The energy policy paradox: cheap tariffs for the savvy mean higher bills for most
AT A time when energy bills are soaring, many families will be angry that British Gas reported profits last week of over £500m. It follows the news ten days ago that EDF’s profits rose to almost £1.6bn and announcements from the other “Big Six” energy firms are due in the coming weeks. But politicians and policy makers need to be careful not to jump to conclusions in their attempt to meet public concern with government action.
It is understandable that energy prices have become a political hot potato. Combined gas and electricity prices have risen by 75 per cent since 2004 while the number of deaths from hypothermia has doubled over a similar period. But although right wing think tanks are wrong to blame the price spike on the cost of renewables (which have contributed just 7 per cent to the increase), the left are misplaced in blaming profiteering.
Compass, the pressure group, and the Independent have recently launched a campaign calling for a 1997-style windfall tax, with price caps to stop the cost being passed onto customers. But it is not clear what, if anything, a one-off regulatory intervention like this would do to bring down costs and prices in the energy market. The opaque nature of energy company accounts means that it is hard to apportion the true nature of profits derived from their separate wholesale, retail and energy efficiency service businesses. But these profits do not appear to be consistent with “profiteering”.
The main source of high energy bills has been the soaring costs of transporting gas and electricity from power stations to peoples’ homes, which has driven four-fifths of the price rise. This does not mean that the Big Six are lean, efficient companies. Cost reductions should certainly be sought. But instead of slapping distortionary taxes on the sector, which will reduce incentives for investment and discourage new market entrants, policies are needed to increase competition. Chief among these measures is tighter control of the energy companies’ complicated tariff structures, which end up blocking new entrants.
It works like this. The government believes that encouraging people to switch energy provider will increase competition, yet only 40 per cent of customers have ever done so. The big incumbents are able to offer attractive initial offers to the young and upwardly mobile customers who have the time and savvy to find a better deal. But these tariffs, often set below cost price, are offset against higher tariffs for their existing customer base. New research by the Institute for Public Policy Research (IPPR) has found that some households are paying up to £330 a year more than their neighbours for the same amount of electricity.
The IPPR examined different tariffs offered by British Gas, EDF, E.ON, Npower, Scottish Power and SSE in a range of cities. Scottish Power was the worst offender, with a differential between its standard and cheapest tariff of over £330. The difference was greatest in Sheffield, at £339, and second greatest in London, at £333. Npower offered the second largest differential, of up to £315. British Gas, SSE and EDF all offered much smaller differentials, of up to £126, £100 and £86 respectively. While some suppliers have taken action to improve their pricing, none of these price differences can be justified on the basis of different payment methods alone.
This practice is unfair in two ways. Firstly, it means that as many as 5m customers, many of whom are elderly or on low incomes, are being overcharged. Secondly, these loss-leading tariffs are acting as a barrier to entry for new firms. Without an existing group of “sticky customers”, they are unable to subsidise switchers by offering the same attractive looking tariffs.
The IPPR is pressing Ofgem, the energy regulator, to act with much greater urgency. It first identified the problem in 2007 but has effectively sat on its hands for half a decade. By licensing introductory discount tariffs, Ofgem would ensure that prices were cost-reflective, while more effective enforcement of existing powers to fine suppliers would punish those that are currently in breach.
In a perfect world, all customers would shop around for the best deal and new entrants to the market would be able to compete by offering simpler and more innovative processes for heating people’s homes and keeping the lights on. In the real world, however, most people do not have the time, inclination or know-how to switch. The advantage gained by the big energy firms from this situation has created a pseudo-cartel. Greater competition in the market, somewhat paradoxically by controlling tariffs, is the only way ahead.
Will Straw is associate director for globalisation and climate change at the Institute for Public Policy Research.