The energy market needs a Competition Commission investigation

Posted October 10, 2013
by John Fingleton CBE

If our politicians genuinely want to make the UK energy market perform more effectively, and to serve UK consumers, they should support a reference of the market by Ofgem, the energy regulator, to the Competition Commission (CC). This is the proven and established approach for addressing competition problems, and it is regrettable that Ofgem has not referred the market before now.

Only the CC has the ability and independence to examine these issues thoroughly and, if necessary, to re-structure the market so that competition is more effective.

Recent surveys show the majority of energy customers think prices are too high and that energy companies are not properly regulated. Consumers have little trust in the energy sector. Their suspicion is aimed not only at energy companies, but also at politicians and at Ofgem.

Efforts by the government to simplify energy tariffs, and the recent proposals by Ed Miliband to implement price controls, are unlikely to restore consumer trust. They could even be counterproductive. Moreover, the recent political debate will increase uncertainty in the sector, which is likely to reduce investment, something that would be damaging to consumers over the long-term.

Concerns about energy markets are not new. Politicians, consumer groups and Ofgem have all expressed varying concerns for some time. Indeed, Ofgem has undertaken two separate reviews of the UK’s gas and electricity retail markets since 2008.

In both instances, it found that features of the market weakened competition between providers. It has made a series of recommendations to increase customer switching, such as simpler tariffs and increased transparency. It has declined formally to consider a reference to the CC.

While there may be benefits from Ofgem’s approach, it suffers from two problems: firstly, it is largely treating the symptoms of the problem rather than the causes (namely the structure of the market, and the incentives for the suppliers to complete fairly for customers); and secondly, following each of its reviews, Ofgem it has increased the role of regulation.

Apart from additional cost burdens on energy companies, which are undoubtedly passed on to consumers, it means that our energy companies increasingly focus on pleasing regulators and politicians, and not consumers. The outcome is a market in which regulation trumps competition, with a bigger role for Ofgem. Potential entrants face even larger barriers because of the regulatory complexity. Big business meets big government and both get bigger. Competition, not regulation, has consistently proven to be a more successful mechanism to produce markets that effectively serve their consumers.

In a market where incumbents are not threatened by entry, and where pricing is heavily regulated, it is hardly surprising that competition is weak.

The bigger issue is that this approach fails to address structural problems in the energy markets which dampen competition between providers. The most crucial issue is that providers are ‘vertically-integrated’; the big retail suppliers are either producers or distributors of gas or electricity. This reinforces barriers to new entrants.

A restructured market should be better for entrants, consumers, and ultimately for investors in the energy sector.

A CC reference was used to break up the BAA airport monopoly in London and Scotland. Recent inquiries have scrutinised markets such as private healthcare, payday lending, motor insurance, aggregates and the audit market.

The UK energy market is a prime candidate for such detailed scrutiny. The concerns in energy markets are arguably more serious than those in the markets which have already been referred. Energy markets affect a broader customer base, and the cost to consumers of a poorly functioning market could be considerable.

A reference to the CC has the added benefit of depoliticising the issue. The sector needs a stable, non-politicised environment if it is to undertake the investment needed to serve consumers and businesses, and to meet climate change goals. Even if the CC did not ultimately decide to implement structural changes, its detailed examination would have the benefit of clearing the air. Consumers could have greater confidence, for example, that pass-through of wholesale prices was fair and competitive.

Why make a reference now? A market inquiry can take up to two years, and implementing remedies can take longer. BAA’s airport monopoly, for example, was referred to the CC in 2006, and the sale of Stansted Airport only completed earlier this year. Waiting until after the next election may mean that structural change, if needed, would be unlikely to be implemented until after 2020. In the meantime, consumers will continue to suffer from a lack of competition. If launched now, a market inquiry would report soon after the next election.

Perhaps the biggest obstacle to a reference is the argument that it will create uncertainty that will damage investment. Indeed, this may be what has stopped a much-needed reference decision since 1998. There are two retorts to this concern: firstly, the tactic is almost always used by those who seek to maintain the status quo, and was widely made at the time OFT began the BAA referral process in 2006 (you don’t make an omelette without breaking eggs); and secondly, Ed Milliband’s remarks have created a huge deal of uncertainty that, no matter what he or the government says, cannot be brushed aside. Not only is now the perfect time to make a reference, but it would probably reduce uncertainty, by removing the political point-scoring from the matter, which should make investment more likely.

Market inquiries may not be as attractive to politicians as announcing new laws or statutory price controls, but they are a better way of addressing competition concerns. Ofgem has been too timid in its market reviews to date. If it is not willing to make a reference, it should pass the baton to the OFT which has shown that it has the appetite for referring markets to the CC. This would put competition above regulation, take politics out of the issue, and provide the right competitive market structure for UK energy companies to make long-term investment, and to effectively serve their customers.