The Findings of the OFGEM Analysis with Regards to the UK Energy Market - Coursework Example

The findings of the OFGEM report with regards to the UK energy market Introduction Energy is among the basic factors that determine economic progress of a country. Almost all sectors of the economy require energy for the productions of goods or service. Energy is generated from either renewable or non-renewable sources. Sources of energy should be conserved and maintained in order to avoid exhaustion. Sources such as coal and natural gas are nonrenewable and therefore exhaustible. Energy production and supply has been very expensive across the world in the recent past. The increase in the production and supply costs has led to the increase of the energy prices. The UK energy market has never experienced stiff competition from either new or existing energy supplying firms. A critical analysis of the current level of competition in energy supply proves that it is harmful to the consumers. In essence, the current competition in the energy sector has increased the energy prices and led to additional expenses to consumers. The competition among the six major energy firms in the UK is unhealthy as far as consumer welfare is concerned. Competition in the UK energy market need to be increased in order to improve service delivery and reduce the energy prices. Rise in the level of competition in the energy industry would be of great importance to the consumers. Analysis of the UK Energy sector Allen, Hammond, & McManus, (2008) states that the UK energy sector has experienced several changes in the past few years. The prices for electricity and gas have been on rise, with that of gas rising at a higher rate. A research conduct from 2011 to 2013 on domestic energy prices showed that the price levels have been on an increase with no signs of decrease. The energy expense has risen by over 4% in the past ten years. Consumers have to keep on adjusting their budgets to meet the ever increasing energy expense. As a result, some customers keep on switching from supplier to supplier for better deals. However, the rate at which consumers switch from one supplier to the other is very minute and, therefore has little influence on the annual energy consumption expense (Johansson et al., 2012) The UK government has established mechanisms to move to cleaner sources of energy. Use of energy sources such as gas, coal and nuclear power produce greenhouse gases that are destructive to the ozone layer. Research has shown that the increased production of greenhouse gases has contributed to climate change. For instance, over the past ten years, climate patterns have changed and become a little bit unpredictable. In order to control discharge of harmful gases, the government has introduce emission tax to limit the use of harmful energy technologies. For this reason, the energy prices have continued rising since firms transfer the additional expenses to the consumers through increased prices. The number of firms supplying the market are limited and new firms face severe challenges to enter the market. An analysis of statistics collected from 2005 and 2013 depicts that entry of new firms in the market has been very challenging. In essences, the rate at which new firms exit the market is higher than the rate of entry to the market. The year 2006 recorded the highest number of firms exiting the market. Since then, the entry of new firms in the market has been on an increasing diminishing trend. The UK energy sector is dominated by six major firms, which command about 95% of the market. Market structure The energy market in the UK can be described as an oligopoly market structure. There are few firms serving a large numbers of customers/buyers. The firms set the market prices and the consumer has no or little influence on price determination. Firms in oligopoly market can be described as profit maximizers (Sloman & Garratt, 2013). Since the number of firms in the market is limited, the existing firms determine the price to charge on the product. The consumer has little about the costs involved in the production and supply of energy. In this regard, consumers have to accept the market prices set by the sellers. Competition in an oligopoly market structure is not violent and therefore decision by one firms has little impact on the entire market. For instance, if one firm among the big six firms in the UK decided to lower energy prices, the other firms will not follow that decision. Lowering or increasing the price of a product in an oligopoly market structure has insignificant impact on the profit margin. Below is a diagram to illustrating the market structure of energy in the UK:- Source: http://www.economicshelp.org/microessays/markets/oligopoly-diagram/ When the prices change from P to P1, the quantity demanded changes from Q to Q1. It can be identified that change in price has little influence on the number of quantities demanded. OFGEM report findings OFGEM identified that the current energy market has less to offer as far as consumer satisfaction is concerned (OFGEM, 2014). Customers have lost trust with the existing energy supplying firms over the past few years. The energy prices are unpredictable overtime and therefore, consumers cannot be able to plan their budgets appropriately. Actually, the rise in energy prices has led to the increased cost of living. The suppliers set the energy prices at levels that are not favourable for middle and lower income consumers. Most consumers rarely participate in the market and therefore their opinions are not considered when setting the market prices. The current energy market does not give space for new firms to venture in the energy supply. In fact, the current market structure has lowered the level of competition and the quality of services offered to the customers. OFGEM further established that the current level of competition in the energy market is not healthy for consumers. Energy supplying firms concentrate on profit maximization only. Proposed reforms Entry of new firms in the market to be encouraged. The energy markets require more competition than it is presently in order to serve the consumers’ interest. The government and other interested parties should provide funds to potential energy suppliers and generators so that they can penetrate the wholesale Market. Shortage of funds is among the core reasons why many potential firms cannot enter the market. Banks and other financial institution should provide favourable leading terms to borrowers in order to boost investment in the energy sector. Use of clean sources of energy. The challenge of climate change has been of global concern in the recent past (Murray, 2009). Firms in the energy sector should switch to sources that do not produce too much greenhouse gases. Firms should use the modern technology to devise clean source of energy that are healthy to the consumer. Introduction of new mechanisms of managing energy prices. OFGEM identified that the sky rocketing of energy prices should be controlled in order to promote consumer welfare. The frequent changes in energy prices adversely affect the consumers financial planning. Prices should be made stable to facilitate effective budgeting and financial planning. Stability in prices can only be achieved by having many firms in the market. In essence, an increase in supply results in reduced prices, thereby making the product affordable to many customers. Enhance consumer involvement in the energy market. Consumers should be active in all matters regarding energy supply. The government should introduce reforms in the energy sector to give consumers a chance to present the views on energy pricing. Social welfare organizations should be formed and given maximum support by the government to fight for consumer rights on matters of energy pricing. Conclusion The energy market in the UK has experienced eminent changes over the last few years. Use of technology and advanced human resource skills has seen the energy sector develop at a high rate. The cost of producing and supplying energy has been on an increasing trend. Unfortunately, the increase in cost of production is usually transferred to customers through increased energy prices. The number of firms in the energy market in the UK is very small compared to the number of consumers served. The six giant energy firms command about 95% of the total market. A critical analysis of the energy sector in the UK portrays that lack of competition in the market has led to poor treatment of consumers by the existing firms. The firms concentrate on maximizing profits at the expense of consumers’ wellbeing. Apparently, there has been controversial arguments regarding the effectiveness of the six major energy firms in the supply of energy across the UK. OFGEM carried out research and identified several issues that should be addressed in order to develop the energy sector. OFGEM identified issues such as competition, consumer engagement in the market, liquidity concerns and control of greenhouse gases emission to be of great importance in developing the energy sector. In summary, more competition should be enhanced in the energy sector in order to improve the value of services offered to the customers and reduce the energy prices. Energy is a crucial requirement for human existence and survival. Reference list: Allen, S., Hammond, G., & McManus, M. (2008). Prospects for and barriers to domestic micro-generation: A United Kingdom Perspective. Applied Energy. Johansson, T. B., et al. (2012). Global Energy Assessment (GEA). Cambridge: Cambridge University Press. Murray, B. (2009). Power markets and economics: Energy costs, trading, emissions. Chichester, West Sussex, UK: John Wiley & Sons. OFGEM (2014). Consultation on a proposal to make a market investigation reference in respect of the supply and acquisition of energy in Britain. Retrieved from: https://www.ofgem.gov.uk/ofgem-publications/86807/consultationpublish.pdf Sloman, J., & Garratt, D. (2013). Essentials of economics. New York: Prentice Hall/ Pearson. Read More