We must rethink energy to boost competition

Overhauling Britain’s retail market is not just a question of social justice but economic imperative

It was reported this week that the cost of energy produced by new offshore wind farms has halved in two years. Many observers seemed to conclude that Britain’s energy problems have been solved. The truth is rather different. Britain still has significant trouble with its energy retail market, its power generation, and its energy strategy. All three require decisive government action.

The retail market is supposed to be founded on competition, with consumers switching between companies and tariffs. In practice, only a quarter of households have ever switched tariff with the same provider and fewer than half have ever switched supplier. The big energy firms rip off customers who do not switch. Two thirds – 18.5 million households – are on expensive default contracts. These standard variable tariffs, or SVTS, are on average £130 per year dearer than the cheapest tariffs, and can be up to £380 more expensive.

Despite political pressure to change their ways, the big energy companies continue to abuse this market failure. Ofgem reports that the difference in price between the cheapest tariffs and SVTS has grown bigger this year. They also say that the profit margins of the big energy companies are increasing.

Those who lose most in this broken market are, as ever, the vulnerable. For the poorest families, energy costs form 10 per cent of annual expenditure. According to Citizens’ Advice, a quarter of households on low and middle incomes struggle to pay their energy bills. If ministers want to help families with the cost of living and show they are serious about reforming dysfunctional markets, they should introduce a safeguard tariff cap.

This would make the energy market more, not less, competitive. Companies would have to compete on the basis of prices driven by their own efficiency, rather than by offering below-cost prices for the few who switch, subsidised by higher prices paid by others. A safeguard tariff cap would not, of course, reduce the cost of energy overall. To do that, or to at least check the increase in prices, we need a bigger change.

This is not only a question of social justice but of economic competitiveness. Britain’s industrial electricity prices have increased by more than 150 per cent since 2004. They are the fourth highest of the 29 mainly Western member countries of the International Energy Agency (IEA). They are more than double those in America. And they have been getting increasingly uncompetitive. In 2004, our industrial electricity prices were cheaper than the IEA average; in 2010, they were 0.7 per cent more expensive; now, they are 54 per cent more expensive.

It is not possible to have a successful industrial strategy with energy costs that cripple industry. And neither will the Government succeed in rebalancing the economy while industrial electricity prices are so high. We need lower prices, and to get them we need a new energy strategy based on competition and a sensible regulatory framework. For that to happen, there must be meaningful price transparency for all forms of power generation, including nuclear power and renewables.

This will require a new approach to reducing carbon emissions. There is no need to abandon our international commitments, and no need to abandon the Climate Change Act. We should, however, change the trajectory of Britain’s decarbonisation plans, so a greater share of the reduction comes later, through technological innovation, rather than earlier, through the imposition of higher energy costs and lower industrial output.

This would allow us to take sensible measures, such as reducing Britain’s carbon price, which increases costs by pricing every tonne of carbon dioxide at three times the level set by the EU’S Emissions Trading System. It would also allow us fully to exploit the opportunities that lie in Britain’s shale gas reserves.

Proper price transparency and competition should mean no more subsidies for renewable energy. The Government has set out its intention to reduce these costs, but Britain has spent over £23 billion on subsidies for renewables since 2002, and now is the time to phase them out completely.

With the falling price of offshore wind, this should not be a problem. Wind power is still expensive: its intermittency causes higher costs elsewhere in the system, and this should be reflected in estimates of wind’s true cost. But it will almost certainly play an important role in Britain’s energy mix and, if its supporters are correct, it should not need subsidies to do so.

Price transparency would also mean no more nuclear deals without price competition from other providers. It might therefore mean no new nuclear at all, and it should certainly mean no new deals like Hinkley Point. And it would mean an end to long-term renewable contracts with guaranteed excessive prices.

Instead, energy technologies would compete against one another on a level playing field. That would mean a more rational energy market, with prices that are fairer for households and more competitive for industry.