On 24 July, the CMA published its Issues Statement setting out four “theories of harm” it is minded to focus on during its investigation into the GB energy market.  

In setting out to explore these issues the CMA notes that, while one valuable outcome of this process is to identify any features of the market that it considers to be having an ‘adverse effect on competition’ (AEC) and addressing those through remedies, an equally valuable outcome might be to investigate a contentious area or issue of high public concern and explain why there is no AEC.  In doing so, the CMA is clearly seeking to manage expectations as to what it may be able to achieve through this process.

Theory 1: Opaque prices and /or low levels of liquidity in wholesale electricity markets 

The concern here is that opaque pricing and / or low levels of liquidity in the wholesale electricity markets create barriers to entry in retail and generation, perverse incentives for generators and/or other market inefficiencies.  The CMA will seek to consider these issues under two hypotheses, recognising that the current electricity trading rules were designed with strong incentives on generators and suppliers to balance their own supply and demand portfolios by making energy imbalances particularly expensive: 

(a) Impact of market (regulatory) rules

As a first hypothesis, the CMA will consider the extent to which these features of the market can be attributed to the market rules themselves, looking at the regulatory system as well as changes currently being introduced and any need for wider-ranging reforms.  The reforms currently being implemented include: 
 

  • reforms to the system of electricity imbalance pricing, ‘cash out’ arrangements; 
  • the introduction of a ‘Secure and Promote’ licence condition’ to improve liquidity in the wholesale electricity market; and
  • capacity auctions introduced as part of the Government’s EMR programme and the ability of the System Operator (National Grid) to contract in advance for reserve capacity.

(b) Impact of vertical integration

As a second hypothesis, the CMA will consider the extent to which these features can be attributed not to the market rules and regulatory framework but to the structure of the market and the high levels of vertical integration across supply and generation.  Interestingly, the CMA says it will also consider the potential benefits of vertical integration, including for example the ability to hedge against wholesale costs and balancing risks.
  
Theory 2: Vertical foreclosure 

The concern here is that integrated electricity companies harm the competitive position of non-integrated firms.  This can take the form of ‘input foreclosure’, where a vertically integrated firm increases the costs of other energy suppliers, or ‘customer foreclosure’, where a vertically integrated firm reduces the sales of other generating companies (i.e. reduces the number of sales they can make).

Theory 3: Market power in electricity generation leads to higher prices

There are a number of concerns here.  First, while market shares as a whole are relatively low, the nature of demand and supply means it is possible that at certain times of high demand, one or more generators may be able unilaterally to influence the price of generation in spot markets, and possibly other transactions.  Second, certain generators may have local market power at particular times, created by transmission constraints.  This is an issue Ofgem has already looked at in detail both under its competition and regulatory powers, resulting in the introduction of the ‘Transmission Constraint Licence Condition’ which aims to restrict any such exercise of market power.  Third, the CMA may also consider whether there is scope for coordinated behaviour by multiple generators as well as, or instead of unilateral behaviour by generators. 

Theory 4: Weak incentives to compete on price and non-price factors

Here the concern is that energy suppliers face weak incentives to compete on price and non-price factors in retail markets, due in particular to inactive customers (customer inertia) and the findings in the State of the Market Assessment that several characteristics of the markets for the retail supply of gas and electricity were conducive to tacit coordination between the ‘Big Six’ suppliers and may reduce their incentives to compete.  The CMA will also consider whether regulatory interventions, such as the introduction of the non-discrimination licence condition in 2009 and the reforms introduced this year to simplify tariffs, actually reduce the incentives on the suppliers to compete.  Both interventions have been heavily criticised by economists as having a negative rather than positive impact on competition.  

Next steps

The CMA invites responses on its Issues Statement by 14 August 2014.  It welcomes views in particular as to whether there are any reasons why it should not be focussing on the issues it has identified and equally whether there are further issues not identified that it should be considering.  The CMA will be exploring these issues with the key stakeholders over the next few months, holding third party hearings in October and then main party hearings in February/ March next year, working towards issuing its provisional findings and possible remedies (if required) in May / June 2015.  The case timetable is available to view on the CMA’s website.