UK: Miliband's Energy Fix: Does He Have A Point?

Last Updated: 10 October 2013
Article by Charles Whiddington

Ed Miliband may have been grandstanding and his energy price-freezing announcement was certainly populist.  Superficially, fixing the prices of energy for consumers sounds attractive but such state intervention is ultimately crude and unsatisfactory and, as a former energy minister, he would have known this. On the other hand, does he have a point?

Price regulation at consumer level is not in itself an alien concept in the UK. We have it for example, in certain postal services, in air traffic tariffs, rail access charges. In utilities, Ofwat sets separate price controls for wholesale activities and household retail services, plus default tariffs for non-household retail services. Conceptually, price controls (which were designed to protect consumers) were relaxed as competition developed in the markets. Ofcom allowed retail price controls to lapse in 2006 for fixed telephony and the effect of the controls in place was that BT cannot raise prices for a basket of services by more than RPI.

In energy, price caps were removed completely in 2002, because there was felt to be sufficient competition between the retail suppliers. However, from a competition perspective, where there is sufficient competition, then it would be expected that consumer welfare would be assured through market prices determined by supply and demand forces interacting dynamically. Consumers purchase more or less of a product depending on the price and how much they want of it at a given moment. In an efficient market (where suppliers are free to charge what they like) consumers will punish suppliers who 'over-charge', by switching to another supplier. However, even in competitive markets there are inefficiencies and consumers do not face perfect choices or do not have perfect information. This is one reason why transparency to consumers is stressed by regulators.

In energy, at the retail level, there appear to be problems in the way the markets work. Utilities point to worldwide rises in wholesale energy prices as an extrinsic factor causing rises in consumer energy prices. They point also to the cost of meeting ECO targets for emission reductions - a cost borne by consumers which is estimated will cost each household between £60 and £100 per annum. But, as some have pointed out, whilst increases in prices have been readily passed on to consumers, significant falls in wholesale prices have not been passed on to consumers - which might have been expected in efficient competitive markets. In spite of a long and very painful recession, suppliers have been able not merely to maintain prices, but to increase them. Ofgem's SMI model (the supply market indicator') shows consumers' dual prices rose between 2009 and 2013 from £1145 to £1420 - a rise of about 24%. It is also worth noting that consumers do not readily switch between suppliers (which gives incumbent suppliers a great advantage and disincentives potential new entrants). Ofgem has not found evidence of collusion and is aware that there are problems at wholesale level, partly because of the absence of new entrants.

Suppliers claim that there is sufficient competition and they need the flexibility in order to meet their ECO targets. But at the same time there is no real threat of the 'lights going out' as claimed by one CEO. Generators will still get their subsidy for generation plus the market price. There is a licensing requirement on suppliers to supply and not to cut off supplies. In the unlikely event of a supplier going into financial difficulties, regulations are in place to ensure that another supplier would step in.

So Ed Miliband does have a point: the energy market at the retail supply level is not working to the consumers benefit and something needs to be done about it. But price controls generally are very inefficient, crude and would not solve the problems. Each supplier has multiple tariffs: at what point would a tariff be frozen? How would Miliband punish suppliers for pre-Election price increases (as he threatens to do). The proposed 15 month price freeze is too short to enable regulatory consultation to take place and then introduce a new energy regulatory framework. As a principle, most economists and competition experts agree that price controls are not viable as a mechanism to increase consumer welfare in markets in which competition works. There are lots of example of this in recent history - such as the gasoline price controls in the US in 1970s. Choosing the right level of price is almost impossible and where prices are held at a level which is below its natural level, resources and especially capital will tend to leave the industry to seek out pastures offering better margins. In an environment in which substantial investment is desperately needed in  energy projects to implement the Third Energy Package, meet carbon reduction targets, increase the mix of energy from renewable sources, expand and modernise transportation systems across Europe, Mr Miliband's message is not a good signal to the markets. But it does offer a strong signal to the regulators to act now on the current awareness of the inefficiencies and to start a process now to develop measure which will deliver benefits to consumers, rather than sitting on the sidelines waiting for something to happen.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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