Consumer inertia in energy markets: a sobering lesson from Italy
20 July 2015
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Government and Institutions
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The British retail markets for electricity and gas are not delivering. But is the proposed cure better than the disease itself?
The Competition & Markets Authority has recently released its provisional findings and a notice on possible remedies following up a specific request from Ofgem. The inquiry finds that energy markets are plagued by several problems, the most important ones being over-regulation and low consumer engagement. In order to address the former, it reasonably suggests to reshape those regulation (such as the so-called “simple choices” package) that are least effective, by either deregulating or turning to smarter regulations. As far as the latter is concerned, though, the CMA proposes that Britain – the first EU member state to liberalise energy far before Brussels introduced its directives – goes back to the mother of all regulations: price control, or, to be fair, a softer version thereof.
The CMA explains that, according to an extensive survey it has performed, 34% of the British consumers have never even considered switching supplier. The number of those with sticky habits is higher among the poor and the less educated. Consumers’ inertia may have boosted energy suppliers’ profits by as much as £1.2bn in 2009-13.
Promoting greater engagement through more transparent information, or by removing harmful regulations that prevent suppliers to better customise their commercial offers, is not enough, says the CMA: a “transitional safeguard regulated tariff” should be introduced, in order to “provide direct protection to disengaged customers”. This may seem both reasonable and simple, but it is neither. As the CMA itself admits, “if [the price] is set tightly, it will have a damaging effect on competition, undermining incentives for customers to engage in the markets. On the other hand, if set at too high a level, then at best it will provide no protection to customers, and at worst potentially provide a higher focal point for default prices to settle”.
Even if one buys the argument that disengaged consumers must absolutely be woken up, one should be careful of the unintended consequences of the proposed policies. Despite a relatively high proportion of “sleepy customers”, the UK still displays switching rates well above the EU average (slightly above 12% in 2013, vs an EU average of 4%).
Luckily enough, the British do not need to implement such a complex reform to check whether the supposed protection of the inert is worth the potential cost of disengaging the most dynamic customers: they just need to look at what happens in Italy.
Italy opened up its retail electricity market in 2007. Ever since, though, a programme has been in place to protect disengaged customers by making available what might be described as a “transitional safeguard regulated tariff”. The so-called “maggior tutela” (“higher protection”) applies to all households or SMEs who have not chosen a supplier on the market. The price they pay, which is set on a quarterly basis by the regulator, is formally being defined as a “market price”, rather than a regulated price, insofar as it reflects a) the procurement costs incurred by a public entity (Acquirente Unico, or Single Buyer) in charge of purchasing power on behalf of the “clienti tutelati” (protected customers); b) a commercialisation fee which is set by the regulator at a level which is supposed to match the cost of entry of a new entrant into the market.
If the CMA is right, one would expect to find in Italy a) higher switching rates and b) fewer disengaged customers. The data do not seem to support that theory. Switching rates in Italy – while not negligible – were well below the British benchmark (7% in 2013, up from a 4% average in 2008-12). What should ring an alarm bell at the British antitrust authority, though, is the figure of those who stand still under the “transitory” umbrella of the “maggior tutela”: In 2014, 7 years after the liberalisation, 22.2m out of 29.6m of households (72%) and 4.2m out of 7.4m of SMEs (57%) did not choose their supplier. (The actual figure is slightly lower because there is a small flow of people moving back from the free market into the maggior tutela). A survey performed by the national regulatory authority found that 73% of the respondents have never changed their supplier.
The main reason why the Italians are this “disengaged” is certainly not because of prices. Those seeking to save money can find very good offers on the free market – up to 10-12% less than the reference price. Neither is it the lack of variety on the supply side: a growing number of offers is available that allow consumers to best meet their preferences with regard, for example, to green energy, fixed versus variable prices, or more complex services such as energy efficiency devices or various insurance policies which are bundled in the price they pay for the kWh.
There are, of course, several explanations for the widespread disengagement. But one can hardy ignore the elephant in the room: a state-backed tariff which is supposed to grant “higher protection”. This has at least two consequences. On the supply side, a standard offer that covers a large share of the relevant market may work as a focal point – at the very least it works as a benchmark, as the CMA itself recognised. On the demand side, it may still generate a sort of “feel safer” effect, so that customers’ propensity to switch is reduced accordingly. Ironically, the Italian government has just proposed a roadmap to overcoming this problem.
The CMA might consider visiting Italy to examine the unintended consequences of “transitory” attempts to control the outcomes of the market or to change consumers’ preferences.
Dr Carlo Stagnaro is a Senior Fellow at the Milan-based Instituto Bruno Leoni. Prof Philip Booth is the IEA’s Editorial and Programme Director and Professor of Finance, Public Policy and Ethics at St. Mary’s University.
The Competition & Markets Authority has recently released its provisional findings and a notice on possible remedies following up a specific request from Ofgem. The inquiry finds that energy markets are plagued by several problems, the most important ones being over-regulation and low consumer engagement. In order to address the former, it reasonably suggests to reshape those regulation (such as the so-called “simple choices” package) that are least effective, by either deregulating or turning to smarter regulations. As far as the latter is concerned, though, the CMA proposes that Britain – the first EU member state to liberalise energy far before Brussels introduced its directives – goes back to the mother of all regulations: price control, or, to be fair, a softer version thereof.
