Cold Comfort and Hot Air

Energy prices have risen by 18% in the past few weeks. Many have speculated that there may be some form of cartel operating in the energy sector and that something must be done. At the very least it is clear that the market for energy for domestic consumers doesn’t appear to be providing the benefits of competition to consumers as it ought to. Although a large proportion of the price of gas and electricity is made up of the costs of fuel on international markets, this does not explain why the profit margins for energy companies have risen along with rises in unavoidable input costs. At the same time as prices have risen 18%, the average profit per customer has gone up from £15 to £125 a year.

Competition and Energy Markets

There is at least, therefore some basis for concluding that there has been a market failure. Although it is unappealing, there is also some truth in the suggestion by the beleaguered Energy and Climate Change Secretary, Chris Huhne, that part of the problem stems from consumers themselves being insufficiently active in switching between providers. A majority of consumers do not even consider alternative suppliers and only 15% of customers actually switch. It is quite possible or even likely that this is too low a level of customer churn to influence the energy companies price competition strategies. However, it is also true that customers can only be active in voting with their wallets if the process of determining better deals is straightforward. Where there are multiple tariffs which need complicated calculations to work out the relative prices the effort might well be too much for many to face. That said, there are online services available which attempt to simplify this process such as USwitch.

Ofgem’s suggestion of a budget tariff with a regulated fixed charge and a single tariff for each company would at least have the benefit of being much easier to compare for consumers. It is possible however, that these tariffs may well not offer the very best deal available for each supplier with there being a trade-off between simplicity and price.

There is also a question mark as to whether regulatory action and greater competition will have as significant an effect as some might like. Even in the absence of the recent price increases there has been the perception of energy prices being too high. It is not clear what price would not be too high, but I suspect that even cutting out the entirety of the recently increased profit margin would not bring prices down enough to stop them being an issue because the actual cost to consumers would still be around say £900 a year rather than £1000. A reversion to what a properly competitive market ought to charge may be too small a victory, particularly in the context of Ed Miliband’s remarks on how the energy companies ought to be regulated.

Fuel Poverty

As we are moving into autumn and winter and the colder weather they bring, the issue of the cost of energy is brought into focus. We have certainly noticed a substantial difference in the warmth of our home since installing double glazing earlier in the year but even then the central heating has recently had to be fired up. The issue is likely to be most keenly felt by those deemed to be in fuel poverty.

The concept of fuel poverty is apparently simple. It is defined in legislation as meaning that any household which needs to spend more than 10% of its disposable income on ensuring an adequate level of warmth in the home is to be deemed to be in fuel poverty. The Department of Energy and Climate Change has commissioned an independent report on fuel poverty (the Hills Report) which has recently published its interim findings as part of the process in the legislation on fuel poverty, the Warm Homes and Energy Conservation Act 2000.

There has been a lot of coverage of the headline figure in the Hills Report stating that 2,700 people a year die in the UK due to fuel poverty, that is, more than the total number who die in road accidents each year. This has been seized upon for political ends both by anti-poverty campaigners seeking to highlight the terrible toll of poverty and by those opposed to environmental taxes such as those proposed by Chris Huhne’s department on the basis that such taxes increase fuel poverty by raising the price of energy.

Curiously, there seems to have been little assessment of the meaning or validity of the figure. On reading the Hills Report it becomes clear that the figure is an estimate based on modelling, assumptions and statistical analysis. The starting point is the data showing that there are around 27,000 “Excess Winter Deaths” a year in the UK – that is, there are this many more deaths in the UK each year during the winter months than in the summer. The Hills Report also looks at evidence showing that cold has an adverse impact on health. It then concludes that the problem is worse in the coldest quarter of homes than in the warmest quarter and estimates that around a fifth of all the Excess Winter Deaths are attributable to cold homes (ie 80% is due to other factors outside the house) and that half of these are presumed to be homes of people in fuel poverty. These might be reasonable assumptions, or they might not. The prevaling wisdom on optimum domestic temperatures varies – for example it used to be thought that it was good for babies to be exposed to cold, then that became frowned upon and keeping babies in much warmer rooms was mandated to the current position of avoiding overheating children. Prior to the installation of double glazing our house was often uncomfortably cold for adults while being pleasant for our son and his friends.

The difficulty is that they are merely assumptions. There is no actual up to date evidence about how warm people keep their houses (the Hills Report itself regrets that the most recent data on this is 15 years old) or the domestic temperatures of the homes of those who fall into the category of being an Excess Winter Death.

Although anecdotes of the poor and elderly choosing between food and heat are heartbreaking and are examples of things which ought not to happen in a civilised and advanced modern society, the Hills Report is not great support for the impact of fuel poverty because the concept is too artificial. Fuel poverty implies that a solution needs to be found in relation to energy rather than more generally in terms of ensuring that no-one is in poverty in more general terms. The Hills Report rightly notes that we don’t have a concept of food poverty. If anything, food poverty is seen to manifest itself not in starvation but in obesity.

Both the debate over fuel poverty and the broader issue of energy pricing being too high are unhelpful because they rely on subjective and vague criteria, and the use of potentially misleading assumptions. It would be better either to be open about this and to state that energy pricing should be no more than a certain percentage of people’s income or to ensure that the market operated competitively and to leave the choice to individuals with separate measures to address general poverty without trying to pre-empt how poor people ought to look after themselves. Apparently sophisticated statistical rationalisations and populist calls for the energy companies to “do something” are not a sensible long-term way of looking at the energy sector.

6 thoughts on “Cold Comfort and Hot Air

  1. Regretfully, the poor management of the communications around the ‘cartel’ means that a belief has been created that the suppliers can charge up to the 10% of disposable limit of income. The creation of that limit infers the energy companies can move to that with impunity, irrespective of whether it is ‘fair’ or not.

    • Interesting point. It is an inherent problem in markets subject to regulatory price controls or other apparent consumer protections on pricing that these protections and controls can have the effect of setting a target rather than putting a ceiling on pricing with the expectation that actual prices would be competed down way below the celiing. Almost invariably, even if somewhat counterintuitively, prices fall after price caps are removed because businesses don’t have a state-mandated safe maximum they know that they can probably get away with. There’s little need for a price fixing cartel (ie where there is an agreement or concerted practice between operators to keep prices at a certain level) when the regulators have told you what price would be acceptable. It is one of the reasons why the Competition Commission almost never recommends the introduction of price caps.

      The 10% figure is a completely arbitrary one – the research ahead of the 2000 Act showed that about half of all households paid more than 5% and half less for energy and this was then doubled to set a notional level for fuel poverty. It isn’t based on any particularly rigorous analysis of what would be a reasonable proportion of disposable income to pay for energy, the costs of energy or even the actual income level of any real people whether in general poverty or not.

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