The Cleggite solution to rising UK utility prices: Kemp

LONDON Wed Apr 11, 2012 8:35am EDT

The sun rises behind electricity pylons near Chester, northern England October 24, 2011. REUTERS/Phil Noble

The sun rises behind electricity pylons near Chester, northern England October 24, 2011.

Credit: Reuters/Phil Noble

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LONDON (Reuters) - Deputy Prime Minister Nick Clegg promised on Wednesday energy suppliers will have to inform customers at least once a year of the cheapest power and gas tariffs available in a bid to stimulate competition and push down prices.

It is another indication of the chaotic state of Britain's energy policy. Both government and energy suppliers are desperately trying to shift blame for rising utility bills, which have added to the financial strain on millions of households, and caused the government to miss its target of eliminating fuel poverty by a wide margin.

The result is an increasingly bizarre and contradictory set of interventions which do little to alleviate fuel poverty, improve efficiency or cut carbon emissions.

The government's climate strategy depends on guaranteeing returns for the big six energy suppliers to encourage investment, so ministers cannot do anything which would jeopardize revenues, including forcing big price cuts.

NUDGES AND SWITCHING

"Seven out of ten customers are on the wrong tariff for their needs, so are paying too much.

The deputy prime minister pointed out that Britain's big six energy suppliers offer over a confusing array of more than 120 tariffs, ensuring most customers are unaware of the best rate and stick with the devil they know. Inertia meant three-quarters of customers stayed with the same tariff in 2010.

So the government has agreed with the big six that customers will be contacted once a year (twice in the case of vulnerable households receiving subsidized tariffs) to notify them of the best tariff for their needs with the same supplier.

The government and energy markets regulator, Ofgem, have already pressed for suppliers to simplify their range of tariffs to improve comparability. In future, energy bills may be bar-coded to facilitate price comparisons using a smartphone and faster, simpler switching between suppliers.

Will any of this reduce the amount spent on heating, lighting and power by the average household? Not much if at all.

In 2009, the average household in England spent 1,340 pounds on gas and electricity, according to the comprehensive annual survey published by the Department of Energy and Climate Change ("Annual Report on Fuel Poverty Statistics 2011"). Since then prices have continued to rise. Most households will save far less than 8 percent on their combined fuel bills by switching.

However, Britain's current administration is attracted by the work on behavioral economics and "nudge" theories popularized by Cass Sunstein and Richard Thaler in the United States ("Nudge: Improving Decisions about Health, Wealth and Human Happiness" 2008).

In the energy sector, the government believes that complex bills and apathy have prevented large numbers of customers from switching suppliers, causing them to be significantly overcharged. Ofgem has diagnosed lack of competition among the big six as central to the problem in Britain's energy market.

More information prominently displayed could give the right nudge to boost switching, intensify competition, and drive down gas and power bills.

Except that it probably won't work. Soaring bills have little to do with the opaque arrangements in Britain's retail power and gas market.

COMPLEXITY AND RETURNS

Complaints about confusing products, lack of switching and customer dissatisfaction in energy are precisely the same as those which regulators and consumers have expressed for years about Britain's banks and mobile phone companies. Advocates of reform have moaned for years the average Briton is far more likely to get divorced than separate from their bank.

Complex tariff structures are no accident. Banks, phone companies and power and gas suppliers provide an essentially undifferentiated product. The most profitable form of competition limits discounts and special deals to new customers, while exploiting the inertia of the mass of existing customers by continuing charge them more (or in the case of banks offer lower rates of interest).

The result is the constant introduction of new products to secure marginal customers, while terms on old products become gradually less favorable. With their 120 tariffs, electricity and gas companies have only followed a well-worn path used by banks, phone companies, insurers and pension providers.

Government and regulators have not been able to tackle the apparent market "failure" in those other industries; there is no reason to expect they will be any more successful in power and gas.

Even if the government's strategy were successful, there is no reason to expect it would cut average bills. At the moment, inertia by the great mass of customers pays for discounts available to aggressive switchers. But if everyone becomes a switcher, the cross-subsidy would disappear.

WHERE ARE EXCESS PROFITS?

Prices could improve for everyone if greater switching enforced more competition and eliminated excess profits among the big six. But the government and Ofgem have failed to point out precisely how much those excess returns are or who is earning them.

If there are concerns about the way the market is functioning, it is not simply about excess profits in the retail market.

The major concerns are (1) the opportunities for integrated suppliers with generation/production, wholesale trading and retail distribution to exploit their market power to the detriment of customers via inappropriate transfer pricing; and (2) uniform investment strategies by the big six suppliers which have minimized risks for their investors but maximized fuel price risks for customers by concentrating excessively on gas-fired generation.

Encouraging more switching by households will not solve either of these problems.

CONTRADICTORY APPROACHES

Bills have been rising sharply because of a combination of rising natural gas prices in Europe (where gas prices remain strongly linked to oil) as well as government programs to incentivize more investment in green power and the associated transmission infrastructure.

In the case of rising energy costs, officials have privately welcomed increasing prices as providing an incentive for more conservation and efficiency (for example energy efficient lighting and better insulation) even as they publicly worried about the impact on household budgets. Rising prices are essential if the country is to meet its ambitious decarburization targets.

Bills have also risen because the government wants to encourage investment in alternatives like wind, solar, tidal and eventually nuclear, while building out the necessary transmission infrastructure. The response has been a mix of feed-in-tariffs, higher grid charges, and a minimum carbon price, all of which directly raise the cost of power and gas bills.

The industry insists higher prices and guaranteed returns are necessary to make all this possible. Because the government has opted to make customers pay for improvements through bills, rather than provide subsidies from the taxpayer, they show up directly in higher household prices.

The costs may or may not be worth it. The government insists prices would otherwise rise even more because of rising global energy prices, though the shale gas revolution may challenge that assumption.

What is certain is that prices are primarily rising because of a private consensus between the big six and the government, while each side publicly blames the other to deflect public anger, but not too much.

The result is a strange sort of kabuki theatre. Ministers fulminate (quietly) against firms for overcharging, but promise only half-hearted remedies which are not expected to cut revenues or bring costs down, while the companies point to all the extra costs the government is making them shoulder and threaten to provide detailed bill breakdowns that show just how much all those extra green measures are contributing to prices.

The deputy prime minister's initiative is nice, but the average customer should not expect to see any significant bill reduction, and it will be swamped by all the other initiatives that will push bills higher in the next few years.

(John Kemp is a Reuters market analyst. The views expressed are his own)

(Editing by Keiron Henderson)

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