27 Mar 2014

(by ) The decision to refer the energy market to the new Competition and Markets Authority (CMA) will be welcomed by many but will also have costs. On the positive side, the opportunity for a thorough review of the market enables analysis without immediate political pressure, either directly on the market or on the regulator. It is important to restore public confidence in the market, either by giving it a clean bill of health, or identifying any problems and remedying them.

But such market investigations are costly. The CMA costs will be over £2 million, and those who provide evidence, including regulators and companies, will have to spend both time and money presenting their evidence to the Authority. One of the reasons for rising energy prices is the need for greater investment to reduce greenhouse gas emissions and replace generation and distribution capacity. The inquiry will take eighteen months to reach a conclusion, and this period might be extended through appeals against potential remedies, such as vertical separation of companies, during which investors might be reluctant to commit funds. But the current arrangement is also fraught with uncertainty, and investors might be more comfortable with a well-structured competition inquiry than with intermittent and apparently random interventions from politicians. As one of the first market inquiries for the new CMA, we would hope for a period of stability and acceptance at the end of the process, so that the sector can be left to develop with more confidence from both decision makers and the general public.

These benefits will only be maximised if politicians stop using the market as a political football by calling for structural changes or price freezes – the object of an inquiry is first to establish whether the market really is ‘broken’ i.e. whether there is a feature or features which have an ‘Adverse Effect on Competition’ (an AEC). Only if the CMA does find such an effect will it go on to suggest appropriate remedies, which will depend, of course, on the nature of any AEC which is established.

Of course politicians intervene in this market because energy is essential both for industry and commerce and, more particularly, to households. Electricity, light and heat are crucially important to run appliances, use modern communications and stay warm and healthy. Households have faced rising costs for the past decade, and a combination of world gas prices and environmental policies are likely to push them higher in the future. It is not surprising that politicians find voters are responsive to their calls for action. The danger is the familiar fallacy of ‘something must be done. ‘This’ is something. Therefore ‘this’ must be done.’

As in any market it is all too easy to make mistakes. The regulator, anxious to alleviate concerns that the ‘Big Six’ energy suppliers were discriminating against the households who had never switched supplier, imposed non-discrimination clauses which contributed to a reduction in competition, a decrease in the size of savings which could be made from changing supplier and a consequent dramatic fall in switching, which remains very low despite the inroads of new entrants. Stephen Littlechild has estimated that this intervention added up to £3billion per year to household bills in 2013, around an additional £135 per year for a dual fuel household. Some of the regulator’s more recent changes to simplify tariffs will have similar effects on competition and price levels. Against this background there are obvious benefits of an in depth analysis of the market from a new perspective.

What could we reasonably hope and expect for this sector? One of the perceived problems has been that many households do not switch energy supplier, even though they could save money and the product is homogeneous, so that the same gas or electricity arrives through pipes and wires whoever supplies it. If competition is very fierce and drives prices down to marginal costs, then companies will not be able to cover their fixed costs, and even if these are small, there may be room for very few, perhaps only one supplier in the market. A vibrant market with several competitors might require some ‘softening’ of competition so that companies can cover their fixed costs. Just what a well-functioning market would look like in the retail energy sector is one of the crucial issues which the CMA will need to resolve.

Features of the market which have an Adverse Effect on Competition might be intrinsic to the sector, or a result of earlier developments or regulatory intervention, and the Authority will need to decide how far these are reversible. The reference is important to the competitiveness of the UK and to the well-being of every household, as they face rising underlying energy costs in the coming years. These rising trends make it all the more important that he market works as well as it can do, and that consumers, companies, politicians and potential investors have well-placed confidence in its operation. The CMA has an important and high profile challenge as one of its earliest inquiries.

 See Non-discrimination Clauses in the Retail Energy Sector, by Morten Hviid and Catherine Waddams Price in The Economic Journal, 122, F236-252, 2012 for why the clauses had this effect; and Pricing in the UK Retail Energy Market, 2005-2013, by Catherine Waddams Price and Minyan Zhu, CCP research paper 13-12 for evidence that they did indeed have the expected impact, and reduced rivalry within the market.

 (Response to Ofgem consultation, ).

 Well-functioning markets in retail energy by Morten Hviid and Catherine Waddams, European Competition Journal, April 2014.