Thursday, 27 March 2014

That OFGEM Consultation in Full


There is evidence that customer switching has been falling over recent years despite increasing prices and significant savings available for consumers that change supplier. There was a significant spike in switching in late 2013 but it is not clear whether this trend will be sustained, and we note that the switching rate has materially decreased in January 2014. Crucially, consumer trust has fallen significantly in recent years with the last survey showing that 43 per cent of consumers did not trust energy suppliers, an increase of 4 percentage points from the previous year. 

I've been on various price comparison sites for electricity and while there are savings for switching, the amounts barely warrant my time and trouble calling someone, changing my direct debit and so forth.

Previous analysis suggested that incumbent energy suppliers in both electricity and gas all have a relatively high proportion of customers who never or rarely engage in the market. These suppliers are able to charge higher prices to these "sticky" customers whilst making cheaper deals available to more active customers. 

So, some customers can be bothered to switch on a regular basis and others can't. If some customers can switch, how is this not a functioning market?

Previous analysis showed evidence of weak competition in the market due to aligned pricing strategies of the six larger suppliers. Ofgem would stress that it found no evidence of explicit collusion between these suppliers. But tacit coordination can have the effect of reducing competition between suppliers and worsening outcomes for consumers.

The Assessment has found further evidence of possible tacit coordination and indeed that this pattern of behaviour may have become more entrenched over recent years. It has found evidence of strong alignment of pricing announcements, in both timing and extent, as well as a pattern of suppliers raising prices more rapidly and to a greater extent in response to an increase in costs than they reduce prices in response to a fall in costs. This is a sign of a lack of competition. 

Well, as the energy companies are all buying from a commodity market the prices are going to stay pretty much the same. Gas isn't like cars where you can buy Suzuki gas or Rolls-Royce gas with each special properties. It's just gas. If someone's flogging it for 10 dollars a cubic litre, you can't flog yours for 11 dollars a cubic litre.

And it's a sign of real competition. You see it when Tesco and ASDA decide to have a price war over petrol or oranges. One announces a price fall followed by someone else doing the same. In the cloud hosting market you see the same thing. Amazon drop the price of EC2 servers and Microsoft announce something a week later.

Many stakeholders highlighted barriers to entry and, particularly, expansion in energy markets. These include low wholesale market liquidity, credit and collateral requirements, suppliers’ pricing strategies, regulatory barriers and reputational risks. While there has been recent growth in new entrants who now have a 5 per cent market share, there is no evidence of sustained expansion at a scale which would provide a disruptive competitive threat. 

I've checked these companies on the price comparison sites and again, they aren't much cheaper than my current supplier. Certainly not to the point where I can be bothered switching.

There has been evidence of increasing average profitability in the six larger suppliers over the last four years. The Assessment has not come to a conclusion as to whether excess profits are being made but notes the recent increases and questions the suppliers’ contentions that five per cent is a fair margin. It also notes that there is variation in profitability amongst the large suppliers, and that there has been no clear evidence of efficiency improvements that might be expected in a strongly competitive environment.

While the evidence of profitability is not conclusive, the rise over the last few years allied to no clear evidence of increasing efficiency is indicative of a possible lack of effective competition. 

Really? 5%? I'm pretty sure you can tuck money away in bonds at about 3.5%, so 5% hardly seems like that much of an excessive return on investment.

But OK, let's strip out that 5% profit margin. Let's imagine no profits at all. That still doesn't account for the 37% rise in the past 3 years, does it? So, why have bills risen in that time?

And that's what this exercise is really about - it's not about a serious investigation into these companies because the report contains nothing but suggestion about their activities. It's a political exercise to keep the blame on the electricity companies to distract attention from the government having an utterly failed energy policy.


paulc156 said...

Barclay's analyst recently wrote that margins of 2-4% after tax was typical in comparable markets.
You referred to food sales. Typical margins of 4%. Water companies under 2%.
They operate at around 5% on sales but 20-24% margins on the generation side in 2011 and 2012. They could be shifting profits made by retail into other areas.

Lola said...

TS - You are bang on. This is an entirely political exercise to keep the fat entitelments coming in for all those quangocrat wnakers. Apropos of which someone I know well has just had a meeting with the Financial Catastrophe Authority who having made a ginormous cock up with a thing called the RDR are now thrashing about for ways to lay off the blame. You really couldn't make it up. Oh, of course. Ayn Rand did.

Mark Wadsworth said...

Be careful with that 5%.

A 5% net profit as a % of sales seems perfectly fair and reasonable, but you cannot compare that with a 3.5% return on bonds.

To get a fair comparison with other capital-intensive businesses, you have to express their profits (plus interest siphoned off to related companies along the way tax free) as a % of the value/cost of real capital they own (pipelines, meters, switches, repair vans etc).

Bayard said...

"It's a political exercise to keep the blame on the electricity companies to distract attention from the government having an utterly failed energy policy."

and also an exercise in finding something to blame for the rising cost of living that isn't house price inflation.

H said...

I would check OVO. They were £200 cheaper p.a. for me (over 10%), and they didn't come up on the price comparison sites I had tried.