If it’s broke, fix it…

Another winter looming, another crisis about energy bills. The Prime Minister has called for action to force energy companies to provide people with their lowest tariffs, although there is still confusion about what this means. The energy regulator Ofgem has come up with the ideas of more information about alternative tariffs being shown on bills and a maximum of four different tariffs per company (what is a bit odd is why this is only being considered as neccesary now, more than 15 years after the liberalisation of household gas and electricity markets). But this may be the right time for a more fundamental rethink.

As in other areas, including banking and railways, markets in energy are not working well. The two basic Hayekian functions of open markets are supposed to be providing information signals about costs across the economy, and about spurring innovation. Energy markets in the UK currently do neither.

Retail energy pricing is so obtuse and un-comparable that people can’t tell whether the company they are with is charging over the odds or not. I recently considered switching, and had to run various  scenarios on a spreadsheet in order to work out whether it would be worth it.

At the same time, energy companies remain resolutely un-innovative, and compare remarkably unfavourably with the telecommunications industry. They have offered energy efficiency measures only because they are obliged to do so by government, and have totally failed to open up an energy services market or any kind of demand response offerings. However, this is not entirely their fault, in that the liberalised energy market doesn’t really provide them with any incentiove other than to keep on selling energy; the more the better from their point of view. In many ways, despite privatisation, energy is still run how it was in the 1950s.

How could we do this better? One option would be to take the bold step of re-regulating the domestic retail market. One interesting model, from California, would de-couple company revenue from sales, guaranteeing a certain return per customer, and with prices set by the regulator which rise with use (instead of falling, as in the UK). This removes the disincentive for companies to help people save energy and at the same time creates an incentive for householders to use less. Companies can still compete for market share, but on the basis of service rather than price. To create a positive incentive to save energy and grow an energy services market, California also introduced an incentive scheme (not an obligation) whereby savings from measures installed by the energy company are shared between the company and the household.

Regulating in this way, and fixing prices, would of course be controversial, but it has some real advantages. It gives responsibility for cross-subsidy between better off and poorer pre-payment customers to the government (which is where it belongs) rather than to companies. It would make the relationship between the retail price and the wholesale porice a lot more transparent, and open to public debate. It would make it possible to have a smooth increase in energy prices to help drive energy saving, rather than sharp price spikes that simply hurt the least well off.

A final issue is how to create more demand for energy services amongst a reluctant public. It is widely accepted (probably even within DECC) that the Green Deal is not going to be taken up on a wide scale. Again, the US experience is that the market for green finance for home retrofits has only taken off in places like Berkeley, where regulation known as RECO (Residential Energy Conservation Ordinance) requires the energy upgrading of properties when they are sold. Ultimately, given all the transactions costs and the problem that energy efficiency is a credence good, only regulation is likely to be effective in driving major consumer change, and government will have to face this issue sooner or later.

All of this is, of course, unlikely to happen under this government, or possibly the next, but until it or somethig like it does, we are likely to see plenty more winters of discontent about energy prices, and plenty more hot air from policy makers in response.

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