2. The energy market explained
Supplying energy to homes across the UK involves three key elements: making electricity through generation transporting gas and electricity and selling it to the customer. Energy companies can work in any of these different areas, and some operate in all of three of them The electricity and gas markets in the UK are privatised. This means that private companies make sure we have the energy that we need. It also means that customers can choose which companies supply their energy.

3. Element 1.) Electricity generation
Most electricity is generated at large power stations connected to the national transmission network. However, electricity can also be generated in smaller scale power stations which are connected to the regional distribution networks. The number and type of power station built is the decision of each individual company based on market signals and government policy on issues such as the environment. There are many companies in the electricity generation sector, from large multinationals to small, family-owned businesses running a single site.

4. Element 2.) Transmission and distribution networks
There are two types of electricity network: transmission and distribution. Transmission networks carry electricity long distances around the country at high voltages. Distribution networks run at lower voltages and take electricity from the transmission system into homes and businesses.
The transmission system is run by National Grid, which is responsible for balancing the system and making sure that the supply of electricity meets the demand on a second-by-second basis. Similar infrastructure exists for the transmission and distribution of gas.

5. Element 3.) Energy supply
Suppliers buy energy in the wholesale market and sell it on to customers. Suppliers work in a competitive market (is it?, does it work well?)and customers can choose any supplier to provide them with gas and electricity.

6. Energy regulation
The electricity and gas markets are regulated by the Gas and Electricity Markets Authority, operating through the Office of Gas and Electricity Markets (Ofgem). Ofgem's role is to protect the interest of consumers by promoting competition where appropriate. Ofgem issues companies with licences to carry out activities in the electricity and gas sectors, sets the levels of return which the monopoly networks companies can make, and decides on changes to market rules.

7. Why Regulation is Needed

8. Competition and the Consumer
Almost always competition is beneficial for the consumer because:
It increases choice
Encourages firms to charge competitive prices
Incentivises quality and value for money
Leads to an allocatively efficient allocation of resources

9. Protection of the Consumer
Monopolies and oligopolies with market power are regulated as they may distort the process of competition:
Prices may be raised
Output may be reduced to an inefficient level. This leads to a market failure as the industry may be a less than optimum size
BUT
We should not assume that big is always bad or monopoly is always bad. Large firms reap economies of scale. Large profits can be used to fund R&D. Firms may have achieved market power through being efficient and meeting customer needs effectively

10. Strategies for Dominating
Anticompetitive practices (cartels, collusion, restrictive practices)
Growth in market share (pricing, marketing, meeting customer needs)
Mergers/Takeovers

11. Cartels
A cartel is an agreement not to compete between two or more producers within an industry. Typically cartel members agree to coordinate prices and production

12. Collusion
Agreeing with competing producers to avoid any action that would make the competition stiffer
Tacit Collusion – occurs when competing firms simply avoid price cutting in order to keep profits high. No agreement is made they just behave in a way that doesn’t cause trouble for each other (happens due to interdependence)

13. How cartels collude Restrict output Market sharing agreements
Price Fixing
Bid Rigging

14. In 2013 The bosses of the energy companies appeared before the House of Commons Energy and Climate Change Select Committee to answer for their large price increases. The energy companies claimed that the increases are necessary to cover not only rising wholesale prices, but also green levies by the government and ‘network charges’ for investments in infrastructure. However, it is hard to see how, even taking into account all three of these possible sources of cost increases, the scale of price increases can be justified.
Price increases averaged 9.1% – way above the rate of consumer price inflation and even further above the average rate of wage increases. What is more, they are considerably above the rate of increase in wholesale energy prices, which, according to Ofgem, have rose by just 1.7% in that year

15. Restrictive Practices
Any action that limits competition these include:
Full-line forcing – forcing the purchaser to buy a full range of products not just those the purchaser wants to buy
Tie-in sales – bundling where the purchase of one product is made conditional on the sale of another
Resale price maintenance – refusing to supply a product unless the purchaser sells it for an agreed price
Refusal to supply – works as a threat to retailers that are seen as threatening profits eg if they are selling at discounted prices.

