British Gas under the spotlight

The recent announcement that the Department of Energy and Climate Change (DECC) wants an investigation into British Gas has the potential to open the gas market in a way which has not happened since the industry was privatised.  While academics and commentators pore over every aspect of the regulation and operation of the electricity market, gas has remained something of a black box, with few people understanding – or probably even caring – about how it all works.

This could change as a result of the DECC announcement.  In a nutshell, Ed Davey wrote to Ofgem asking the regulator to consider investigating British Gas to see whether it is abusing its market power and therefore inflating profit margins. The result could be that the company, and other elements of the gas market are broken up in some way to reduce abuse of market power.

There can be little doubt that Davey’s actions are in large part the result of continuous and growing scrutiny of energy companies and Ofgem over the last couple of years.  In the face of voter-friendly announcements about price capping and abolishing Ofgem from the Labour Party, and screaming headlines in the newspapers, it is unsurprising that he felt that he had to be seen to be doing something concrete to limit the impact of rising prices on consumers.  In that context, British Gas presents an attractive target on which he can exercise his interventionist credentials. It’s the largest gas supplier, its parent company, Centrica, is a major gas producer and it has some of the sector’s highest profit levels.  It’s hard to feel sympathy with them as they prepare to announce profits of nearly £3bn later this week.

Unpicking the gas market will serve several ends.  Firstly, it should expose the behaviour of the gas companies (not just British Gas) to a level of scrutiny which they have not experienced so far, and which may in turn lead them to adjust the way they maintain their profit margins.  It should also mean that the wider world will understand more about how the gas industry operates, no bad thing given the importance of gas in the UK’s current energy mix.  It might even mean that the monolithic British Gas is broken up, diminishing its market dominance.

However, these are all relatively short term impacts which may or may not lead to a reduction in customer bills.  It’s also worth thinking about the possible longer term implications of breaking open or even overhauling the gas market.  If British Gas is no longer so dominant, it will be easier for new entrants to enter the market, creating greater levels of competition and bringing new ways of doing things.

This is where it all gets a bit more interesting.  While everybody has concentrated on the British Gas investigation angle, Davey’s letter to Ofgem also contained a section on new business models, and the degree to which it might be possible for energy companies to operate in different ways.  At the moment, energy companies make their money by selling as much electricity or gas as possible.  This approach puts them in conflict with broader policy goals of increasing energy efficiency and/or reducing demand for energy, which delivers benefits in terms of reducing overall bills, enhancing the overall security of energy systems and cutting carbon emission targets.

There is a different way of doing things.  Most consumers aren’t really interested in buying a certain number of units of energy.  What they want is to have the services – heat or light – that the energy can deliver.  A different business model from the current Big Six approach would be focused on delivering those services to consumers as efficiently as possible, and profits would come from providing consumers with a level of service while using fewer units of energy.  While examples of such Energy Service Companies exist and provide services for large customers, the challenge is to extend the model to smaller consumers, including individual householders. This is something which is much more commonplace abroad.

The potential for such a shift has not really engaged politicians before.  Generations of Secretaries of State have treated the gas and electricity markets as entirely separate entities independent of Government, and shied away from interfering with the energy companies’ business models.  Davey’s letter, however, shows that this may no longer be the case.  He explicitly refers to both the gas and electricity markets as vehicles to deliver energy efficiency measures.

Although Davey has taken a step in the right direction here, it is just a first step and how this new energy market design could be supported is yet to be seen. It could range from general political statements supporting a more service based approach to providing energy, to something more draconian such as the requirement to deliver a certain proportion of their business in the form of energy services rather than units of energy.  Like most energy policy decisions, the political will of the policy makers must be strong enough to push changes through the system in the face of opposition from the archaic yet powerful incumbents.

In the face of low-customer churn, high profits and a small number of players, the question of whether the energy market requires re-design has a straight answer. Of course it does. However, whether Mr Davey or his counterparts in the other parties have the courage, grit and capability to take it on remains to be seen.

Bridget Woodman and Richard Lowes, Energy Policy Group, University of Exeter 

This blog first appeared on The Conversation: 

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