Energy Prices: Loyal customers are inactive consumers

It’s a big week for energy markets, as the Competition and Markets Authority and Ofgem prepare to announce the results of their initial assessment of state of competition and whether a full investigation is merited. Consequently, there have been news stories all week about what energy companies are and aren’t doing, and what effect this is having on consumer bills. It was also the hot topic at today’s Prime Minister’s Questions, with the Prime Minister and Ed Miliband coming to blows over how best to reduce energy costs.

There is significant merit in a detailed look at whether the structure of the energy market is indeed holding back competition and choice, especially given the lack of trust in the market: a recent study found that just one in five consumers trust energy firms. Lack of trust is likely to undermine perceived gains from switching and dampen consumer activity, causing a vicious circle of lack of competition. But we need to be careful not to construe everything that energy firms do as indicative of substantial problems in the market.

Yesterday, IPPR released figures showing that “loyal” British gas customers were being charged £89 more than those who have switched supplier. Caroline Flint, Shadow Energy Secretary, promptly commented that “In a competitive market, you would expect to see good customer service with companies hungry to win and keep customers. Instead the only reward for loyalty for British Gas customers is a bigger bill”.

But British Gas would be unusual if it wasn’t offering better deals to entice new customers. Offering more attractive deals to new customers is standard practice across a lot of markets. You may have come across them before in the guise of “half prices for six months” type offers for gym and TV subscriptions or low interest rates on savings accounts that only last for the first year. In telecoms one survey found that over half of broadband providers said they made available some offers to new consumers that were not available to existing ones.

Another term for “loyal customer” is “inactive consumer”. The differential between what new and existing customers are charged suggests British Gas is actually working quite hard to attract new consumers. That sounds like competition to me. As we argued in our briefing paper Illuminating the energy market: Encouraging greater switching, what we need to do is make it easier to compare providers, push the message that there are savings to be made from switching, and help “loyal” consumers compare what they are currently spending against what they could spend if they switched. In other words, we need to encourage more consumers to become more active more generally. This is not a problem specific to the energy market.  Trying to force energy firms to charge existing and new customers the same price risks reducing incentives to switch and dampening what competition in the market there is.

But that’s not to say that there aren’t any structural problems in the energy market. Wholesale costs are the single largest component of energy consumer bills. In the last ten years, Ofgem estimates that wholesale electricity costs have more than doubled, and wholesale gas costs have more than trebled. Even if higher levels of consumer engagement and activity create a more competitive retail market, overall bills may not reduce by very much if there are other factors that prevent competition in wholesale markets. Two potential structural problems that the CMA and Ofgem are looking at are barriers to entry of new suppliers and vertical integration between retail and generation that may make wholesale markets less competitive.

Today SSE announced a retail price freeze, and perhaps more interestingly, that it was voluntarily splitting its wholesale and retail arm – possibly a sign of what it expects to come out of the CMA and Ofgem’s conclusions. SSE is one of the larger wholesale suppliers of electricity, so a split could make a big difference, making wholesale prices more transparent. In turn, this has the potential to make it easier for new retail players to join the market and increase competition. The precedent of a split will offer regulators the opportunity to observe how much separation costs, and give them a stronger lever to push for separation amongst the other vertically integrated suppliers, if they decide this is needed to increase competition.

There is more to do to make retail markets more competitive, but with the majority of energy bills driven by the wholesale market, it is clear where the bigger gains are to be made.

Read the SMF’s energy briefing paper: Illuminating the energy market: Encouraging greater switching


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