04 May 2012
(by Catherine Waddams) Ofgem is considering renewing its undue discrimination clause requirements in residential energy markets. This is not a good idea from a competition perspective. Evidence is accumulating to suggest these requirements have dampened competition in exactly the way predicted by a CCP research paper. The history of electricity privatisation left a strong local incumbent in each geographic area and effective competition requires them to compete out of their own area. The ability to cut prices in a target market is precisely what is needed to attract customers from a local incumbent. The regulator’s non-discrimination clauses introduced in 2009 have limited the allowable price differential a firm offers in and out of its home area. The evidence suggests that this has been achieved by raising out-of-area prices and not by cutting in-area prices. The non discrimination clauses may have produced a ‘fairer’ outcome but only at the cost of higher prices for consumers.
Ofgem and Government figures show that profit margins have risen substantially, and customer switching has fallen off significantly. Margins began to rise soon after the non-discrimination policy emerged as a likely ‘remedy’ in 2008 during the Energy Supply Probe. Consumer transfers in both gas and electricity are now down to the levels last seen in 2003. If Ofgem is seeking a competitive solution for the residential energy market, it should allow the non discrimination clauses to lapse.
All this was entirely predictable. The non discrimination clauses have reduced both the intensity of competition in standard tariffs between suppliers, and the incentives for consumers to switch, by reducing their potential gains. Research on consumer behaviour from both Ofgem and the Centre for Competition Policy demonstrates that expected gains from changing supplier are the main motivation for consumer search and switching activity. The reduction in price differentials has narrowed these possible gains within standard tariffs. Good deals are only available through one of the special time limited offers which Ofgem now blames for consumer confusion, and which were stimulated by the clauses themselves. As we concluded in our response of 13th May 2009 “There is a real danger that the regulator will succeed in achieving the worst of both worlds, with the undue discrimination ruling softening competition, while the exception for temporary discounts leads consumers, particularly those for whom the regulator has a statutory responsibility, to make poor decisions.” Unfortunately this seems to be exactly what has happened, with a plethora of special offers generated by the non discrimination clauses and their exceptions, illustrated by Ofgem’s monitoring of the Supply Probe remedies.
However, there is a new perspective which complicates consideration of the current proposals. It seems that Ofgem is moving away from market solutions in favour of deeper regulation. In this case, considerable care is needed to assess the overall package of regulatory controls. Ofgem’s proposals for limiting tariffs in the Retail Market Review constitute extensive intervention in the market through the determination of the standing charge of standard tariffs, indicating a regulatory rather than a competitive solution to the problems perceived in the market. If these are to be pursued, it may just be sensible to retain the non discrimination clauses rather than try to increase competitiveness by removing them, at a time when other regulatory restrictions are being imposed on the market.
If Ofgem wishes to return to pursuing competitive solutions, which are likely to deliver better results for consumers as a whole but do not deliver guaranteed outcomes to particular groups within the market, then it should allow the non discrimination clauses to lapse. If, as seems more likely from its Retail Market Review proposals, Ofgem now intends to increase intervention in the market, then it may make sense to extend the non discrimination clauses as it proposes, and review the whole working of the market/regulation before their 2014 expiry. In either case a consistent decision to pursue either competitive or regulatory processes would help to avoid the danger that consumers as a whole will be denied the best outcome, while the protection of particular groups deemed to be vulnerable is ineffective.
, an updated version is forthcoming in the Economic Journal; please ask the authors if you would like a copy of the latest version
see for Ofgem’s latest figures, April 2012
DECC, QEP 2.7.1 at
The Energy Supply Probe Initial Findings
See our response to the retail market review proposals and Effective empowerment: Empirical estimates of consumer switching behaviour, by Catherine Waddams and Catherine Webster, Centre for Competition Policy discussion paper, forthcoming, 2012
See for example figure 2.5 in