Competition between the Big Six UK Energy Firms - Assignment Example

family and first ID: of Foundation group: The essay The Discuss the findings of the OFGEMreport with regards to the UK energy market; and discuss if more competition between the big six UK energy firms may benefit UK consumers. Contents Introduction 3 Analysis of the UK Energy Sector 3 Application of Economic Theory 6 Answer a: Market Structure of the United Kingdom energy sector 6 Answer b: Four proposed reforms of OFGEM 8 Conclusion 9 References 11 Appendices 12 Appendix 1: Domestic Energy Prices 2011-2013 12 Appendix 2: % Household Disposable Income spent on Energy: 2002 – 2012 12 Appendix 3: Profits of the large energy companies split by generation and supply 13 Appendix 4: % Market Share by UK Energy Firm – December 2014 – Current Data 14 Appendix 5: % Increase in the Average UK Household Spending on Energy (2002- 2012) 14 Introduction The main objective of the Office of Gas and Electricity Markets (OFGEM) in the United Kingdom is to protect and monitor the interests of the electricity and gas consumers in the existing and future market of the United Kingdom energy sector. As per the report published by the organization in 2014, the effectiveness of the energy sector in the United Kingdom and the level of competition in this market are found to be inefficient and may lead to the creation of more difficulties and constraints for the consumer groups in this sector. Therefore, the OFGEM has proposed a number of reforms that should be employed in order to make the market more transparent, functional, and effective and consumer oriented in nature. The main objective for this essay is to study the report prepared and published by the OFGEM about the United Kingdom energy sector and analyze the proposals and reforms suggested by the same. This would be done by evaluating the economic aspects of this sector like the market structure, the price and demand elasticity, the present condition of the sector, the entry barriers and common strategies, the areas of the sector that need immediate interference and change and the propose reforms as suggested by the OFGEM. Analysis of the UK Energy Sector The UK energy sector is an intensely concentrated market in which the Big Six energy suppliers control the way the market functions. Also, the pricing strategies of one of these companies tend to affect that of the other companies in a direct and significant manner. The consumer groups for this market have been identified to have low involvement and low level of trust since the influence of the customers have become restrained due to the less number of options available to them. The low degree of consumer engagement has stemmed from a number of factors like the intrinsic nature of the energy products, the long periods required for switching suppliers, the excessive influence of the energy suppliers on the market and the lack of proper government interference and regulations for monitoring and supporting the interests of the consumer groups. These factors are identified to be hazardous for the future sustainability and health of the market structure because a significant lack of competition among the enmities in the market, a lack of interest and engagement of the consumers and excessive control of a handful of energy suppliers are noted in this sector. Other data given in Appendices 1-5 are suggestive of the above identified factors and features of this sector. Figure 1: The oligopolistic nature of the United Kingdom energy market (Source: Aune, Golombek, Kittelsen and Rosendahl, 2008). The Herfindahl-Hirschman Index (H-H) index can be used to measure the level of concentration within a sector. If the H-H index for a market is more than 1000, then the market is said to be highly concentrated in nature. The H-H index for the United Kingdom energy sector for the years 2005-2013 is given below which indicates that the index has remained more than 1000 and has been increasing. This market is found to be controlled by the six dominating firms and as such, is an oligopolistic market in nature. Figure 2: The United Kingdom Energy Firm Market concentration (2011-2013) (Source: Hannon and Bolton, 2014). The energy sector in the country, as per the OFGEM report is experiencing non sustainability conditions in the present scenario. The expansions in the market are limited by the high concentration levels. Also, the high degree of tacit coordination and vertical integration between the Big Six energy suppliers in the areas of production and supply of energy to the end consumers is a major reason that has instigated the unsustainable conditions and the unhealthy competition level in this market. Application of Economic Theory Answer a: Market Structure of the United Kingdom energy sector The market structure of the United Kingdom energy sector is a kinked oligopolistic structure. An oligopolistic market according to the principles of economics is a market structure in which the armlet is dominated by a few companies. Though the dominating firms have the major control and market share yet there are other smaller firms operating in the same market in an oligopolistic markets structure. The energy sector of the United Kingdom is currently being dominated by six main firms which are known as the Big Six and include the following companies- EDF Energy, Scottish Power, SSE, Centrica, Eon and RWE Npower (Allen, Hammond and McManus, 2008). These energy suppliers are the most powerful entities in this sector and together account for approximately 95% if the total energy supplies market in the country. In a kinked demand curve under the oligopolistic market structure, the market faces a downward moving demand curve. However, the elasticity of the market depends on the actions and reactions of the rival firms that may lead to changes in price and production outputs. Figure 3: Kinked demand levels in an oligopolistic market (Source: Sloman and Garratt, 2013) Since, the United Kingdom energy sector is following a kinked demand curve, it can be inferred that The rival companies will not follow the increase in prices influence by one company and as such, the level of demand will be relatively elastic in nature and an increase in price would result in a decrease in the total revenues of a company. The rival companies in this sector are more likely to adjust their prices to the price falls influenced by one company so as to avoid the loss in market shares. In these cases, the demand levels would become more inelastic in nature and a decrease in the price of products would lead to a direct decrease in the revenue of the companies (Warren, 2014). Figure 4: Kinked demand in the UK energy market explained (Source: Sloman and Garratt, 2013) Answer b: Four proposed reforms of OFGEM The OFGEM identifies that the major energy companies operating in this sector have coordinated in a tacit manner to exercise their control on the timing of price increases as well s the pricing decisions (OFGEM, 2014). In order to improve the competition level in the market and make it a healthy sector, the OFGEM has suggested the following four reforms. 