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    • The political football of energy markets, prices and deregulation. Blog: Richard Murphy
    • 18 June 2019
    • What’s changed since deregulation of the UK energy markets?

      Energy markets and prices in the UK have long been a “political football”, so perhaps it was no surprise when re-nationalisation of distribution and transmission networks became a focus for Labour policy a few weeks ago. This followed the eventual introduction of the price cap for domestic customers on standard variable tariffs, these being the energy consumers who seldom, if ever, voted with their feet in the market for competitive energy supplies which have been around for 30 years or more.

      So, what has happened in the energy markets since they were committed to the world of competition all those years ago? For those of us with long enough memories, the idea was to take the elements of the energy supply chain, generation for electricity, exploration and production for natural gas, then transmission, distribution and finally supply to all including the 18 million or so households in the UK, break them up and introduce (or force) competition. We were all asked to “Tell Sid” to buy shares in the former nationalised industries which made up the energy sector, with gas the first to go in 1986. So, when the businesses were “floated”, the small investor took their profits from the initial share-price rises and left it to the institutional investors to reap the dividends year-after-year from “the family silver”.

      The principle was that different businesses competing in each part of the chain would make the market better than the prior state owned inefficient and costly monopolies. Names like National Power and Powergen emerged in the generation market, along with British Gas (a traditional gas supplier). In distribution, the Americans and Germans came and, in most cases, went as the attraction of regulated industry operators in the UK represented a safe bet. The aim was, at this stage, to allow competition to drive down prices while making use of economies of scale for large businesses to run either part of the networks or, in some cases, multiple parts.

      Alongside the early steps in market de-regulation, we also saw the emergence of a wholesale market for electricity and gas. There had been a degree of seasonal-time-of-day (STOD) pricing before which was intended to make it more expensive to consume electricity during peak hours, but no market for the new providers to source their forward electricity and gas requirements to underpin their portfolio of new supplies, whether on domestic tariffs or commercial fixed term contracts. So British Gas was forced to “release” its long term contracted gas to other providers and industrial and commercial electricity customers had the choice of 13 rather than 1 electricity supplier. These contracts were then priced against an emerging wholesale market. As with most traded markets, this opened up the new commodity market to players with only a tentative interest in making or using electricity and gas; as banks and trading houses began to play in these thinly traded markets.

      Throughout this process, there has been constant regulatory tinkering in order to solve the challenging “energy trilemma” – securing affordable prices, secure supplies and sustainability through renewable energy. But the regulators have almost been setting and then implementing policy on the basis of “nothing more predictable than prices that continue to rise” and while in real terms they have, have they risen by as much as the policymakers might have expected?

      A Citizens Advice report suggested that domestic consumers alone have been over-charged by £11 billion over 15 years as a result of OFGEM setting incorrect levels on price controls for the operation of energy networks. Maybe Mr Corbyn has something right on this basis?

      Based on the average electricity and gas bill for a domestic user, the graph below shows a positive impact on domestic costs in the early stages of the competition. However, since 2004 the rise has been steady, pausing in 2012 ahead of the introduction of market reform designed to support the growth in renewables, since which time electricity has started to rise at a higher rate than gas, a first since 2002.

      Is nationalisation really the answer after so many years of market forces setting with the commodity or energy price component of bills?  Natural monopolies do appear to operate better under state, or central control and electricity transmission is an example of this. With transmission costs making up only 5% of the typical domestic electricity bill and 3% of a gas bill, there is much less to be gained from driving these small costs down further, particularly when re-nationalising the businesses involved in these services will cost many millions of £.

      There could be a positive impact based on the belief that energy markets would benefit from different and key parts being under separate ownership. Ironic then that it was under a previous Labour administration that we saw the emergence of vertically integrated businesses operating in generation, distribution and supply in both domestic and non-domestic markets. The current levy control mechanisms designed to attract new renewable generation, guarantee to keep the lights on when intermittent renewables cannot and a mechanism to improve the energy efficiency of UK housing were also designed by the energy minister under the last Labour government, one Ed Milliband, and implemented under the coalition government under David Cameron and Nick Clegg.

      And it is this mechanism which has added new cost layers to the existing regulated and commodity structure to the extent that the parts of the bill that used to dominate the cost stack make up less than 40% while supplier profit margins have grown to just 4% in recent years. Against this background, it will be interesting to see the next developments in the UK market in a post Brexit era. Whether re-nationalisation of any part of the market which has taken over 30 years to develop into the current model is the answer, I suspect we will never know.