The CMA explains that, according to an extensive survey it has performed, 34% of the British consumers have never even considered switching supplier. The number of those with sticky habits is higher among the poor and the less educated. Consumers’ inertia may have boosted energy suppliers’ profits by as much as £1.2bn in 2009-13.
Promoting greater engagement through more transparent information, or by removing harmful regulations that prevent suppliers to better customise their commercial offers, is not enough, says the CMA: a “transitional safeguard regulated tariff” should be introduced, in order to “provide direct protection to disengaged customers”. This may seem both reasonable and simple, but it is neither. As the CMA itself admits, “if [the price] is set tightly, it will have a damaging effect on competition, undermining incentives for customers to engage in the markets. On the other hand, if set at too high a level, then at best it will provide no protection to customers, and at worst potentially provide a higher focal point for default prices to settle”.
Even if one buys the argument that disengaged consumers must absolutely be woken up, one should be careful of the unintended consequences of the proposed policies. Despite a relatively high proportion of “sleepy customers”, the UK still displays switching rates well above the EU average (slightly above 12% in 2013, vs an EU average of 4%).
Luckily enough, the British do not need to implement such a complex reform to check whether the supposed protection of the inert is worth the potential cost of disengaging the most dynamic customers: they just need to look at what happens in Italy.
Italy opened up its retail electricity market in 2007. Ever since, though, a programme has been in place to protect disengaged customers by making available what might be described as a “transitional safeguard regulated tariff”. The so-called “maggior tutela” (“higher protection”) applies to all households or SMEs who have not chosen a supplier on the market. The price they pay, which is set on a quarterly basis by the regulator, is formally being defined as a “market price”, rather than a regulated price, insofar as it reflects a) the procurement costs incurred by a public entity (Acquirente Unico, or Single Buyer) in charge of purchasing power on behalf of the “clienti tutelati” (protected customers); b) a commercialisation fee which is set by the regulator at a level which is supposed to match the cost of entry of a new entrant into the market.
If the CMA is right, one would expect to find in Italy a) higher switching rates and b) fewer disengaged customers. The data do not seem to support that theory. Switching rates in Italy – while not negligible – were well below the British benchmark (7% in 2013, up from a 4% average in 2008-12). What should ring an alarm bell at the British antitrust authority, though, is the figure of those who stand still under the “transitory” umbrella of the “maggior tutela”: In 2014, 7 years after the liberalisation, 22.2m out of 29.6m of households (72%) and 4.2m out of 7.4m of SMEs (57%) did not choose their supplier. (The actual figure is slightly lower because there is a small flow of people moving back from the free market into the maggior tutela). A survey performed by the national regulatory authority found that 73% of the respondents have never changed their supplier.
The main reason why the Italians are this “disengaged” is certainly not because of prices. Those seeking to save money can find very good offers on the free market – up to 10-12% less than the reference price. Neither is it the lack of variety on the supply side: a growing number of offers is available that allow consumers to best meet their preferences with regard, for example, to green energy, fixed versus variable prices, or more complex services such as energy efficiency devices or various insurance policies which are bundled in the price they pay for the kWh.
There are, of course, several explanations for the widespread disengagement. But one can hardy ignore the elephant in the room: a state-backed tariff which is supposed to grant “higher protection”. This has at least two consequences. On the supply side, a standard offer that covers a large share of the relevant market may work as a focal point – at the very least it works as a benchmark, as the CMA itself recognised. On the demand side, it may still generate a sort of “feel safer” effect, so that customers’ propensity to switch is reduced accordingly. Ironically, the Italian government has just proposed a roadmap to overcoming this problem.
The CMA might consider visiting Italy to examine the unintended consequences of “transitory” attempts to control the outcomes of the market or to change consumers’ preferences.
Dr Carlo Stagnaro is a Senior Fellow at the Milan-based Instituto Bruno Leoni. Prof Philip Booth is the IEA’s Editorial and Programme Director and Professor of Finance, Public Policy and Ethics at St. Mary’s University.
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It is disappointing that the CMA have failed to note the impact of OFGEM’s benchmark – the Supply Market Indicator – on prices. It is designed to justify the heaping of added costs onto customers, and obfuscate rather than clarify. It accepts without question the added costs imposed by greenergy (as OFGEM is required to do by Miliband’s 2010 Energy Act), much of it hidden in increased transmission charges necessitated by the loss of reliable capacity and its replacement by wind farms distant from the centres of demand. It imposes a cost of a long forward hedge on consumers without comment, and does so in a very untransparent manner – there is no open market price benchmark that equates. Of course, this suits energy companies and complacent regulators very well.
If we really want lower bills, then we need a reliable, low cost network of generators – something that the CMA dares not mention (I assume that the DECC and OFGEM know that CMA stands for Cover My A…). We need far greater transparency in pricing benchmarks: I can look up the price of coal and of NBP gas, and of power traded on exchanges, and form a far more meaningful view of the extent to which we’re being ripped off – primarily by GOVERNMENT POLICY – with the lap dog oligopoly merely doing the politicians’ bidding while acting as convenient intermittent whipping boys.