16. Natural Monopolies
A natural monopoly exists when there is a great scope for economies of scale to be exploited over a very large range of output. In this case it would be impractical for an industry to have any market structure other than a monopoly.
Eg National Grid– owns and manages the grids that connect people to the energy they need. They run systems that deliver electricity to millions of people, businesses and communities. It would be inefficient to have more than one company due to the high costs of duplicating infrastructure

17. What the government does

18. The UK Government
Has a number of agencies which exist to apply competition law and to regulate the market behaviour of businesses

19. CMA – Competition and Markets Authority - Work to promote competition for the benefit of consumers, both within and outside the UK. Aim is to make markets work well for consumers, businesses and the economy. From 1 April 2014 the CMA took over many of the functions of the Competition Commission (CC) and the Office of Fair Trading (OFT).
EU Competition Commission – works EU wide to ensure markets work in interest of consumers
Regulatory Bodies – As well as the CMA there are numerous other regulatory bodies put in place by government to exercise a degree of supervision over health, food and all other industries. Eg Department for Health, Public Health England, Food Standards Agency.

20. The UK Energy Market How are UK electricity and gas prices regulated?
UK gas and electricity companies are carefully regulated to ensure that customers’ needs come first. It is essential that such a large market be regulated to protect customers when things go wrong, to safeguard the environment, to protect natural resources and to help to keep electricity and gas prices fair.

21. Energy Regulator - OFGEM
Ofgem is the Office of Gas and Electricity Markets. We are a non-ministerial government department and an independent National Regulatory Authority, recognised by EU Directives. Our principal objective when carrying out our functions is to protect the interests of existing and future electricity and gas consumers. We do this in a variety of ways including:
promoting value for money
promoting security of supply and sustainability, for present and future generations of consumers, domestic and industrial users
the supervision and development of markets and competition
regulation and the delivery of Government schemes.
We work effectively with, but are independent of, government, the energy industry and other stakeholders within a legal framework determined by the UK government and the European Union.

22. CMA Responsibilities We are responsible for:
investigating mergers which could restrict competition
conducting market studies and investigations in markets where there may be competition and consumer problems
investigating where there may be breaches of UK or EU prohibitions against anti-competitive agreements and abuses of dominant positions
bringing criminal proceedings against individuals who commit the cartel offence
enforcing consumer protection legislation to tackle practices and market conditions that make it difficult for consumers to exercise choice
co-operating with sector regulators and encouraging them to use their competition powers
considering regulatory references and appeals

23. The Public Interest This means the interest of society as a whole.
Competition law recognises that some markets that are dominated by a few large firms may well still act in the public interest
Competition authorities have to exercise judgement in deciding whether a market is working in the public interest

24. Contestable Markets
A contestable market is where it is relatively easy for firms to enter and exit the market
Barriers to entry and sunk costs are likely to be low (a sunk cost is a cost that cannot be recouped in the event of a business failing to make a profit and then closing down)
If a market is contestable firms may be behaving in a competitive way even though they may appear to have a dominant position

25. Barriers to Entry
Energy suppliers buy wholesale gas and electricity and sell it to customers. The industry has a considerable degree of vertical integration, with the energy suppliers also being involved in both generation and local distribution (long-distance distribution through the familiar pylons is by National Grid). There is also considerable horizontal integration, with energy suppliers supplying both electricity and gas and offering ‘dual-fuel’ deals, whereby customers get a discount by buying both fuels from the same supplier.
Smaller suppliers have complained about substantial barriers to entry in the industry. In particular, they normally have to buy wholesale from one of the Big Six. Lack of transparency concerning their costs and internal transfer prices by the Big Six has led to suspicions that they are charging more to independent suppliers than to themselves.
Under new regulations announced by Ofgem, the industry regulator, the Big Six will have to post the prices at which they will trade wholesale power two years in advance and must trade fairly with independent suppliers or face financial penalties. In addition, ‘a range of measures will make the annual statements of the large companies more robust, useful and accessible.’ According to the Ofgem Press Release:
From 31 March 2014 new rules come into force meaning the six largest suppliers and the largest independent generators will have to trade fairly with independent suppliers in the wholesale market, or face financial penalties. The six largest suppliers will also have to publish the price at which they will trade wholesale power up to two years in advance. These prices must be published daily in two one-hour windows, giving independent suppliers and generators the opportunity and products they need to trade and compete effectively.
But will these measures be enough to break down the barriers to entry in the industry and make the market genuinely competitive?

