Understanding Regulation

Facts, Analysis and Comment

Energy Regulation

Introduction, Overview and Summary

UK gas and electricity bills rose by 140% between 2004 and 2013, driven not only by higher wholesale prices but also by government climate change policies such as the cost of supporting renewable generation and the reintroduction of nuclear generation. The Government was not, of course particularly forthcoming about the impact of these policies - rather as successive governments have been less than fully honest about the cost of environmental improvements within water bills. Further detail is towards the end of this web-page. (But Note 1 below explains how difficult it is to settle on an optimal energy policy.)

The post-2004 price rises clearly caused big problems for many consumers, and were devastating for those on the lowest incomes. But many consumers - and especially poor and vulnerable consumers - did not take advantage of the opportunity to shop around and switch to lower cost suppliers. Follow these links for a further discussion of switching and effective competition and to read about the 2016 CMA report on the energy industry.

Businesses too - and especially energy intensive industries such as steel makers - complained they were, for instance, being 'crippled by electricity costs twice as high as Germany'. [The Times 26 August 2015]

Energy prices became even more controversial in late 2013 when most of the larger companies announced further price rises approaching 10% but were unable to explain how these could be justified. There were suggestions that the Big Six energy companies were not competing effectively because there were engaged in tacit coordination. Politicians accordingly scrabbled to react, generally in ways which did not impress expert commentators. But they did eventually ask the Competition and Markets Authority (CMA) to mount an investigation of the energy market, and its final report was published in June 2016. The CMA did not try to tackle tacit coordination, but did take steps to help customers identify and switch to the best deals.

Concerns have also been expressed about whether the UK will have sufficient electricity generation capacity during forthcoming winters. Looking forward, it has been estimated that it will be necessary to invest £200 billion in UK energy between 2010 and 2020. Bills will probably need to rise by a further 14-25% to attract and fund this investment.

The rest of this note focusses on the consequences of government intervention in the energy market. You can also follow the underlined links, above, or in the menu bar to the right, to read more detailed analyses and history of the above issues.

Government Intervention Increases Prices

This first chart shows the power of competition and independent regulation. British Gas was privatised, and Ofgas created, in 1986 with electricity and OFFER following around three years later. Investment in coal and nuclear electricity generation had previously been very inefficient but it rapidly got much better. But government re-interference in the energy market began around 2003 as oil/gas prices rose and the government (and less than fully independent Ofgem) responded by introducing quotas and capacity payments.

This next charts show what happened after 2003. Typical annual combined gas and electricity bills increased from around £590 in 2004 to £1420 in 2013. The first chart shows trends in the size of the main components of the cost of providing energy to the home.

The second chart includes the same data but shows how they add together to create the total cost.

These two charts show that a very large part of the pre-2013 increase in domestic fuel bills was due to government/regulator imposed costs (the red line in the charts) including investment in new transmission capacity, the £2 billion pa Renewables Obligation and the 2.2% Non-Fossil Fuel Obligation. Energy company profits (the purple line) have also risen and are now typically around £100 pa per household. Wholesale oil/gas prices (the black line) rose sharply from 2004 to 2006 but have risen by only around £100 pa since then. Note, however, that part of this increase is likely due to the policy decision to switch away from cheap coal generation to more expensive gas-fired power stations.

The figures underlying the above charts are in Note 2 below.

Ofgem subsequently published a further chart containing similar data from 2009 to 2014. You can find it on this web-page.


Note 1 - Speaking in 2015, Sussex University's Professor Tol explained how difficult it is to settle on a optimal energy policy. Paraphrasing him somewhat:

A switch from traditional biomass to fossil fuels in power stations is good for indoor air pollution but bad for greenhouse gas emissions. A switch from petrol to diesel (in vehicle engines) is good for carbon dioxide emissions but bad for particulate emissions. Filters and scrubbers on power plants are good for acid rain but bad for climate change. Dearer energy is good for the environment but bad for poorer consumers and heavy users such as steel plants, and may anyway only shift heavy energy users offshore where they will face even lower regulatory standards. ... We can therefore confidently say that the current energy system is sub-optimal, but we cannot begin to answer the question what the optimal energy system would look like.

Note 2 - The figures underlying the above charts are summarised in this note:

Note 3 - The NAO reported in 2016 that subsidies for green electricity would add £110 to the average household energy bill by 2020.