1.0. Introduction
Current data released by OFGEM (Office of Gas and Electricity Market) shows that the prices of energy (both gas and electricity) are at persistent increase in the wake increasing market concentration in the industry (OFGEM, 2014). In such situation, the government has to intervene either through Demand Side or Supply Side Management to balance the situation. This paper sets out to analyse the current trends in the energy sector of the UK from every critical angle. It also aims to connect them to the economic concepts to come up with the most appropriate solution in the end.
2.0. Analysis of UK Energy Sector
UK energy sector is exposed to certain issues besides having some opportunities of growth (Allen, Hammond, and McManus, 2008). Many micro and macroeconomic changes are at the bottom of developing current scenario. It is found that the prices of electricity and gas have been on increase over the past decade (Hannon, Foxon, and Gale, 2013). It is also illustrated through the diagram given below:
(OFGEM, 2014)
It can clearly be seen that the increase in the prices of both gas and electricity is parallel though the level of electricity price has been lower as compared to that of gas.
Furthermore, the spending of the UK consumers on energy is also rising gradually but persistently, and the poor community is more affected by it. It implies that they are consuming less than they are spending, which is a serious concern on their part. A clearer idea of it can be derived from the figure shown below:
(OFGEM, 2014)
This situation is one of the major headaches for the government that is striving to formulate appropriate strategy to tackle the issue (Winning, 2013). There are multiple reasons at the very base of this worrisome situation such as increasing oil prices, green levies and other high taxes, and failure to be energy efficient (Renssen, 2014).
However, the biggest of all these threats is the increasing power of suppliers in the region (detailed in the following section of discussion). There are six big names collectively termed as “big six” in the UK energy sector having great (though not complete) hold on the whole market. These include British Gas, EDF Energy, E. On UK, RWE Power, SWE, and Scottish Power (IBP, 2015; Great Britain, 2012). It is found that these six companies are enjoying the 95% share in the market (explained in the later part). It means that consumers have very limited options with regard to switching. It provides big six with a solid ground to determine the prices at the most profitable level from the business prospective but regardless of the consumers’ benefit.
Apart from this, while the profit of the large energy companies was divided with respect to generation and supply, it is found that their dependence on supply is increasing with respect to profit generation. It means that major burden of increase in prices is being shifted to consumers as also shown in the figure below:
(OFGEM, 2104)
Furthermore, development on industry and household level has increased the demand for energy that is reflected through the persistently increasing spending of households and businesses on gas and electricity (Warren, 2014; OFGEM, 2014). According to the recent findings, poorest fifth of households were spending 11% (3% up from the level in 2002) and richest fifth of household 3% (2% up from the level in 2002) of their total disposable income on energy. On the whole 43% increase is seen in the household expenditures on difference energy sources from 2002 till 2013. It is also depicted in the diagram as under:
(OFGEM, 2014)
It shows that lower and middle class is more affected from the rising prices as compared to upper one. Need of the hour is to address the issue in order to provide significant relief to the energy consumers in the region.
3.0. Application of Economic Theories
Before pointing out the link between current situation and relevant economic concept, it is wise to have a brief introduction of some key theories relating to the competition in the market basing on the insight derived from the studies of Sloman, and Garrett (2013) and Samuelson, and Nordhaus (1985). This brief overview is given in the table below:
Characteristics of the UK energy market show that it is faced by the situation of oligopoly where six big firms (as discussed above) are enjoying the high level of concentration. And this concentration is gradually increasing (as shown in the figure below) in the wake of high level of entry barriers.
(OFFGEM, 2014)
In other words, these so called big six are price makers due to low power of buyers and high switching cost. Therefore, the government has to improve the competitive scenario in the energy sector to pass the benefits of its energy-efficiency policies to the customers.
4.0. A Critical Overview of the Proposals by OFGEM
OFGEM has responded to the situation (explained above) by proposing some practical initiatives (Lorence et al, 2013). The researcher identifies four of its proposed ideas in the best interest of consumers. These four proposals as derived from the studies of Littlechild (2014), and OFGEM (2014) are as follows:
4.1. Advance Posting of Prices
Through new regulation, the giant industry players will be forced to post their intended levels of prices on trading platforms two years before they implement the same. It will prevent any sharp spike in the prices in given timeframe, which will benefit the consumers in the end. It will also allow the concerned department to take any appropriate action if the big six are found guilty of any violation in this regard.
4.2. Competition Investigation
OFGEM offers competition investigation. It is a good initiative because only through proper scanning of the market condition will give the clear idea regarding the natural or unnatural barriers to new entries and the ways to remove them in order to break the oligopoly of highly concentrated firms.
4.3. Fair Trade
Another practical proposal targets the two big generators in the UK energy sector. The OFGEM finds that suppliers are unable to come up with customer-oriented pricing due to unfair use of power by generators. New regulations will force these generators to provide energy to much smaller suppliers on fair rates which will be booster to the competition on the whole.
4.4. Listed Prices
All the suppliers including big sixes will be given prices determined to strike the balance between suppliers’, generators’, and consumers’ interest. This effort is also a positive indication for suppliers on smaller level that will be able to compete with the big industry players in more efficient way than ever before. It will allow the consumers for low switching cost and will help the industry to transit to the monopolistic competition from the current state of oligopoly.
5.0. Conclusion
Main Issue with the UK energy sector is imperfect competition to unfair extent. Six big companies are enjoying the status of oligopoly without taking the consumers’ concerns into account. The proposed policy of OFGEM is an appropriate response to the emerging scenario in the UK energy sector. The department aims to bring the competitive strength of big six lower by encouraging the existing small suppliers to increase their market share. It also brings down the barriers to new entrants, which is a positive sign for energy consumers. This paper analyse the current trends in the energy sector of the UK from every critical angle. It also aims to connect them to the economic concepts to come up with the most appropriate solution in the end.
List of References
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