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Without reform to the energy market consumers could miss out on as much as £1.9bn in 2020 in cheaper energy bills, according to a new report published by the think tank IPPR yesterday. The report argues that tougher regulation of the energy market is needed by regulator Ofgem to improve competition and to ensure that pricing is fairer for consumers.

It argues that Ofgem’s own evidence gives no indication that the ‘Big Six’ energy companies have achieved efficiency savings and passed these savings onto consumers through lower bills, as would be expected in a competitive market.

IPPR analysis shows that if annual efficiency savings of just 2.5 per cent were achieved in the UK’s energy market this could deliver £1.9bn in savings for consumers in 2020. As well as easing the squeeze on living standards, this would more than offset the cost of green policies for affected consumers.

The report, which estimates the true costs to energy companies of supplying households with gas and electricity, also finds that:

• Costs to suppliers of delivering environmental and social obligations may be £9 per customer per year less than Ofgem estimates
• Most of the Big Six energy companies are continuing to overcharge their existing customers to subsidise cheap offers
• As a result some families are paying as much as £330 more than their neighbours to use the same amount of energy from the same company

Over 5 million people could be overcharged because tariffs are not cost reflective as required by Ofgem. So-called loss leading tariffs from the Big Six also prevent competition as smaller suppliers cannot compete.

Will Straw, IPPR Associate Director, said:

“Our research adds to the growing body of evidence that competition is not working in the energy market. We are calling on the Big Six and Ofgem to demonstrate whether efficiency savings are being achieved in the energy market and whether consumers are benefitting from lower bills as a result, as we would expect if competition was working.

“We need more competition among energy companies so that households get a fairer price for their energy. Ofgem’s previous attempts to reform the market have not delivered the changes needed. UK consumers cannot afford further delays in bringing down bills.

“Some of the Big Six are failing to offer consumers tariffs that properly reflect the true cost of energy. Some households are paying £330 more than their neighbours while millions are being overcharged. What’s worse is that poorer and older households are the most at risk of being overcharged. Ofgem must crack down on firms found to be breaching their rules on cost reflectivity.

“Energy prices are a huge burden on UK consumers. Ofgem must act faster, bare its teeth and enforce its policies”.

Ofgem has proposed new reforms for the market, including important proposals to increase liquidity in the wholesale market to lower the barriers to competition, but it needs to go further to tackle loss leading and improve competition. It first identified problems with competition as far back as 2008 but its last package of reforms failed to improve conditions. Across 16 indicators 12 showed no improvement or deteriorated, three slightly improved and only one improved.

IPPR is calling on Ofgem to raise the bar with its current set of reforms which should be seen as the last chance for the current market structure. IPPR recommends that:

• Ofgem addresses the problem of overcharging and loss leading by enforcing its own policy that energy companies must offer tariffs that are reflective of their costs. Ofgem should reconsider its proposals for tariff reform and consider restricting suppliers to offering a fixed number of tariffs 
• Ofgem should consider fully the needs of independent generators in its proposals to improve wholesale market liquidity and consult on the full range of reform options for the market, including a return to a pool

Notes to Editors

IPPR’s new report - True Cost of Energy – is available in advance from the IPPR press office and will be available to download from: http://bit.ly/IPPR9040

It investigates the costs to energy companies of supplying electricity and gas for the financial year 2011/12. Key findings include:

Improving competition: IPPR model a number of scenarios to see how different levels of competition in the supply market could affect energy bills in 2020. Under a mid-range scenario, a reasonable approximation of a healthy competitive market, suppliers would achieve annual efficiency savings of 2.5 per cent with profit margins at 4 per cent. Under this scenario £70 is saved from the average annual bill. Across all consumers this would create a saving of around £1.9 billion. This level of savings in 2020 would cover the costs to consumers of the electricity market reform, the carbon price floor, the feed-in tariff (FIT), the warm home discount and most of the renewables obligation combined. (See executive summary for full details)

Operational costs: in a competitive market, operational costs should converge over time. However evidence shows that the difference between energy suppliers spending on operational costs was in fact greater in 2010 than in 2007. In 2007, Ofgem found that the least efficient supplier was spending 90 per cent more on each customer account than the supplier with the lowest costs (Ofgem 2008 Supply Probe). IPPR estimated figures for 2010 and found that the least efficient supplier was spending 113 per cent more than the most efficient (see executive summary for full details). 

Efficiency savings: in a properly competitive market the suppliers should continually strive to improve their operational efficiency. However Ofgem’s quarterly analyses of suppliers’ costs show no sign of operational efficiency savings over time. Ofgem’s estimates of operating costs increased from 2007 to 2009 before levelling out. In 2011 Ofgem’s estimates of suppliers costs were £9 per customer per year higher in real terms than in 2007.

Environmental and social policy costs: IPPR analysis finds that there is huge uncertainty about how much it costs the suppliers to deliver energy efficiency policies which could have big implications for assumptions about how profitable they are. Only one evaluation of the costs to suppliers has ever been carried out which found them be 23 per cent less than the government expected (Eoin Lees Energy (2008) Report to DECC: Evaluation of the Energy Efficiency Commitment 2005–2008).

Loss-leading tariffs and overcharging: IPPR analysis shows that people who use the same amount of energy and live in the same area are paying vastly different amounts for their energy because of the way they pay their bills. Those who are on a ‘standard credit account’ (paying for their energy use in arrears) and are so-called ‘sticky’ customers because they are very unlikely to switch tariff or supplier are most likely to be paying over the odds. With more than 60 per cent of all households having never switched energy supplier and 34 per cent being on standard credit accounts, over five million may be being overcharged.

IPPR tested tariffs for British Gas, EDF, E.ON, Npower, Scottish Power and SSE for three different payment types using a price comparison website for properties in London, Sheffield, Dumfries in Scotland and Aberystwyth in Wales. Across each, Scottish Power was found to consistently offer the greatest differential between their standard and cheapest tariff at over £330. The difference was greatest in Sheffield at £339 and second greatest in London at £333. Npower offered the second largest differential between these tariffs of up to £315. Whilst British Gas, SSE and EDF all offered much smaller differentials of up to £126, £100 and £86 respectively, as a whole the difference in the tariffs offered could not be justified solely by the cost of different payment methods (see executive summary and appendix in full report for more details.

Recommendations: Ofgem launched a major package of reforms for the energy supply market in 2008 but according to their own evaluation these have failed to improve conditions. IPPR argues that Ofgem’s Retail Market Review (RMR) is the ‘last chance’ for the current market structure. If the RMR fails to significantly improve levels of competition, government should intervene and investigate alternative regulatory approaches to the market. IPPR also argues that Ofgem should step up its efforts to deal with the problem of cost-reflectivity, extend the RMR to deal with the issue of loss leading tariffs, and consider introducing an absolute restriction on the number of tariffs that suppliers can have in operation, with a ‘one-in, one-out’ policy, to make it easier for consumers to choose between offers.

Contacts:

Richard Darlington: 07525 481 602 / r.darlington@ippr.org

Tim Finch: 07595 920 899 / t.finch@ippr.org