Ofgem (the Office of Gas and Electricity Markets) has warned consumers and the Government that the soaring gas prices will feed into customer bills, causing prices to rise. The typical gas and electricity customer is likely to see their bill go up by £139 to £1,277 a year from October. This is due to the rise in the price of fossil fuels.
There are several factors that may be influencing these rising prices.
Firstly, the loosening of Coronavirus restrictions has caused a massive recovery in the global demand for gas. This has resulted in Gas producers tightening their markets and raising prices.
Secondly, the strong discipline of the OPEC nations related to their agreement to limit gas and crude oil exports means that they can regulate price levels, thus explaining why prices have risen.
To explain this second point more, OPEC is technically a cartel. Although this agreement is illegal and violates competition laws, they have never been challenged by a Governmental body.
A Cartel is an organisation created from a formal agreement to regulate supply between a group of producers for a good or service. This enables them to manipulate prices. Those that are hurt the most by these agreements are consumers.
Cartels need to have a strong trust in one another however because if a member broke the cartel agreement (and, for example, increased production levels), they would benefit significantly while those that keep the agreement would lose out. Therefore, often cartels are not sustainable, however, OPEC is a rare example, having existed for over 80 years.
However, in some cases, cartels can be beneficial to consumers. With prices regulated by levels of production and mutual agreement of prices, prices do not fluctuate. Although this means they are often high, firms and households can plan ahead as they know prices for goods or services will remain stable. This encourages investment throughout the economy, boosting aggregate demand and causing an increase in real GDP.
However, in the case of energy prices, a rise in energy prices will have many negative impacts on households.
Electricity is a necessity, with almost all households using it for daily tasks such as cooking and lighting. This results in electricity having an inelastic price elasticity of demand, and so when prices rise, the quantity demanded will not alter.
This causes a rise in household expenditure, especially for those with low incomes. The issue is further magnified with the oncoming of winter, as energy usage will rise dramatically due to the necessity of heating.
Because of the damaging effect a rise in energy price has for many households across the UK, Ofgem regulates the price of gas to ensure prices do not skyrocket. This has occurred in the EU, with the price of natural gas tripling due to no regulatory organisation.
The price cap in the UK limits the price that companies can charge customers who have not recently changed their tariff or energy supplier, and allows them only to charge legitimate costs. However, this has still not fully addressed the situation.
To reduce costs, Ofgem suggests switching energy providers for lower prices, signing up to a fixed tariff to keep bills stable whilst using energy-efficient appliances.
However, the energy market is renowned for irrational consumer behaviour.
Complex paperwork and time required to switch energy providers result in habitual behaviour and computational weakness.
Habitual behaviour refers to a form of behaviour that is automatic and routine, and so is repeated due to its ease rather than for the utility gained. Therefore, many energy consumers will not switch providers for years as it is a lengthy process and they are not familiar with other providers.
Computational weakness occurs when consumers find it difficult to calculate the utility gained from switching, and do not have the time or energy to do so. This again results in many energy customers never switching contracts. This issue is further magnified when there are many firms operating in the same market, as there are more options to evaluate and make a decision on.
The Government aims to tackle the growing issue of rising energy costs by working towards ensuring that green energy is the majority of the UK's energy production. This will not only benefit consumers but also have positive externalities on the environment.
However, even with green energy, the issues existing in the crude oil and fossil fuels markets (that being cartels and irrational consumer behaviour) may still exist. Therefore, the Government may need to take further steps in preventing these existing problems from transferring to the new emerging market.
Written by Charlotte Hurst