26. Spectrum Of Competition
PERFECT COMPETITION – Is a theoretical extreme showing how a market could be completely free and efficient.
Homogenous product.
Many sellers, none of which are large enough to influence price.
Many buyers.
Perfect information availability.
Free entry and exit – no barriers to entry.
Profit is competed down to normal levels
Price Taker
MONOPOLY. Exists when there is only one supplier in an industry. This gives the business power over the price it charges.
One firm in an industry.
High Barriers to entry prevent new firms from entering.
Price maker , can choose the price charged or the output level.
May use power to generate maximum profit possible.
Firms make abnormal (supernormal) profit.
May opt for a quiet life – costs not minimised
Price Maker
MONOPOLISTIC COMPETITION 
·   Large number of buyers and sellers
· No barriers to entry or exit
Firms produce differentiated products
OLIGOPOLY 
· A few firms dominate a market
·  High barriers to entry
·  Interdependence may mean firms do not compete strongly on price
Strong non price competition

27. Market Failure
When economists talk about “market failures” they could mean that there is (1) concentrated market power (e.g. monopolies); (2) information failures (e.g. when consumers don’t know about all available prices); or (3) “externalities” that are not fully priced in the market. Looking at the energy market, it could be argued there are several of these failures

28. Retail Energy Market Structure Oligopoly
The UK energy industry (electricity and gas) is an oligopoly. There are six large suppliers: the ‘Big Six’. These are British Gas (Centrica, UK), EDF Energy (EDF, France), E.ON UK (E.ON, Germany), npower (RWE, Germany), Scottish Power (Iberdrola, Spain) and SSE (SSE Group, UK). The Big Six supply around 73% of the total UK market and around 90% of the domestic market.

29. Why the energy market may not be working well

30. 1. Consumers are not exerting competitive pressure on suppliers
. The retail market should be ripe for competition. Price is by far the main reason consumers cite when choosing a supplier. The final product is effectively the same.
Instead, there is ferocious competition for the customers who are willing to switch, while those who stick to their deals pay more than they have to. Sixty per cent of consumers have never switched and 30 per cent said they have but would not do so again, according to Which? It would be perfectly logical for companies to focus their marketing.
Ultimately, the entire model for the British retail energy market is predicated on the idea of consumer pressure. (Competition + consumer choice = a good deal for everyone.)
The precise proportion of disengaged consumers is debatable but the data suggest that policy cannot rely on a model of consumers in which they are active and rational.

31. 2. The market does not make it easy for consumers to exert this pressure.
Britain’s retail energy market could keep researchers in behavioural economics busy for decades. Whether by design or accident, it is hard for the average consumer to figure out the best deal. There are about 900 different tariffs, a number that suggests an overwhelming complexity for the average consumer, according to Which?.
Research from the consumer group suggests that only a small minority of people can select the cheapest tariffs from the information typically provided by energy suppliers. Standard tariffs may sound the cheapest but they are often not. The segmented nature of bills makes it difficult to accurately compare across deals, especially when we tend to pay too much attention to the headline price. Consumers suffer from default bias when they are rolled over into tariffs which by that point are not always the cheapest available.

32. However…
In 2014 OFGEM introduced changes to energy tariffs to create a simpler and clearer market
This included:
banning of confusing and complex tariffs
limiting suppliers to just four tariffs per customer for both electricity and gas, and simplifying how prices are charged.
Energy UK, which represents suppliers, said the changes would "help people get the best deal" on their energy.
However, the consumer group Which claims that energy bills remain complex for those trying to find the cheapest deal.

