The wrong sort of competition in energy

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Last week, David Cameron told the House of Commons that UK energy suppliers will be required to ensure that all their customers benefit from the lowest tariff. Coincidentally, Britain’s energy regulator Ofgem published a document proposing simplification of retail energy tariffs. The document demonstrated that simplification will be complicated. Certainly more complicated than the prime minister’s statement implied.

Many of the products we buy today are, by their nature, complicated. If you want to buy a television or a car or a computer, you are faced with a bewildering range of types, sizes and optional features.

Such complexity means some consumers will inevitably pay more than they need because they make mistakes or do not take the time to understand the options. Some complexity is unavoidable, but much of the complexity consumers experience is not.

For its consumers, energy is the simplest of products. All electricity or gas on the public network is the same. The only material difference between providers is the length of time it takes them to respond to complaints about your bill. The only persuasive claim a salesman can make is that his electricity or gas is cheaper. The time he spends trying to persuade you of this is a clue that it probably isn’t. But to establish the truth may require a computer.

Much complexity has been deliberately created, to encourage consumers to pay more than they need, or expected. Or to reduce the likelihood that they will switch to another supplier. Mr Cameron’s objective that people should simply be given the cheapest tariff for their needs is sound. But Ofgem’s document illustrates the difficulties in making this happen.

Artificially manufactured tariff complexity is endemic in the utility and financial services sectors. Yet these are sectors with particularly active and intrusive regulators. The paradox is that regulation has not only failed to relieve the problem but may actually have made it worse. The economic model in the minds of regulators is one where competition ensures efficient outcomes if consumers are given appropriate information. Their preferred remedy is therefore to promote competition and require suppliers to provide more information.

But that economic model does not predict efficient outcomes if sellers know far more about prices and products than buyers. Such information asymmetry is inevitable. Phone companies have large departments working on pricing strategies. You have only a minute or two to review your bill.

When you shop, you mostly rely on the reputation of the supplier to give you confidence that you are not being ripped off. But in the regulated environment of utilities and financial services, there seems little to choose between the – generally low – reputations of suppliers. All seem ready to push the limits of whatever regulatory rules are imposed.

The problem is less the weakness of competition than its effectiveness. Whatever one supplier does, others are forced to follow if they are to protect their markets and their returns. In the UK many banks have been caught in a scandal over the mis-selling of payment protection insurance, which covers debt repayments if the borrower becomes ill or loses their job. Several of the banks knew their conduct was disgraceful, but the mouth-watering margins on sales of PPI led to intensified competition for the loans that enabled PPI to be sold. That competition eventually also lowered profits. In the long run, all the companies involved would have been better off if they had made an – illegally anti-competitive – agreement to stop selling PPI.

And so with energy tariffs. If the result of Ofgem’s consultation is an extended set of prescriptions of how information must be displayed, companies will fulfil the letter but not the spirit of these rules. In financial services key facts documents have not proved effective in educating consumers, or prescribed interest rates in stopping bad lending practices.

Perhaps Mr Cameron should use his position not to threaten legislation, but to persuade the small number of energy suppliers to reach an agreement on future conduct. In this way, he could help companies extricate themselves from a mire of competitive misinformation. That would benefit both suppliers and customers in the long run.

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