11 Oct 2013

(by Andreas Stephan) We are once again seeing the familiar picture of one energy company announcing a significant price increase, no doubt soon to be followed by other major players in the industry. SSE is to , a figure that is three times the and comes at a time when UK households are continuing to endure declining income in real terms. My colleagues, and have recently written on this blog about proposals by the Labour party to cap prices and abolish the regulator. However, there is also a possibility that statements made by politicians, intended to reduce prices, may actually be having the opposite effect.

Energy prices have become one of the most contentious issues in British politics. The increasing proportion of household incomes spent on energy and the need to protect vulnerable consumers, existed well before the financial crisis and has only been heightened by it. The energy companies argue they are making profits and that price hikes are being driven by three things: (1) increasing wholesale prices; (2) the need to invest in infrastructure to ‘stop the lights going out’; (3) government requirements for cutting energy waste, green energy and the protection of vulnerable consumers. The confidence with which energy companies announce such significant price rises is thought to reflect a lack of competitiveness in the market.

Ironically, statements made by the Prime Minister and the Leader of the Opposition may actually be driving prices up further. David Cameron announced that energy companies would be forced to put their customers on the cheapest tariff and Ed Miliband suggested introducing price caps.

The problem with political statements about future policy intentions is that they give the industry in question time to act strategically. Cameron’s lowest tariff policy incentivises firms to offer less competitive energy tariffs to reduce any potential loss from switching all customers to the cheapest. Miliband’s price cap promise incentivises firms to increase prices by as much as possible before the next General Election. This protects future profits, as any price cap is unlikely to force prices to go down, but simply prevent them from increasing further.

Voters want to see an end to energy price hikes, but this may not be possible (regardless of energy industry profits) if we want greener energy and sufficient infrastructure to meet our future energy needs. Moreover, the UK does not have any control over wholesale energy prices.

So what should politicians / OFGEM be doing?

The key to greater competitiveness in the energy market may lie with consumers. British households are rightly very concerned about rising energy prices, but they show a remarkable reluctance to search for a better deal and switch providers. Energy switching by consumers is actually in decline and currently stands at . The vast majority of households do not even ask their current energy supplier if they are on the best tariff. The potential savings are enormous. Indeed, there are deals available now that allow you to freeze your energy tariff at current levels until March 2017.

With such a low propensity to switch, it is unsurprising that the dominant strategy for the big six energy companies is to stay in line and react to each other’s price increases accordingly. The size of the market up for grabs through the aggressive targeting of new customers is simply too small. More could be done to make comparing energy prices and switching easier. However, the biggest barriers are the perception that switching is difficult and the lack of consumer enthusiasm for energy price comparison (as compared to mobile phones or even car insurance).

So rather than announcing future interventions in the energy market, which could prove damaging in the long run and may actually raise prices further in the immediate future, it is more sensible for politicians to focus on facilitating greater competitive pressures. Switching needs to be made easier and consumers need to understand that they hold the key to a more competitive energy market. They should also focus on encouraging energy firms to target each other’s customers more aggressively and incentivise the introduction of more efficient electrical and gas products.