Understand the Energy Market

Understand the energy market: What am I actually paying for and who do I pay really?Geek John and Energy Market

What does my Energy Supplier actually do?

Technically your energy supplier is the company that buys the energy on your behalf on the energy market and bills you for the amount of energy you use. This is true of both gas and electricity. The easiest way of understanding the true nature of a supplier is by imagining them as:

  1. Giant billing engine with a back office of traders, analysts and modellers that create the systems and activities necessary to manage the fact that no one knows how much energy they are going to use until they have used it (and sometimes not even then if the meter isn’t actually read!)
  2. And secondly as an enormous revolving credit facility because they need to buy the energy on the energy market in advance of you using it, at which point you will quite often be paying for it 3 months in arrears. If you take your quarterly energy bill (approx. £300 for example), multiply it by 4 million homes which is slightly less than 1/6th of the UK’s homes, and that gives you a feel as to how much credit they are managing each month – £1.2 billion

Many of the problems you encounter are a function of energy suppliers trying to manage these – at first glance simple – activities in order to make money and reduce risk for their shareholders, and we will return to this aspect of the energy market in a later section if you are still awake and interested.

Suffice to say at this point that it is because they are the ones that do the billing that they are the well-known brands; after all it is them that you do deals with and whose energy bills you see each month/quarter, it is them that you blame when things go wrong and it is them that spend all that marketing money on sponsorship, feel good advertising, door knockers, boiler insurance initiatives and brand enhancement. But are they the only instrument in the orchestra or are they simply the loudest?

If my Supplier doesn’t generate the electricity or drill for the gas then who does?

There is a separate crowd of companies that actually produce the electricity or extract the gas that is then sold on the energy market, a term that has become synonymous with the confusion and mistrust that pervades the energy industry; and we explore and hopefully demystify that knotty issue here. Theoretically therefore there is a virtual energy market place where our well known, brand conscious suppliers are buying large chunks of bulk energy from these other not very well known generators (and upstream gas producers who as an aside are normally much better known for their oil production – Shell, BP and the like). It is here, at this assumption, that we encounter a somewhat thorny problem.

In the energy market, it turns out that the conductor, the strings section and the tuba are all part of the same family and aren’t actually individuals in their own right – or at least not as we would like them to be. To take the virtual market analogy – it would appear that our well known suppliers also own much of the means of production as well; or in business speak they are vertically integrated. This means that we have what is known as an “illiquid” energy market (relatively few transactions) which in turn means that a comparison of “true” energy market prices and these illiquid traded energy market prices may be materially different due to the fact that most of the action, as it were, is going on within the walls of these vertically integrated businesses, far from external observation. This doesn’t mean that anything untoward is happening, but it does mean the energy market is somewhat opaque.

So I now know who produces it and who sells it, but who moves it?

When the energy market was deregulated the key to making that deregulation work was the splitting up of the suppliers (the sales team) and the transportation infrastructure owners (the guys who inherited the transmission and distribution assets – we’ll call them the operators). The operators would have their prices regulated to ensure that they could not abuse the captive market they had through virtue of a geographic monopoly. This system continues today. In the case of the electricity market the owner of the transmission network (extra high voltage power lines etc) is National Grid. They also own the old gas pipelines of Transco. Their prices are regulated by OFGEM on a regional basis – these prices being a function of complex formula designed to ensure that National Grid do not engage in profiteering whilst at the same time ensuring that they have the funding and the incentive to make the necessary upgrades to our vital energy transportation infrastructure. In the case of electricity there are also localised distribution network operators (14 on mainland Great Britain) that run the high voltage and low voltage distribution systems, along with substations and transformers, that move electricity around your local area. These 14 distribution areas replicate the old energy company areas that you may remember from the days before regulation. These companies – called DNO’s – also have their prices regulated by OFGEM for the same reasons as National Grid is regulated. So whilst everyone in a DNO area is secure in the knowledge that the costs of transportation and distribution in their area are regulated, these costs are not the same between areas which is why we and other switching sites ask you for your postcode – we need to know which DNO area you are in so that we can ensure that we are comparing the right prices from suppliers. So whilst you never get to directly deal with the distribution and transportation companies, you are paying them through a fixed charge that your supplier incorporates into your bill each month.

If you are a real Geek, who always want to know more, have a look at the Energy Saving Trust website to learn more about energy.