Introduction

On 7 July 2015, the Competition & Markets Authority (CMA) published its provisional findings arising out of its investigation into the market for the supply and acquisition of energy in Great Britain. The CMA has identified a number of features of the wholesale and retail markets for electricity and gas that it provisionally considers gives rise to an adverse effect on competition (AEC). The CMA invites comments on the provisional findings and proposed remedies by 31 July 2015.

Overview of the CMA’s findings

The CMA has provisionally found that:

  • electricity generators do not have market power.
  • there are no features in wholesale gas markets that lead to an AEC
  • there is no evidence of tacit co-ordination between retail suppliers in relation to price announcements. In particular, the CMA does not have any evidence of suppliers using price announcements as a mechanism to signal their intentions in relation to the pricing of their standard variable tariff (SVT).
  • the presence of vertically integrated companies does not have a detrimental effect on competition in these markets. It therefore seems that calls for the break-up of the largest six suppliers were an over-reaction.

These issues are considered further below.

Provisional findings

Competition in wholesale gas and electricity generation markets

The CMA found that competition in the wholesale gas and electricity generation markets generally works well. There is no evidence to suggest that the main energy firms earned excessive profits from their generation business or that wholesale market prices were above competitive levels. One feature of the market that does constitute an AEC, however, is the absence of locational pricing for transmission losses. The CMA provisionally found that the current system of uniform charging for electricity transmission losses creates a system of cross-subsidisation that distorts competition between generators and is likely to have both short-run and long-run effects on generation and demand (higher costs and inefficiencies in location of generation plants).

The CMA also identified the mechanisms for allocating Contracts for Difference (CfDs) as a feature giving rise to an AEC. CfDs are long-term contracts which are intended to provide stable and predictable incentives for companies to invest in low-carbon generation. They form a key part of the Electricity Market Reform Programme and are intended to reduce investors’ exposure to volatile and rising fossil fuel prices. This is done by paying a variable top-up between the market price and an estimate of the long-term price that is needed to bring forward investment in a given technology, known as the "strike price". The CMA has found that some elements of the CfD allocation process currently in place potentially restrict the use of competition in setting the strike price in the future. The CMA also has concerns about the division of technologies into particular "pots" under the CfD. It calls for the Department of Energy & Climate Change (DECC) to regularly monitor this division and provide a clear justification for the allocation of budgets between pots.

Vertically integrated electricity companies

The CMA considers that vertical integration of energy generators and suppliers is not problematic for competition. In particular:

  • the CMA has found no evidence that independent (non-vertically integrated) generators are unable to compete effectively because of the prevalence of vertically integrated suppliers. Continued investment in independent generation suggests that this is not of concern to operators
  • the CMA considers that the lack of unilateral market power makes it implausible that vertically integrated generators would be able to discriminate by refusing to supply independent (non-vertically integrated) suppliers, or by supplying them on worse terms. The recent growth of independent retailers suggests that they have not been foreclosed from the market in this way
  • the CMA's analysis of wholesale market liquidity suggests that vertically integrated firms carry out extensive external trading, and liquidity in the product that vertically integrated firms use to hedge their exposure to wholesale market risk is sufficient for independent firms to hedge in a similar way. Therefore, vertical integration does not seem to raise barriers to entry and growth by new suppliers due to difficulties in securing sufficient wholesale supply.

Microbusinesses

The CMA is concerned that many microbusinesses appear to show limited engagement with the energy market and have little apparent interest in, or awareness of, their ability to switch supplier. For example, in 2013, 45 per cent of microbusinesses were on default electricity tariffs – these would not have been actively negotiated between the energy provider and customer. Potential remedies are discussed below.

Competition in retail markets

The CMA has identified three particular areas in which domestic retail markets may not be working well for customers:

  • weak customer response and lack of engagement with domestic retail energy markets
  •  the ‘Big Six’ energy companies (British Gas, Eon, EDF, nPower, Scottish Power and SSE) enjoy unilateral market power over their respective inactive customer base (i.e. the high numbers of customers that have not, and are unlikely to, switch to a cheaper tariff and therefore remain on the standard tariff), which they have been able to exploit through their pricing policies
  • the regulatory framework governing domestic retail market competition.

The CMA investigation has shown that savings that are available to a significant number of domestic customers are ignored. Those customers who are associated with certain demographic characteristics, such as low incomes, tend to be less engaged with the domestic retail energy markets; specifically, they tend to stick with the same supplier. Reasons why customers are prevented from understanding the energy market and making informed decisions about their supplier and tariff include the use of conventional meters which are not always visible, user-friendly or informative, and the public perception – of the complexity and burden of the process associated with trying to find a better energy deal; as well as a lack of access to the internet. The CMA is concerned that the lack of customer engagement gives energy suppliers a position of unilateral market power, thus affecting their behaviour and causing suppliers to exploit their position through their pricing policies(such as pricing their SVT above a justifiable level).

