This September the UK's Competition and Markets Authority (CMA) is expected to step up a gear in its energy market investigation.  Fuelled by the summer's responses to its Statement of Issues and asubmission by the UK's energy regulator, Ofgem, the CMA must now take the next steps towards its provisional findings (expected in May/June next year). 

Of particular interest will be the emerging theme of the role of sector regulation and the unintended effects that this can have on competition.  In its submission to the CMA, Ofgem itself highlights that the numerous policy objectives which govern how Ofgem operates may at times conflict with the promotion of effective competition.  Unusually, Ofgem has also faced criticism from five of its former executives who, in a joint submission to the CMA in August, have suggested that over-regulation of the energy market has hindered effective competition and stressed the need to be realistic in terms of what can be expected of the market.  Vigorous debate is likely to continue, given the high-profile and politically sensitive nature of this sector and the Government's pressing desire to rebuild consumer trust and investor confidence in order to achieve energy security at affordable prices. 

What is the energy market investigation?

Ofgem initiated the market investigation by making a formal reference to the CMA under the Enterprise Act 2002 on 26 June 2014. The market investigation regime allows the review of entire sectors where there is a concern that competition is not working well.    

The CMA must determine whether any features of the retail gas and electricity (household and microbusiness only) and wholesale power markets have an adverse effect on competition to the detriment of customers.  If the CMA concludes that this is the case, it must consider whether (and, if so, what) remedial action should be taken.  It has wide-ranging remedial powers including the ability to restructure the industry, for example, by ordering the break-up of vertically integrated companies in order to separate production and generation from distribution and supply activities.  The statutory deadline for the CMA's final report is 25 December 2015.

Why was an investigation needed?

Ofgem made the decision to remove domestic price controls and introduce retail competition in the GB energy sector over ten years ago, but there have been persistent concerns about insufficient levels of competition in the market.  In particular, in its Energy Supply Probe in 2008 and the Retail Market Review in 2010 Ofgem found several features of the market which weakened competition. In recent years Ofgem has faced persistent criticism for not doing enough to address these competition issues and what are perceived as high energy prices in the UK.  In response, Ofgem launched the State of the Market Review, published a joint Assessment with the then competition authority, the Office of Fair Trading and its successor, the CMA, on 27 March 2014 and proposed to refer the energy market to the CMA for investigation. With "near-unanimous" support from consultation responses, Ofgem published its decision to make a formal reference to the CMA on 26 June 2014.

CMA Statement of Issues

In late July, the CMA published a Statement of Issues regarding its investigation, identifying the key characteristics of energy markets that it will consider during its assessment: the non-storability of electricity and the need to balance generation and demand in real-time;

  • the fact that distribution and transmission are natural monopolies;
  • volatility of demand and generation costs;
  • the fact that small-scale customers do not respond to short-term wholesale price changes;
  • the prevalence of regulation; and
  • the external costs of climate change

The CMA recognises two key challenges which it faces when conducting this investigation, namely, identifying the appropriate benchmark against which the energy market should be assessed (a "well-functioning market" would still be one in need of regulation) and appropriately managing a rapidly evolving sector (expected changes include the roll-out of smart meters and the increase of renewable and low-carbon generation).

The CMA lists four "theories of harm":

Theory of harm 1 – lack of liquidity and opaque prices in wholesale electricity markets may create barriers to entry in generation and retail, perverse incentives for generators and/or other inefficiencies in market functioning.

Theory of harm 2 – vertically integrated electricity firms may harm the competitive position of non-integrated companies by increasing the costs of non-integrated suppliers or by reducing the sales of non-integrated generators.

Theory of harm 3 – market power (stemming from peaks in demand or transmission constraints) in generation could result in higher prices.  The scope for coordinated behaviour between generators may also be under scrutiny.

Theory of harm 4 – in retail markets, energy suppliers face weak incentives to compete, both on price and non-price factors.  This may be due to inactive customers or tacit co-ordination between suppliers.  It may also be attributed to regulatory interventions, such as the controversial non-discrimination licence condition (which, by requiring uniform pricing in order to ensure that the best deals are available to everyone, has apparently deterred suppliers from discounting) and the Retail Market Review reforms (intended to simplify tariffs but which may have resulted in a general levelling up of prices).  It will therefore be interesting to see the extent to which the CMA is prepared to criticise Ofgem in its role as sector regulator.

Although the CMA has stated that wholesale gas markets are not directly subject to the investigation, the CMA has stressed that the sector will play an important role its investigation, as the CMA hopes to compare and contrast the wholesale gas and power markets.  Ofgem has also highlighted that it will be important to understand why the benefits of a competitive wholesale gas market are not flowing through to consumers.

Next steps

The window for responses to the Issues Statement has now closed.  During September, the CMA intends to issue questionnaires and hold site visits.  It will hold hearings with third parties in October, before publishing any relevant working papers and an updated issues statement in January or February 2015.  Main party hearings and opportunities to comment have been ear-marked for February and March 2015.  The CMA aims to then publish its provisional findings and, if applicable, possible remedies in May or June 2015.