the public sector price freezes of the Wilson and Heath governments in the nineteen sixties and seventies may also recall the subsequent underinvestment, poor quality and shortages. Privatisation and independent regulation were seen as a solution to those problems, but energy markets in particular have proved very controversial. This isn’t the first political intervention.

The regulator (Ofgem) was persuaded by the last Labour government in 2008 to investigate a market which had been deregulated in 2002.  Since then it has introduced a number of measures which have failed to deliver the competitiveness they were seeking. One of the most obvious was the introduction of non-discrimination clauses.  This prevented companies from discounting energy to attract new customers unless they also lowered their mark-ups on current customers to the same level. Ofgem saw this as fair, but as Morten Hviid and I pointed out[1], it meant that companies had little incentive to compete with each other, that there were fewer gains from changing supplier, and that switching fell dramatically.  Stephen Littlechild estimates that the consequent reduction in competitive pressure raised average prices by about 6%, costing the average household £400[2].

More recently both the deputy prime minister and the prime minister have declared their intention to intervene in the market – in the latter case ‘putting everyone on the lowest tariff in the market’ – superficially a great idea, but of course the good deals will disappear quickly in such a scenario, just as they are doing now in the face of Ofgem’s simplification of tariffs under the Retail Market Review.  The Cameron scheme is incompatible with a competitive market.

There are real concerns that the energy companies may not be competing vigorously enough to ensure that prices are as low as they could be.  Research from the Centre for Competition Policy suggests that when retail competition was first introduced in the UK, companies used tariff structures to divide the market and avoid competing too strongly against each other[3]. But there has been no evidence of any explicit collusion (which would be a criminal offence). The UK has a unique tool, the market inquiry, for investigating markets which may not be working well, and many have called for such an inquiry into the energy market – an opportunity for the new Competition and Markets Authority which will be inaugurated next week.

On the positive side, the Labour party’s proposals have the merit of being honest about re-regulation, rather than the creeping variety we have seen over the past five years.  Some of Ofgem’s actions (which may have been motivated by political pressure) have almost certainly increased both prices and company profits by interfering with the competitive process. They were aiming for a fairer market, but the negatives are substantial.  A UK politician cannot control the global oil price.  Just as markets are not perfect, neither is out-and-out price regulation, a return to which may lead to even higher costs and ultimately prices. It will certainly risk lower security of supply and slower realisation of environmental objectives.  If we want more investment in generation and infrastructure, and to slow greenhouse emissions, we need to face the reality of higher energy prices.  We should help households who struggle with their energy bills by ensuring they have sufficient income to meet these higher costs. Otherwise there is a danger that we will get the worst of both worlds – higher bills in the long term, and a real risk that the lights won’t stay on.


[1] Non-Discrimination Clauses in the Retail Energy Sector by Morten Hviid and Catherine Waddams Price The Economic Journal Volume 122, Issue 562, pages F236–F252, August 2012

[2] Stephen Littlehild’s response to the Ofgem Retail market Review consultation at https://www.ofgem.gov.uk/publications-and-updates/retail-market-review-updated-domestic-proposals

[3] Nonlinear Pricing and Tariff Differentiation: Evidence from the British Electricity Market by Steve Davies, Chris M Wilson and Catherine Waddams Price (2014) Energy Journal, 35(1), pp.57-77, Full text: http://www.iaee.org/en/publications/prejournal.aspx.

One Response to Price Regulation is Not the Solution to Unaffordable Energy Prices

  1. […] a time when UK households are continuing to endure declining income in real terms. My colleagues, Catherine Waddams and Chris Hanretty have recently written on this blog about proposals by the Labour party to cap […]

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