Articles from 2012
What's wrong with UK energy prices - and how to fix them.
- Published on 19 October 2012
- Written by Nick Grealy
Before I became involved with shale gas, I worked for London Electricity (now EdF), Total Gas Marketing, an energy consultancy that although relatively kosher by standards of their competitors I won’t identify, and buying gas for the Department of Health. The latter job sounds minor in comparison to the great work the NHS do, but at over 3000 sites that’s one big gas bill falling on the doormat every month, reaching close to £300 million a year at one point.
In other words, I know what I’m talking about and the very first thing I know is the subject really bores most people. Nevertheless, it has important macro- and micro- economic consequences. This is my take on what’s wrong with the UK utility market (and peripherally the UK economy) and how to fix it. However, I believe that so many people make so much money doing the wrong thing that it’s unlikely be ever fixed.
- If Ben Franklin were alive today, he would update his famous maxim to say “There is nothing so sure as death, taxes and gas and electric bills.” First or second hand, we all pay for them, either as direct payments or through all we consume.
- A key point lost in the UK vision of a retail “energy market” is that utility bills are not optional. Just as US Supreme Court Justice Oliver Wendell Holmes said “Taxes are the price we pay for a civilized society”, utility bills are the price we pay for the basis of a modern life of heat and light. The alternative of not using electricity or gas is available to fringe moralist groups possessed of strong opinions and sturdier bank accounts, but the choice is neither realistic or attractive to most of us. We must not forget this key fact: use of gas and electricity serve a purpose analogous to further, and very regressive, taxation.
Once we understand that utility bills are taxation, we begin to understand some key failures of the UK industry:
Energy taxation is unfair in it’s present form: Would we accept a higher tax rate on the poor than the rich? That is exactly what happens when there is no default tariff. Households with time, money and web access pay lower rates than those without. Energy taxation is regressive, with a particular effects on the poor and the elderly.
Energy taxation is a key driver on the UK economy. The Big Six’s increase of £80 a year from 21 million households is the subtraction of £1.7 billion of disposable income from the UK economy.
- To create a “market” in gas and electricity for domestic users as happened in the UK creates a fundamentally dangerous delusion that we can control prices, when in fact individual consumers are powerless. Individuals cannot control utility costs any more than we can control interest rates, petrol prices or any commodity.
- The delusion of competition has created a huge industry of comparison and switching sites. It is difficult to see what useful public purpose that sector serves apart to enrich themselves via commissions and to build an industry based on annoying TV commercials. That has created a lobby, with a seeming independence from suppliers but dependent on them, for the continuance of the present system.
- It is fairly obvious that competition does not automatically provide lower prices. Petrol price choices in the same area are usually similar for example. Major supermarkets prices on key items are generally identical.
- Energy doesn’t lend itself to special offers. Users can’t stock up on specials. A buy one get one free offer per kWh would promote energy waste.
What we lack in the UK is a “default tariff,” where every one pays a standard transparently fair tariff. It would then be up to energy companies to market alternatives to the tariff.
- The original sin of UK utilities is that the metering infrastructure of the old British Gas and Electricity Boards essentially moved over intact. We have the utility market of the 2010’s lumbered with metering structures based on quarterly billing introduced in a shillings and pence era. We have regulation built on good ideas in the 1980’s - and none since.
This means consumers have outdated metering reliant on light touch regulation to mandate a meter reading once every two years, although in practice it’s done two to four times per year for residential and small business customers. Even something as simple as the rate per kWh is absurdly difficult to find within switching sites and the absence of reliable billing.
There surely is no other business where measurement and money are so divorced. One doesn’t go and buy £2 worth of bananas or a fiver’s worth of meat any more than 50 pence worth of milk. Why are we expected to do so in utilities?
A change in the metering structure would help, but the solutions exist right now. They could be available next month, despite protestations to the contrary. This isn’t rocket science. This isn’t disruptive change. Suppliers would still be profitable. The lights would stay on. The switching industry is the only one likely to be affected, and even then not fatally.
