Snouts in the uncertainty trough

There may be hints that the UK has turned the corner and is coming out of recession. But they are just hints and the UK has a long, long way to go to get back to pre-recession prosperity.

And the government wants to be the greenest ever. Bless. Don’t you just love those election promises? Well we are greenish but not in the way it foresaw. Zero economic growth is good for limiting greenhouse gas emissions and saving the planet but it is rubbish to signal the growth of a thriving green economy.

Thankfully the big six are investing in a swathe of new green projects and carbon reduction plans. The drawback is that they are passing on the green costs plus an associated return to customers. Why wouldn’t they? They are private companies and have to make a return for their shareholders. But here is the rub. They are not only passing on the green costs but also acting as a pack together and are keeping their profits up despite the fall in wholesale prices. They are just not cutting prices. In fact they are raising prices…together.

So why hasn’t the fall in prices been past on? The simple answer is the lack of threat of new entry. The big six are quite happy with the market as it is and do not want new entrants seeking to snaffle their market share. As I wrote in another blog City analysts think that the market is concentrated and has a relatively high Herfindahl–Hirschmann Index (HHI) (a measure of competition).

So why then is there no significant new entry? Simple. There are large costs to gain significant market share and enter the market. Especially since the market is dominated by six vertically integrated players. Vertical integration is an inevitable move especially with a trading system that penalizes uncertainty.

As wholesale prices go up or down the big six’s retail prices should mirror them. But because of the lack of threat of new entry the big six follow one another depending on their hedging strategy and long term contracts. They just lose or gain a few customers in the meantime to one another. It looks and smells like active competition but it is the form of competition that companies want not government, regulators or customers.

So what are the possible solutions? It is a tricky one especially because a recommended competition review break up could de-rail green commitments.

Maybe it would be best to separate the generation and supply businesses? The generation arm could get on and build power plant and sell their power to an exchange or through long term deals while suppliers could just buy from an exchange and compete with each other. It might take some determination but it would be a better deal for new entrants and customers.

However there would be a real impact. The share prices of companies would probably fall and investors would think twice about investing in the UK again. And if all low carbon power is contracted for via a CfD that would mean that a Pool has been created again and low carbon generators would not need a supplier to enter into a Power Purchase contract at all, so it would possible to get green power plant built without vertical integration. So what would be the verdict on EMR? A waste of time for most people – except those advisors who have cashed in on the uncertainty that is has caused.

Dominic Maclaine is an EPG Associate and used to be the editor of New Power before he sold the business. He conducted PhD research into electricity supply competition in the UK and Norway at SPRU. He was previously the editor of the monthly newsletter Power UK published by Platts (and previously the Financial Times). He is currently writing a book about recent developments in the UK electricity market, to be published by Routledge.

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