(by Andreas Stephan) The latest round of increases in energy prices has sparked an angry debate about how well competition is working in the UK market. Energy companies claim increases reflect rising wholesale prices and government levies, while politicians are making allegations of collusion. A long term view of how to make the energy market more competitive for consumers has been drowned out by political point scoring. Yet there may be a simple way of jump starting greater competitive pressures against the relentless price rises.
Energy prices have become politicised as a focus point for broader concerns about the cost of living in the UK. Both the government and the opposition have responded to public anger with promises of short term transitory measures to alleviate the problem. Ed Miliband promised a price freeze if labour forms the next government, forcing the Prime Minister to respond with an announcement to cut green taxes. As discussed previously on the blog, announcing a price freeze in advance allows energy firms to factor that freeze within their pricing decisions, and cutting green levies engenders problems of its own. The only welcome announcement in all this is that the energy market will be subject to an enquiry by the competition authority. The leader of the opposition, apparently forgetting the competition authority’s independence and remit, dismissed the suggestion as an opportunity for “more excuses”, despite going on to say that his party would “reform a broken market so that there’s proper competition”. This was not helped by the Chief Executive of E.ON enthusiastically supporting the idea of a competition investigation. Nevertheless, a full enquiry is exactly what is needed to bring long term solutions to failings in the energy market.
In the short term, the major problem is a lack of switching by consumers, with the rate declining and currently standing at just 14% of households. With such a small proportion of the market up for grabs, it is not surprising that firms are choosing not to compete. The majority of their customers will never switch, despite being on some of the highest tariffs in the market. Firms don’t have to collude for there to be little competition, they simply have to act rationally according to conditions in the market. If significantly more households switched, energy firms would have a greater incentive to break ranks and compete. The main barriers to switching are:
- Complicated billing, making comparison difficult.
- The time and trouble of switching.
- The perception that the cheaper energy company will soon increase prices to at least the level of the existing provider, making switching pointless.
- Inertia among consumers, despite significant anger at price rises.
OFGEM have introduced new rules, aimed at making energy pricing simpler, clearer and fairer. In addition, the government have announced plans to reduce the time it takes to switch supplier to 24 hours. However, these measures only address the first two problems identified above.
The other two may be addressed by making energy pricing more like car insurance. The fixed term nature of car insurance contracts provides an important ‘check point’ at which consumers are far more likely to consider their options and act to save money. Consumers with annual contracts (as with car insurance) switch far more frequently than those on unlimited contracts (e.g. bank current accounts). Consumer searching and switching in the energy market could be improved through the introduction of the following:
- Annual energy contracts with a fixed transparent tariff.
- An annual statement clearly detailing the tariff charged, the household’s total consumption, and the total spent on energy over that period.
- A renewal quote offering a fixed tariff for the next 12 months, calculating the total household expenditure based on the previous year’s consumption.
By fixing all tariffs on an annual basis, consumers could switch energy providers with the confidence that their new provider will not raise its tariffs shortly afterwards. The current inertia is fuelled by the fact energy providers can increase tariffs at any point and by the fact searching and switching requires significant positive effort by the consumer, for example in finding up to date information on usage.
As energy companies would only be able to increase prices at the point of renewal, consumers would be able to channel any anger at price hikes into greater price comparison. By forcing energy companies to commit to a fixed tariff on an annual basis, there is also a greater incentive for them to compete on price in order to retain customers. They would make a greater effort to sign up new customers, offering better introductory tariffs and possibly even loyalty discounts. The result could be higher competitive pressures driving against the relentless increases in energy prices.
 The default of inaction would be automatic renewal within a certain grace period.