What I propose is broadly similar to tariffs used by many businesses. The essential choice for a business customer is between a fixed price and a floating price. Many business customers quite simply can’t be bothered with energy and choose a fixed price via a misperception (fostered by consultants and suppliers) that energy prices are inherently dangerous and volatile. (I’ll show that isn't the case later). Those using a fixed approach are not interested in getting the lowest cost per se, but a tariff that can cover their back in the case the decision becomes problematic. They are also busy people for whom energy costs are simply not very important one way or the other.
It’s significant that a floating price approach is used by the largest customers - those with the most to lose. Almost any major business in the UK uses this approach, where the cost of gas and electricity move in tandem with wholesale prices.
The price is 100% transparent. The National Grid costs of delivering the energy are regulated and identical to any supplier and remain broadly constant over a year. The margin or administration fee or whatever euphemism one wants to use for profit is also transparently obvious. The wholesale market price is similarly transparent.
Simply put, no one can game the prices. Significantly, there isn’t much churn in those markets, and margins, such as they are, aren’t the only factor. What switching that does occur is often a result of billing issues resolution.
US readers will be mystified by this, as the answer is happening every day in the majority of US retail domestic markets with the following result:
- Consumers pay a default tariff, based on a transparent cost of service and a floating monthly average gas and electricity price pegged to wholesale markets
- A combination of technology and sufficient workforce means the vast majority of consumers are billed on accurate monthly reads
- A full choice is given to consumers who seek options to either fix prices or have a monthly payment plan aligned with floating prices - all at completely transparent formulas.
The key difference between the default tariff and the UK system of confusion pricing is that in the US, far fewer consumers choose an alternative supplier. Even in the most vibrant US markets, over two thirds of consumers choose the default option of their host supplier. That rate is well over 95% in some. This is in a market where the switching process is far easier than in the UK, often taking less than 24 hours.
What is preventing this in the UK?
Under current light touch regulation, utility prices are entirely under the discretion of the supplier. There is no formula to inform consumers or any requirement for any of the elements of a bill be revealed. How the wholesale cost is derived is considered “commercially confidential” - or it can simply be made up. What the system does produce is insignificantly different prices depending on payment type. This leads to consumer lethargy and anger, often directed towards government.
But governments, under Ofgem in both Labour and Conservative administrations, often continue to insist that a market exists and Ofgem particularly seems to blame the victim - consumers themselves, for not buying a computer, digging up gas bills and spending hours of time (a cost rarely considered by regulators). In other words, high prices are the result not of the market but feckless consumers.
How hard could this be when two key UK energy businesses, Centrica and National Grid have millions of US domestic customers who use my proposed approach. National Grid is the electricity and gas supplier in New York City and parts of New England. They remain profitable under the US regulatory regime. Why not here?
One answer why not is the experience of Direct Energy, the US retailing brand of Centrica, owner of British Gas. They are the second largest independent supplier in the US, present in the majority of states - but they have less US customers than they do in the far smaller UK market.
The only difference Direct Energy can give their customer is either a minimal saving over current rates or a fixed price option. US consumers know that prices move up and down, mainly because one uses varying amounts of energy each month. Simply put, the UK British Gas experience of trying to convince customers that volatile energy prices are some sort of threat doesn't convince people who have been given the choice. The UK experience of energy marketing has utterly failed in the US. What Direct Energy's parent fears is that the importation of the US experience will cause them to fail.
It’s worth noting that under a default tariff, customers can still stick to plans similar to those today if they prefer their default option of bettter the devil they know. No one is going to be forced into anything undemocratic or unfair.
While Automatic Meter Reading is more widely used in the US, there are still plenty of customers who depend on monthly physical reads. But even estimated reads are remarkably accurate and the technology that uses them can easily be used in the UK (and often is currently). Suppliers could introduce this, with some work, by January.
The experiences of both UK businesses and US domestics says that actually the difference between prices from one supplier to another is inconsequential and a matter of personal choice. The choice is overwhelmingly to do nothing. Utility bills are perceived, correctly, to be as unavoidable as taxes. But the key point of taxes is that they must be fair and uniformly enforced. As UK utility bills must be.
I’ll elaborate on this another time, with actual examples of costs. It’s easy. But it won’t happen when there are many people whose jobs depend on them not understanding it.