1. OFGEM has proposed that a proper market investigation should be carried out with reference to the CMA. The main objective of this investigation would be to identify whether there are clear characteristics in this sector that have restraining effects on the desirable market competition level and whether other reforms that are beyond the control of the OFGEM can be established to improve the state of the market. 2. The reforms introduced by the OFGEM are aimed at making the energy sector more transparent and simple in terms of functionality and control. The new rules and liquidity reforms under the Retail Market Review (RMR) are suggested that would support the new wholesale energy suppliers to easily enter into the market and compete effectively with the Big Six by gaining more control on the generation of energy and supply to the end consumers. This would also make the market functionalities fairer towards the consumers. 3. OFGEM aims to develop measures that would address the issues identified in this sector. The organization has suggested the establishment of measures to enhance customer satisfaction and involvement and to reduce customer vulnerabilities by imposing restrictions on the vertical integrations and monitoring the pricing decisions of the Big Six energy suppliers. Apart from these, the reforms would also employ stricter rules regarding the conduct of marketing and sales by the energy suppliers. 4. The reforms to control the unjustified differentials in price like control on the influence of the big companies on the generation of energy are suggested. OFGEM has proposed that limits should be placed on the volume of the energy generated and supplied by the companies and also the price differentials should need an authorization from the regulatory authorities. Conclusion Thus, it can be concluded from the findings that the current state of the energy sector of the United Kingdom is quite unhealthy and uncertain in terms of efficiency, competitiveness and sustainability. Factors like the kinked oligopolistic market structure of the sector coupled with other factors like the excessive concentration level, the control of the energy suppliers on the price decisions, the lack of trust on the part of the consumer groups, an unhealthy level of competition, the increasing barriers to entry for other suppliers due to the high level of tacit coordination between the Big Six energy suppliers , have led to the creation of a number of possibilities for fallouts in the future eyras of the sector. As such, the reforms and changes suggested by the OFGEM should be employed in the sector to control the increasing dominance of the Big Six companies and help the market to recover from the kinked demand levels that it is currently facing. The implementation of proper reforms and regulations is likely to improve the conditions of the market by boosting a healthy level of competition, interest and involvement of the consumers and lowering of the entry barriers so that new suppliers can enter into the market and control the oligopolistic market structure and pricing of products and services in this sector. References Allen, S., Hammond, G. & McManus, I. 2008. Prospects for and barriers to domestic micro-generation: A United Kingdom Perspective. Applied Energy, Vol. 85(1), pp. 528-544. Aune, F. R., Golombek, R. Kittelsen, A. C. & Rosendahl, K. E. 2008. Liberalizing European energy markets: an economic analysis. Cheltenham: Edward Elgar. Hannon, M. J. & Bolton, R. 2014. UK Local Authority engagement with the Energy Service Company (ESCO) model: Key characteristics, benefits, limitations and considerations. Amsterdam: Elsevier. OFGEM. 2014. Consultation on a proposal to make a market investigation reference in respect of the supply and acquisition of energy in Britain. [Pdf]. Available at https://www.ofgem.gov.uk/ofgem-publications/86807/consultationpublish.pdf. [Accessed on 15 January 2015]. Sloman, J. & Garratt, D. 2013. Essentials of Economics, 6th edition. London: Pearson. Warren, P. 2014. A Review of Demand-Side Management Policy in the UK. Renewable and Sustainable Energy Reviews, Vol. 29(1), pp. 941– 951. Appendices Appendix 1: Domestic Energy Prices 2011-2013 As per Appendix 1, the domestic energy prices in the United Kingdom from 2011-2013 have been increasing at a steady rate. This is supportive of the view presented in the report that the energy supply sector of the country should be adequately monitored and controlled. Appendix 2: % Household Disposable Income spent on Energy: 2002 – 2012 As per Appendix 2, the household disposable income spent by the people residing in the United Kingdom on energy sources has also been increasing at a steady rate from 2002-2012. The percentage has significantly increased from 8% in 2002 to 11% in 2012. As per the OFGEM report, this increase in spending is necessary to be controlled so that the interests and concerns of the consumers in the energy sector of the country can be addressed. Appendix 3: Profits of the large energy companies split by generation and supply The profits of the main energy supply companies in the UK from electricity, gas and other fuels generation and supply are given in Appendix 3. This pie chart indicates that the dominating energy suppliers in the country gain major profits from various energy sources which accounts for 92% of the profits. The electricity supply accounts for 43% of the profits and the gas supply accounts for 56% of the profits of these companies. Appendix 4: % Market Share by UK Energy Firm – December 2014 – Current Data Appendix 4 shows that the major shares of the energy sector in the UK is held by the British Gas company followed by EDF energy, which account for 30% and 11% of the market share, respectively. The other independent energy companies take up the remaining parts of the market share in varied proportions. Appendix 5: % Increase in the Average UK Household Spending on Energy (2002- 2012)   £ per month       Year Electricity Gas Other fuels1       2002 35 37 68       2003 35 37 65       2004 36 38 78       2005 38 41 91       2006 43 47 104       2007 47 50 101       2008 48 51 140       2009 54 60 107     2010 50 58 126       2011 50 55 139       2012 51 57 131         The increases in the average spending on energy by the households in the UK are given in monetary values for the period 2002-2012 in Appendix 5. This table shows how the spending of the households on three energy supplies which are electricity, gas and other energy sources have increased multiple times over the 10 years of computation. This Appendix is supportive of the data presented in Appendix 2. Read More