A potential government investigation into British Gas has offered up the chance to restructure the market in a way that has not happened since the industry was privatised, and could skew the market to favour the consumer.
While academics and commentators pore over every aspect of the regulation and operation of the electricity market, gas has remained something of a black box, with few people understanding – or probably even caring – about how it all works. This could all change as a result of the Department of Energy and Climate Change (DECC) announcement last week.
Energy secretary Ed Davey’s letter to Ofgem asked the regulator to consider investigating British Gas to see whether it is abusing its market power and therefore inflating profit margins. The result could be that the company, and other elements of the gas market are broken up to reduce the abuse of market power.
There can be little doubt that Davey’s actions are in large part the result of growing scrutiny of energy companies and Ofgem over the past couple of years. The minister has had to weather voter-friendly announcements from the Labour Party about price capping and abolishing Ofgem as well as screaming headlines in the newspapers about enery prices. It should be no surprise he felt something concrete must be done to limit the impact of rising prices on consumers.
In that context, British Gas presents an attractive target on which he can exercise his interventionist credentials. It’s the largest gas supplier, its parent company, Centrica, is a major gas producer and it has some of the sector’s highest profit levels. It’s hard to feel sympathy with them as they prepare to announce profits of nearly £3 billion later this week.
Unpicking the gas market will serve several ends. For a start, should expose the behaviour of the gas companies (not just British Gas) to a level of scrutiny which they have not yet experienced. In doing so, this may lead them to adjust the way they maintain their profit margins. It should also mean that the wider world will understand more about how the gas industry operates, no bad thing given the importance of gas in the UK’s current energy mix. It might even mean that the monolithic British Gas is broken up, diminishing its market dominance.
New dogs, new tricks
But these are all relatively short-term impacts which may or may not lead to a reduction in customer bills. It’s also worth thinking about the possible long-term implications of breaking open or even overhauling the gas market. If British Gas is no longer as dominant, it will be easier for new entrants to enter the market, creating greater levels of competition and bringing new ways of doing things.
This is where it all gets a bit more interesting.
While attention is concentrated on the British Gas investigation, Davey’s letter to Ofgem also contained a section on new business models, and the degree to which it might be possible for energy companies to operate in different ways. At the moment, energy companies make their money by selling as much electricity or gas as possible. This approach puts them in conflict with broader goals of increasing energy efficiency and/or reducing demand for energy, which delivers benefits in terms of reducing overall bills, enhancing the overall security of energy systems and cutting carbon emission targets.
There is a different way of doing things. Most consumers aren’t really interested in buying a certain number of units of energy. What they want is to have the services – heat or light – that the energy can deliver. A different business model from the current Big Six approach would be focused on delivering those services to consumers as efficiently as possible, and profits would come from providing consumers with a level of service while using fewer units of energy. While examples of such Energy Service Companies exist and provide services for large customers, the challenge is to extend the model to smaller consumers, including individual householders. This is something which is much more commonplace abroad in countries such as Germany and the USA.
The potential for such a shift has not really engaged politicians before. Generations of secretaries of state have treated the gas and electricity markets as entirely separate entities, independent of government, and shied away from interfering with company business models. Davey’s letter, however, offers an opportunity to break that habit. He explicitly refers to both markets as vehicles to deliver energy efficiency.
The minister has taken a step in the right direction here, but it is just a first step. This new energy market design could range from general political statements supporting a more service-based approach to providing energy, to something more draconian such as the requirement to deliver a certain proportion of business in the form of energy services rather than units of energy. Like most energy policy decisions, the political will of the policy makers must be strong enough to push changes through the system in the face of opposition from the archaic yet powerful incumbents.
In the face of low-customer churn, high profits and a small number of players, the question of whether the energy market requires redesign has a straight answer. Of course it does. The only question is whether Davey or his counterparts in the other parties have the courage, grit and capability to take it on.