Memorandum submitted by the Sussex Energy
Group[368]
ABOUT THE
SUSSEX ENERGY
GROUP
There is growing awareness that a transition
to a sustainable energy economy is one of the main challenges
facing us in the 21st Century. Although climate change is a significant
factor, there are many other reasons why we need to address the
energy transition, including security of supply, fuel poverty
and the attractions of innovations such as renewable energy resources,
distributed generation and combined heat and power. Critically,
the energy transition needs to be designed in such a way that
maximises economic efficiency. An effective response requires
technical ingenuity, behavioural change and virtually unprecedented
political commitment. These are the challenges that the Sussex
Energy Group is addressing. We undertake academically excellent
and inter-disciplinary research that is also centrally relevant
to the needs of policy-makers and practitioners. We are supported
through a five-year award from the Economic and Social Research
Council from April 2005, but also have funding from a diverse
array of other sources.
INTRODUCTION
The committee has requested evidence on seven
inter-related questions. In line with our competences, we have
chosen to respond in two areas: competition and market structure
(effectively spanning the first three of the Committee's issues);
and the final issue, fuel poverty. The main theme of our evidence
is the implication of market structures, regulation and fuel poverty
policy for the vital long-term objective of reducing carbon emissions
COMPETITION, MARKET
STRUCTURE AND
LOW CARBON
OBJECTIVES
Energy policy in the UK wants: competition (low
costs and potentially low prices); radically lower carbon outcomes;
energy security; and abolition of fuel poverty. These are very
difficult to pursue simultaneously and various trade-offs will
usually exist. Competition may impede low carbon objectives (for
instance if coal prices are low); and energy security may exacerbate
fuel poverty if we pay an "insurance premium" to get
more secure supplies or more rapid reductions in demand.
The main focus for this inquiry is competition.
This can come in several different forms: in the UK liberalised
market-place it has usually taken the form of short-term price
competition, rather than competitionfor instancein
offering different quality/type of service (eg green tariffs or
energy services rather than selling a simple energy commodity).
This kind of short-term price competition in the retail sector
puts a premium on reaping economies of scale and this has meant
a minimum financially viable size for energy suppliers of several
million customers. Given, too, that economic regulation is vigilant
against market domination by too few companies this has led to
an apparently quite stable oligopolistic market structure consisting
of six main suppliers who hold some 98% of the market: companies
can be neither too small nor too large.
A given market structure (in this case oligopoly
with substantial vertical integration of retail and generation
businesses) cannot in itself tell you if behaviour is competitive.
Where there are as many as six firms in oligopoly, a high degree
of competition is at least possible. It is impossible to judge
whether or not behaviour is anti- or pro-competitive without detailed
and difficult analysis. If different companies' prices move together
and tend to converge, they may do so either because the market
is competitive or because it is implictly or explicitly collusive.
Price convergence in competition is a result of the need on one
hand for firms to avoid charging too high a price (or they will
lose market share) and on the other, to avoid engaging in price-cutting
to gain market share (because the regulator will not allow much
further market concentration). Equally prices may converge in
the opposite situation of implicit or explicit collusion.
It is sometimes argued that high levels of consumer
switching between suppliers is evidence high levels of competition.
However, a very high proportion of vulnerable and elderly consumers
have never switched,[369]
and while consumers can make small short-term gains from switching,
the high levels of switching seem evidence more of the way in
which regulation and advertising have facilitated switching in
the British system, rather than that there have been significant
long-term consumer benefits. It is certainly the case that there
have been no major changes in long-term market share among the
six suppliers as a result of switching activity.
The two critical questions then become:
are these more or less common
price levels allowing high profit margins relative to activities
of the same risk (indicating little or no competition) or low
margins (indicating high levels of competition)? We have no conducted
no recent work in this area and have no comment to make.
are there major barriers to
entry? If so, there are concerns that while there may still be
a degree of competition, incumbent firms may collectively (for
example) be slow to pass on input price falls to their customers,
but much quicker to pass on input price rises.
The fact that the six retailers have 98% of
the market and that a significant number of smaller new entrants
have failed to establish themselves suggests that barriers to
sustainable entry (mainly due to economies scale represented by
large customer numbers) are high. Whatever the results of these
barriers may be for short term profitability, this is a serious
issue in relation to the longer term objective of low carbon.
New niche players have tried to establish themselves
on the basis of radically greener tariffs and offering energy
services rather than energy commodities. Some, such as Good Energy,
have been successful in offering green tariffs but still have
a very small market share. The regulatory systemdominated
by the need to show that prices to consumers are minimised in
the short termhas also taken a rather individualistic view
of competition and consumer choice. An example is that Ofgem has
seen smarter metering (which could open up avenues for lower carbon
futures) as a matter of individual consumer choice and preference,
rather than as an infrastructure issue facilitating wide-ranging,
national-level learning and innovation in providing new ways to
deliver energy (especially less energy) in efficient and effective
ways.