33. 3. The “Big Six” are under little competitive pressure from new entrants.
The current market for the supply of Britain’s gas and electricity has been in place for about a decade. The previous Labour government continued on the path begun by Margaret Thatcher, who privatised British Gas and regional monopolies for supply and distribution. It took until the late 1990s for competition among these companies to be introduced. Price controls were gradually lifted, under the aegis of Ofgem, the regulator. By 2002, when the last controls were removed, Britain had perhaps the most liberal energy market in Europe. The 14 regional monopolies became five companies and together with British Gas became known as the “Big Six”.
Incumbency seems to be a powerful weapon. The big six energy companies still have over 90% market share with new entrants struggling to make a big impact. Herd-like pricing behaviour also suggests little worry about smaller, newer companies taking customers from the Big Six.
Some competition is better than no competition. But more is necessary. It is often said that the UK has some of the lowest energy prices in the EU, where price controls and regulated monopolies remain common. Like-for-like comparisons across countries are hard to make but when taxes are excluded, the UK has some of the highest electricity prices and is near the middle of the pack in terms of gas prices, according to IPPR.

34. However…
Britain's big six energy companies are continuing to lose market share to smaller independent suppliers, new figures show. Added together, the large suppliers now have 92.4% of the market, down from 99.8% five years ago.
In other words, independent suppliers have increased their share from just 0.2% to 7.6% over the same period. The largest independent has grown ten-fold in just three years, and now has more than a million customer accounts.
Many of the smaller firms claim to offer cheaper bills than the big six suppliers.
If the trend continues, it may reduce pressure on the competition authorities to shake up the energy market.

35. 4. It is hard to know whether retail prices fairly reflect wholesale prices
Whenever retail price rises are announced, energy companies often refer to prices on wholesale gas and electricity markets as the primary reason for the increase. (Although in the latest round charges to upgrade the country’s network were the biggest single cause of the rise, at least in the case of SSE.) Wholesale costs make up more than half of both gas and electricity bills, according to Ofgem. Nevertheless, the vast majority (84 per cent, according to a recent Which? poll) of the public believes that “profits” are the reason for price rises.
Presumably, there is a bit of both at play. And most Britons tend to accept that companies have the right to make profits. However, an important point is often lost in the aftermath of price announcements: the Big Six do not merely accept the prices on the wholesale markets. As noted above, the Big Six supply energy to 98 per cent of UK households – but their generation businesses are responsible for about 70 per cent of electricity generation. This “vertical integration” allows for efficiency within the firm but it also means that it is impossible for outsiders to analyse whether retail prices fairly reflect wholesale costs.
The Big Six companies either self-supply energy, source it from other vertically-integrated companies or buy it on the wholesale markets. The electricity market, in particular, suffers from a lack of liquidity. Often for good reasons of commercial sensitivity, there is a lack of information about the volumes and transfer prices of energy, and about how risks are shared across different parts of the businesses.
There is a lack of transparency about how wholesale prices translate into retail ones. A similar point goes for whether “investment” is reflected in retail prices. Little wonder then that there is a shortfall in trust in what the Big Six are saying.

36. Information Failure
It can be argued that the energy market has not worked well for the consumer as it is difficult to make informed choices due to the vast array of tariffs on offer
However
Ofgem has regulated to make tariffs simpler
Price comparison websites have made it easier to compare tariffs BUT – there has been an allegation that price comparison websites conceal the best deals from customers in favour of those that give them the biggest commission

37. CMA Investigation
In 2014 OFGEM referred the energy market to the CMA for further investigation. The CMA outlined reasons why competition in the energy market might not function effectively before starting its investigation.
These are:
1.) Vertical integration of electricity generation and supply among the big 6 might squeeze out independent retail suppliers
2.) Dominance by the big 6 leads to higher energy prices for example caused by tacit collusion
3.) Unwillingness of customers to switch might lead to weak incentives on the part of suppliers to compete on price and quality of service

