Energy companies’ loyalty problem lights the way forward

Dialing up. Energy companies and the numbers game. Ety, CC BY-SA

The Competition and Markets Authority’s (CMA) latest paper highlights one of the key issues at the centre of its investigation into the UK’s gas and electricity markets: are customers who have not switched energy supplier being fleeced?

The simple answer is yes. Particularly those customers who rarely or never switch their energy suppliers, who are on standard tariffs which tend to be more expensive than “non-standard” ones offered to new or proactive customers.

The gas and electricity retail markets were opened to competition for domestic customers in the late 1990s. Despite the fact that consumers can now pick who supplies their energy, few if any switch regularly to find cheaper – or greener – deals.

Sticking point

The CMA estimates that if consumers switched between 2012 and 2014 they could have saved on average between £158 and £234 a year, depending on the suppliers. This is particularly serious given that the most inactive customers (known as “sticky”) seem to be made up of vulnerable groups: those who are over 65, people in social accommodation, people with no qualifications and/or those on lower incomes. The people who can least afford it are those who are suffering the greatest impact.

Customers getting burned? Taylor Bennett, CC BY-NC

So in the face of substantial savings, and a political and media storm over energy prices, how might the CMA investigation reduce the degree to which people pay over the odds for their energy?

The standard economist’s response would be to say that people should be given more information, that the information should be clear, and that the hassle from switching should be minimised. The consumer’s desire to source ever cheaper energy would then deliver a more competitive market where prices were driven down. That’s certainly what Ofgem, the energy regulator, has said in the past. But despite introducing a set of measures designed to make switching easier, the number of active consumers is still relatively low. For example, in most electricity regions, between 40-50% of customers have been with the incumbent supplier for 10 years or more (CMA issues statement para 115) .

This suggests that you need a more complex and wide-ranging approach than the standard neoclassical economics approach of providing information as a way of driving rational, price-based choices.

Power games

This is because the issue of energy prices is in fact just one part of a much bigger picture. The problem of overcharging customers is obviously an important one, but just focusing on this end point ignores the other contributing factors in the system as a whole, and the longer-term imperatives of delivering low-carbon energy in a way which is both secure and affordable.

In our evidence to the CMA in December last year, we argued that these contributing factors in large part relate to the structure of energy markets and the nature of the governance of gas and electricity systems. Energy markets are designed to reflect and maintain the current configuration of the systems by rewarding large-scale, flexible (and therefore fossil fuel) energy, while industry codes support the established technologies and practices.

Getting the wind up. David Joyce, CC BY

Both tend to exclude new technologies, particularly renewables, which have different operating characteristics, and new entrants with different ways of doing things. In addition, the design of the electricity market (known as BETTA) in particular has led to the vertical integration and market domination of energy companies that we see today. So the governance of the systems has contributed to the dominance of the Big Six energy companies and given rise to the current concern about energy prices.

Just concentrating on prices and the performance of the retail market was treating the symptoms rather than the cause of the problems in the UK’s energy markets. Instead, we argued that the CMA needed to broaden the scope of its investigation to take the bigger picture of overall system governance into account and to consider issues such as market design when investigating new entry and the impact that could have on end user prices.

The CMA’s paper today has recognised the need for a broader perspective on governance and regulatory issues, and the degree to which they may or may not shape competition and development in energy systems. As a result, the CMA investigation holds out the potential of being more than just an economist’s examination of short-term pricing issues, and instead being a more sophisticated examination of the broader social, political and technical issues shaping energy systems. If it delivers on that potential, we might at last see some longer-term, more innovative approaches to the future of our energy systems.

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