Consuming Issues: Fuel bills have gone up due to Ofgem stupidity

Now that we've all cranked up the central heating, perhaps it's time to ask why fuel bills are quite so high. MPs will be seeking an answer to that question when the bosses of Britain's six biggest energy companies appear before the Energy and Climate Change Select Committee on Tuesday for what promises to be a few awkward hours.

It's only a shame that Ofgem won't be joining them because the regulator is just as much to blame for the fact that average bills are top-heavy at £1,220 a year.

After all, as the financial journalist Martin Lewis pointed out last week, the power giants are acting rationally by seeking to make as much money as possible: it's the job of Ofgem and the Government to make sure that bills are reasonable.

Admittedly, Ofgem finally took some action last week by launching a review of prices after disclosing that the average margin for a duel fuel bill had spiked by 38 per cent in the past three months, from £65 to £95 (given that the firms generate their own power, I suspect it's much higher than that, but anyway...). But its inquiry is unlikely to end up pointing the finger at one of the main culprits: itself.

A new academic paper published last week suggests that the regulator last autumn made a change to the pricing policies of the Big Six which instead of lowering prices actually had the effect of driving them up.

This is the extraordinary story of the foot-shooting incident, according to Professor Catherine Waddams, director of the ESRC Centre for Competition Policy at the University of East Anglia, and her colleague, Morten Hviid, professor of competition law.

Essentially, after Ofgem found £500m of overcharging in its last inquiry in 2008, it decided to try to stop firms profiteering from customers in their regional powerbases.

These "home" areas, where firms had a monopoly before privatisation in the 1990s, are highly lucrative because millions of people have never switched from their old supplier, perhaps out of a misguided sense of loyalty to their "local" firm, because they don't know they can switch, or because they don't have the financial or mental wherewithal to do so.

Whatever, these "sticky" customers tend to be poorer and less educated than active consumers and get charged more as a result.

So, in the hope suppliers would lower prices for this large block of immobile customers, Ofgem forced energy companies to equalise their profit margin across the country. It banned "price discrimination", essentially saying suppliers should make the same amount wherever they operated.

But, as the professors explain, the opposite happened: suppliers naturally wanted to keep hold of the fat margins in their home markets and so raised prices in their weaker away areas – where they had been offering cheaper prices.

Meanwhile, they competed aggressively for new business by offering cheap "time-limited" offers, the only exception to Ofgem's new rule.

So, since September 2009, when the ban on price discrimination was introduced, a big price gap has opened up between standard prices and these "time-limited" internet deals.

So while smart, mostly middle class, people with home computers have taken advantage of these internet deals, which can be £300 a year cheaper, the vast bulk of other customers have been left no better off and sometimes worse off as suppliers have equalised prices upwards: hence the rising margins over the last year reported by Ofgem.

Now the really interesting point here is that competition theory suggested that this was exactly what would happen; that banning price discrimination would raise prices as players retrenched to their strongest markets with the fattest margins. And Ofgem knew this.

"Ofgem knew because we told them," Professor Waddams told me this week. "And they said: 'Yes, we know this might happen and we'll keep an eye on it.' And they have started an inquiry."

Let me leave you with one more fact: Alistair Buchanan, Ofgem's chief executive, earns – rather, is paid – more than £200,000 a year.

martin.hickman@independent.co.uk