38. Update (full report will be released later in year)
The report questions whether the market is working for consumers as almost half of households have been with the same supplier for more than 10 year. The CMA says these customers are "less educated, less well-off, more likely to describe themselves as struggling financially, less likely to own their own home, less likely to have internet access, more likely to be disabled or a single parent".
Long-term customers - many deemed vulnerable - were paying a higher price for failing to move between energy companies. It said 95% of dual fuel customers of the so-called big six suppliers could have saved an average of between £158 and £234 a year by switching.
BUT - the CMA found that their average profit margin across gas and electricity was 3.3%, with gas being the more profitable of the two. It did not comment on whether this is excessive
Competition and Markets Authority's (CMA) update also contained criticism of the energy regulator's powers, saying excessive regulation at Ofgem may be creating barriers to new market entrants.
It will also investigate the idea that recent decisions by the energy regulator Ofgem to simplify tariffs have done more harm than good by reducing the number of them available to consumers.

39. Effects of polices and implications for business

42. Government Intervention in the Energy Market
Key to the justification for government intervention is the concept of market failure. Government may well intervene to:
Ensure energy security
Tackle externalities associated with energy production
Make the energy market work better for the consumer
Equity - fairness – make sure the costs and benefits of policies are distributed fairly so that we protect the most vulnerable and fuel poor households

43. Government Failure
Government Failure - However any intervention to reduce market failure may well lead to government failure eg:
Subsidy paid to wind energy producers may reduce the incentive for them to generate energy at the lowest possible cost
OFGEM regulation to simplify tariffs (aim to reduce information failure) may prevent suppliers from offering innovative new tariffs that enhance competition
Excessive regulation by OFGEM may act as a barrier to new market entrants by making it difficult for smaller suppliers to compete

44. Energy industry 'over-regulated', say former regulators
In their letter to the CMA, the former regulators say that "regulatory interventions to promote more consumer engagement can increase customer and supplier transactions costs, leading to lower customer benefits including via higher prices, and weaker rather than stronger competition."
"Regulatory interventions can also affect suppliers' ability to compete as well as their incentives to do so," they add.
Ofgem has recently changed the industry's rules so that energy suppliers are now restricted to offering just four tariffs. This means some cheap special tariffs for "vulnerable" customers such as the elderly and the poor have been withdrawn. Suppliers have also been stopped from offering cheaper tariffs only to new customers, while refusing to offer such deals to existing ones.
Stephen Littlechild told Wake Up to Money on Radio 5live that changes made by Ofgem "seem to be restricting competition". He said that in trying to simplify the market, Ofgem had reduced the number of deals on offer and the effect was that "customers are less interested in shopping around".

45. Are UK Energy Prices Too High?

47. BUT… Is it just our taxes are lower?
ALSO - there is a very important distinction between prices and the bill you end up paying. The other variable which influences the size of the bill is the amount of energy consumed. Despite having much cheaper energy prices than, say, Sweden, UK households end up paying more because we are much less energy efficient.

52. Possible questions Define government failure (2)
Examine two potential government failures associated with the case study (8 marks)
Assess the extent to which government policy to reduce externalities associated with fossil fuel energy may lead to government failure (12)
Assess the extent to which the UK energy market is failing (20 marks)
Assess the likely effectiveness of UK government energy policies in correcting market failure (30)
Evaluate the extent to which the UK government should intervene in the energy market (30 marks)
The six leading energy companies have more than 90% of the retail energy market. Examine the importance of this combined market share for the UK Consumer (9marks)
Analyse 2 reasons why different countries have different energy prices (see evidence... 8 marks)
Analyse 2 possible reasons why UK energy prices are lower than in other countries (8 marks)
Analyse 2 reasons why the energy market may be failing (8 marks)
Analyse 2 impacts of higher energy prices (evidence B&C 8 marks)
Assess 2 likely consequences for the uk economy of rising energy prices (evidence B&C 10 marks)
To what extent should the government intervene to increase competition in the UK energy market(30 marks)