Using tariff data over the period 2012 to 2014, the CMA found that customers who were on a tariff with the cheapest of the 'Big Six' energy firms were paying around £95 less than a customer on a tariff with the most expensive of the 'Big Six' energy firms. The CMA does not yet have the same level of information regarding mid-tier suppliers to be able to include them within the analysis; however, evidence does suggest that the average domestic prices offered by the 'Big Six' are above the competitive benchmark level, with tariffs being offered by mid-tier suppliers around £30-£40 cheaper than the cheapest tariff offered by a 'Big Six' energy firm.

Ofgem

Ofgem has been criticised in the provisional findings, with the CMA noting some decisions Ofgem took that did not have the effect of promoting competition:

  • not approving the introduction of locational charging of transmission losses
  • prohibiting regional price discrimination between 2009 and 2012
  • introducing the four-tariff rule.

In Ofgem’s defence, the CMA also noted that the later two of these decisions were taken against a background of the DECC stating its readiness to use its powers to implement changes in primary legislation if Ofgem did not act, with implications for Ofgem’s independence.

Possible remedies

The CMA is consulting on a number of remedies (aimed at giving customers information to help them make choices) and market-opening measures (which aim to remove or reduce barriers to entry, or make it easier for customers to switch). These include:

  • disengagement by domestic and microbusiness customers – a number of remedies are proposed to tackle the CMA's central finding – lack of customer engagement – including the roll-out of smart meters; a penalty for firms that fail to switch customers within the mandated period; the introduction of specific measures to facilitate switching for customers living in rented accommodation; Ofgem to provide an independent price comparison service. A key proposal is the introduction of a “default” regulated tariff for those disengaged customers who do not switch
  • the simpler choice component of the RMR rules – remove from domestic energy suppliers' licences the "simpler choices" component of the RMR rules, which would seek to enhance competition amongst domestic retail energy suppliers by allowing them to offer customers as many tariffs and/or tariff structures as they wished. This would give domestic retail energy suppliers an incentive to tailor tariffs to the needs and/or preferences of different customers, allowing them to compete vigorously for these customers.
  • absence of locational adjustments for transmission losses – the introduction of a new standard condition to electricity generators', suppliers', interconnectors' transmission and distribution licences to require that variable transmission losses are priced on the basis of location in order to achieve technical efficiency
  • administration of CfD mechanism – DECC to undertake and consult on a clear and thorough assessment before allocating technologies between pots and the CfD budget to the different pots; separately, DECC to undertake and consult on a clear and thorough impact assessment before awarding any CfD outside the CfD auction mechanism
  • regulatory framework - the CMA proposes giving Ofgem more “teeth” by measures including: revising its statutory objectives and duties to increase its ability to promote effective competition; introducing a formal mechanism to address disagreements with DECC over policy decisions; improving the accounting framework so that Ofgem has a better, more consistent set of data from suppliers to work with; and giving Ofgem more powers to develop and implement code changes.

Remedies not being considered include:

  • price control regulation of all domestic and microbusiness retail energy tariffs
  • requiring energy firms to inform customers about the cheapest tariff on the market
  • opt-out collective switching of disengaged customers
  • introduction of a single price for gas and electricity customers
  • introduction of price non-discrimination provisions
  • a transitional safeguard regulated price structure (save as to the proposal for the introduction of a “default” regulated tariff for those disengaged customers who do not switch)

Comment

The background to the CMA’s market investigation was major concerns about the effectiveness of competition in the energy market, accusations of profiteering by the ‘Big Six’ energy companies and a loss of trust and engagement on the part of energy consumers.

The CMA’s report recognises that competition is working well in the wholesale gas and electricity market, despite the presence of vertically integrated firms. However, the CMA has highlighted specific features of the retail market that it considers may be hindering competition. The CMA’s main concern is that customers may have limited awareness of their ability to switch or a lack of interest in switching. One of the CMA’s key recommendations is the introduction of a 'default' regulated tariff for those disengaged customers who do not switch. Whilst welcome from the consumer perspective, this is a relatively soft change given the original speculation of a more radical measure to break-up the 'Big Six' energy companies. Given that the CMA presently lacks sufficient data regarding prices/costs of mid-tier suppliers, such companies might anticipate receiving requests for information.

The CMA has further questions, as addressed in its provisional report, which will need to be answered before a comprehensive picture of the current state of competition within the energy market can be drawn; for example, whether the average domestic prices offered by the 'Big Six' are above those that would be expected in a well-functioning competitive market. The CMA plans to publish its final report by the end of the year.

If your business is likely to be affected by the ongoing market investigation or if you require further information, please feel free to contact any member of our Competition or Energy teams.