Select Committee on Business and Enterprise Written Evidence


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 competition—for instance—in 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 system—dominated by the need to show that prices to consumers are minimised in the short term—has 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 poverty—for 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 Budget—of roughly £550 million—this 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


 
previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2008
Prepared 28 July 2008