Carbon Briefing: What could energy price fixing mean for consumers and markets?
Gas prices are always big news, but news this week that energy companies may have been attempting to ‘fix’ UK gas markets appears pre-programmed to push our buttons. From energy bills to international fears for wider energy security, we look at some key questions around the gas market fixing allegations.
Gas and electricity market fixing allegations
The story broke on Monday when a whistleblower working at gas price reporting firm ICIS Heren drew attention to anomalies in gas prices. Other price reporters then suggested that price fixing may also be happening in the electricity market.
Both the FSA and Ofgem are investigating the case. As energy secretary Ed Davey has warned, if companies are found guilty of price fixing they can be fined up to 10 per cent of their turnover, and individuals could face prison sentences of up to five years.
What’s Libor got to do with it?
The Guardian described the alleged scheme as a “Libor-like” scandal. Libor, short for London interbank offered rate, the benchmark interest rate large international banks use to borrow money from each other.
In June last year, Barclays bank agreed to pay £290 million to settle accusations by US and UK competition authorities that it had improperly manipulated Libor rates to boost profits. The manipulation affected the rates consumers pay on Libor-linked products like mortgages and student loans. The biggest losers appear to be large savers such as charities, who may have had their interest payments depressed. 10 other banks are under investigation and criminal cases in the US and UK may also follow.
This isn’t the first time commenters have highlighted that that energy markets are vulnerable to Libor-style pricing manipulation. Just like the Libor exchange and the gas and electricity markets, the market that decides the price of oil isn’t regulated, relying on companies to submit accurate data. A report from the G20, published in July, warned that banks, oil companies and hedge funds have an “incentive” to distort the market by reporting false oil prices, in order to boost profits.
How did the alleged gas manipulation work?
The energy whistleblowers are saying companies trading on the gas and electricity markets – are doing a similar thing to what the Libor price fixers allegedly did. Companies that trade in this way include the UK’s ‘big six’ energy companies – who deny price fixing – although there are many others.
Companies buy and sell gas within the wholesale market. As Channel 4 explains, price reporting agencies use the price of gas agreed between each buyer and seller, as well as how much the seller asked for, to set benchmark prices which help guide the market.
They do this by asking various sources the price at which the gas was traded every day to build a picture of where gas was trading. Benchmark prices are “critically important”, the Guardian says, “because many wholesale gas contracts are based on them and small changes in the price can cost or save companies millions.”
On the 28th September, which marks the end of the gas industry’s financial year, gas price reporter Seth Freedman says he noticed discrepancies in trading data which led him to believe traders were reporting lower than actual sale prices in an effort to get the price reporters to push the benchmark price down. The benchmark price on this day is particularly important, as it has knock-on effects for the following year, influencing future prices. The wholesale price of gas also affects how “companies set their retail price, and what consumers pay”, Channel 4 says.
How these apparent attempts to manipulate the market benefit companies isn’t immediately obvious. But Freedman told the Guardian he’d noticed a string of dips in the reported price of gas on the 28 September, forcing down the prices companies pay for the new financial year. Professor Monica Giuliette told Channel 4 News that it’s in the interest of big companies to keep gas prices low because they hold large portfolios of products with prices linked to that of gas, meaning they may benefit in the long run from lower prices.
What’s the impact on the consumer, especially energy bills?
The effect on the consumer – and more specifically energy bills – is also more complex. Generally, by keeping prices low, the bigger companies are able to price smaller competitors, who aren’t able to spread the hit from lower gas prices, out of the market. Without smaller companies to compete with the big companies – which Ofgem calculated in a 2011 report control 99 per cent of the market – there’s no-one to challenge the big players’ tariffs.
Despite the complexity of the case, politicians apparently see this case as one that could yield easy wins with the public. A Treasury official has already made the connection, telling the Guardian:
“When people are struggling to pay their gas bills of over £1,000 – the average is about £1,300 – the idea that the bill they are struggling to pay people may be profiting from manipulating is totally unacceptable”.
This is a politically contentious area – combining potential impacts on energy bills with an echo of potential banking misconduct. Public sympathy is likely to be particularly low given gas companies’ announcement that they will be raising household energy bills this winter.
How could this link to other investigations?
Ofgem has already investigated the ‘Big Six’ energy companies’ market dominance. Although it found no evidence of unfair pricing activities, it has called for greater transparency in the gas market in response to finding that falls in energy bills happen much more slowly than rises do.
Following its inquiry, Ofgem has required energy companies to show more transparently how increases in energy bills break down – although some have claimed the breakdowns included with this year’s price rise announcements don’t make the true cost of each contributor clear enough.
Ofgem’s current investigation of energy companies’ pricing practices marks the 19th such look at the way these companies behave on the market. Yet, the regulator has limited powers to deal with the way prices are benchmarked, so it can do little to change the structure of the market. Indeed, in this video, Freedman explains why people in the gas industry believe Ofgem has no powers to investigate price fixing. Labour is calling for Ofgem to be replaced with a new energy regulator with the ability to change the way energy is traded.
International implications
The allegations may also have international implications, just as the Libor investigation did. The UK’s National Balancing Point is the biggest spot pricing hub for gas in Europe, covering all entry and exit points on mainland Britain, so other countries’ competition enforcers may investigate whether any price manipulation has affected their own gas and electricity markets.
The possible fallout could be particularly serious given that the European Commission has just started investigating claims that Russia’s gas giant, Gazprom, is abusing its dominant position in the European energy market by preventing member states from diversifying their gas supplies. The EU’s current energy package dictates gas supplies should become increasingly interconnected, and more of the gas on the European market will be spot priced.
Public anger over higher energy bills, and European fears that price fixing could undermine the EU’s long-term energy plans, mean companies could face costly investigations and fines both in the UK and overseas. Yet structural reform of the market could still be a long way off.