Leading article: Energy market is not working in the interests of customers

Movements in the wholesale price of energy only get passed on to customers when they rise

The great energy rip-off continues. British Gas customers recently discovered that their gas bills will rise by 18 per cent and their electricity bills by 16 per cent from next month. Yet Centrica, the parent company of British Gas, yesterday announced that its dividend to shareholders will increase by 12 per cent. And the group's chief executive expects profits for the year as a whole will rise. It is small wonder that customers are furious.

When the UK energy market was liberalised in 1998, it was argued that competition between separate providers would keep down prices and also force firms to improve their customer service. Neither has been delivered. Prices have been an upwards ratchet. British Gas argues that it has no choice but to increase its domestic fuel prices next month because the wholesale price it pays for gas and oil itself has shot up. The same argument is made by the other "big six" energy firms, who have also increased their domestic prices sharply. Yet movements in the wholesale price of energy only seem to get passed on to customers when they rise. When the wholesale price fell three years ago, domestic bills did not budge. Heads – the energy companies win, tails – the customer loses.

General customer service has been terrible too. A report from the Commons Energy Committee this week accused energy companies of using "Del Boy sales tricks" to pressure customers to switch to more expensive contracts. And British Gas has just been fined £2.5m by the industry regulator Ofgem for failing to deal with customer complaints properly.

What we have here is a clear picture of market failure. The sector is dominated by firms that are "vertically integrated", which means that they both produce energy and sell it to customers. The fact that they can make fat profits at both ends of the supply chain means that the pressure on them to compete for share in the domestic market is drastically reduced. There are also simply too few firms for competitive forces to drive down prices. It was a grave mistake for the regulatory authorities to allow such a level of consolidation to take place. The advantages of vertical integration also mean there are large barriers to entry for potential new players.

Customers have also been let down by a weak regulator, in Ofgem, which has allowed the energy firms to get away with hopelessly confusing tariff pricing structures and behaviour towards poorer customers (in the form of pre-payment meter rates) that has bordered on the exploitative.

In theory, there is nothing wrong with private energy firms making large profits. Profits can be an indication of efficiency. And those revenues can be reinvested in new infrastructure, which should ultimately benefit the consumer. Yet profits that arise from the gouging of customers are simply unacceptable.

The solution is radical action to increase the number of players in the market. The Competition Commission should be asked to review the functioning of the sector without delay. And the Government should be prepared to break up the big six if that is what the commission recommends. We also need a tougher system of regulation, one that will force this market, at long last, to start working in the interests of customers, rather than producers.