Drivers of gross margins in UK retail electricity

Sammanfattning: This thesis aims at explaining why the UK residential electricity (retail) market enjoys high gross margins in comparison to Vattenfall’s markets in for example Sweden. Gross margin is the difference between selling price and purchase costs, in this case the wholesale electricity price. The wholesale market essentially affects all retailers in the same way and can be analysed separately, therefore it is of great interest to analyse how there can be such a wide gap between the end-user electricity price and the wholesale price. Since the UK electricity market is seen as a forerunner to other markets, being an early adopter of liberalisation of a previously state-controlled industry and seen as the most competitive market in the world, it seems a bit odd that retail electricity prices are not pushed down to a margin cost level as is expected on a perfectly competitive market. The report concludes that there are substantially higher gross margins on the UK market and then goes on to determine which the underlying drivers to this situation are. There are two underlying socio-cultural factors that have driven the development of the market. First it is the history of deregulation that brought lower end-user prices but also bad service experiences. Secondly, the UK public has a market-friendly mentality and acceptance to how the industry works. The result is that focus has moved away from price and there is little public worry about the market being too concentrated. Two more underlying drivers are related to the properties of the market: the linkage between gas and electricity that has lessened the impact of the electricity price and the UK trading system that makes it hard for new retailers to enter the market and put a pressure downwards on prices and gross margins. These four underlying drivers have created a market situation where price has not been perceived as the only value component of electricity and where the focus on price and gross margins has been overshadowed by other issues in the public debate. The troublesome history have produced a ‘demand for brand’ that signals safety, which has helped building substantial barriers of entry and survival for non-incumbents retailers. Together with a highly consolidated market structure, a handful of large retailers are enabled to dominate the market and push up prices with little fear of retribution from competitors or society.