Another example of the limited approach to competition
within the UK is the lack of an energy service market for households.[370]
Although this has long been talked about (BERR has been working
in this area since 2000),[371]
it has not yet happened. The current market structure makes it
very difficult for new entrants to establish themselves with such
a different business model. Reforms are now planned for a new
"supplier obligation" to replace the Carbon Emissions
Reduction Target which mandates energy efficiency action by suppliers
in 2011. This is expected by many to shift suppliers towards a
more service-oriented approach to minimise emissions from the
energy they supply. But it will be important to design the new
obligation so that it allows diversity of approaches (including
new entry)and therefore helps to encourage more meaningful
competition between suppliers.
Overall the rather static supplier market structure,
reflecting the particular UK liberalisation context and regulatory
structure, has both channelled competition into a narrow focus
on short-term price movements in energy prices, and acted as an
impediment to longer term objectives of a lower carbon system.
FUEL POVERTY
Fuel poverty is real: it is not just a simple
sub-set of poverty in general. It is true that most people in
fuel poverty have quite low incomes but the match is not anything
like exact. The reason is that those on relatively low incomes
experience great variety in the level of energy efficiency of
both their housing fabric and their space heating system. A poorly
insulated house with a highly inefficient heating system may need
to consume up to four times as many units of delivered energy
(in kWh) to achieve the same comfort level as a well-insulated
house with an efficient heating system.
Fuel poverty cannot be eradicated just by raising
incomes (though that helps a little) and the Government can do
little to affect energy prices in a liberalised market. This means
that the principal policy approach to fuel poverty needs to be
via improved efficiency of both the building fabric and/or the
heating system. There has been recent advocacy of lower "social"
tariffs for those in fuel poverty. While such a measure could
substantially improve the fuel poverty status of many families:
it is a short to medium term
measure at best and should not be used as a substitute for improving
energy efficiency, which is a necessary component of a long-term
low carbon and sustainability objective. If energy prices remain
high, the cost of social tariffs to Government will be correspondingly
high; and
it is unlikely to work unless
made mandatory, and this raises the problems of identifying all
those who are eligible for such tariffs and overcoming probable
resistance from the supply companies. This resistance may have
two origins: a general resistance to the idea that their total
company revenues will initially suffer (and a possible response,
in compensation, to raise tariffs for other customers); and more
specific company resistance that may come from those suppliers
who have a disproportionately high proportion of customers in
fuel poverty.
This suggests a need to persist with, and intensify,
existing Government programmes which do recognise the importance
of improved energy efficiency to overcome fuel povertyfor
example the Warm Front scheme and the Energy Efficiency Commitment
(now the Carbon Emission Reduction Target) which has historically
required companies to concentrate much of their effort on the
fuel poor. There is some way to go before fuel poverty can be
eradicated but concentrating on intensified energy efficiency
measures is both the most reliable policy approach and the one
most consistent with long term lower carbon goals.
However, recent decisions by the Government
have gone in the wrong direction. Before the recent Budget, annual
(revenue) expenditure on Winter Fuel Payments (WFP) was around
£2,200 million per year. Following the WFP increases announced
in the Budgetof roughly £550 millionthis WFP
expenditure in 2008-09 will now rise to something close to £2,750
million By contrast, and against the strong advice of the Fuel
Poverty Advisory Group, the pre-Budget report cut (capital) spending
on Warm Front for 2008-11 by 25%, from roughly £350 m pa,
to about £270 m pa. Thus, revenue spend on WFP in 2008-09
is now roughly 10 times annual capital spend on Warm Front.
This growing, order of magnitude difference
between capital and revenue spend is a poor way to tackle the
fuel poverty question. This not least because househoods treat
their WFPs as just another source of income (consumers are just
as reluctant as Government to hypothecate revenues) and can be
expected to spend relatively little of it on fuel. This is especially
so if they experience low energy efficiency, as a given financial
outlay will have a limited outcome in terms of greater warmth.
A continuation of growing WFPs with diminishing capital spend
on better household energy efficiency will be both expensive in
absolute terms and do little to tackle the experience of fuel
poverty. For both low carbon and fuel poverty alleviation reasons,
it is urgent that Government reverse this recent trend.
April 2008
368 This response was written by Professor Gordon MacKerron,
Director, Sussex Energy Group, SPRU, Freeman Centre, University
of Sussex, BN1 9QE; Tel 01273 873539; Email g.s.mackerronsussex.ac.uk,
with inputs from Dr Jim Watson, Deputy Director of the Greoup
(w.j.weatson sussex.ac.uk) Back
369
energywatch energywatch welcomes MPs' inquiry into energy market
Press release 5 February 2008. Back
370
For more, see J Watson (2006) Domestic Energy Services: What
Will it Take? Power UK No 154, December. Back
371
See the final report of the government's Energy Services Working
Group from 2003: http://www.berr.gov.uk/files/file20139.pdf Back
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