Further developments for competition in the energy sector

19th August 2014

Independent energy suppliers

Following Ofgem’s announcement in June that it had decided to refer for investigation the market for the supply and acquisition of electricity and gas covering supply to domestic and small business customers (which we discussed here), Ofgem and the Department of Energy and Climate Change (DECC) have jointly published an action plan of measures to encourage the growth of independent energy suppliers.

The Government and Ofgem have been working with independent suppliers to identify how to encourage new entrants to the market and to improve the environment in which independent suppliers operate, with a focus on three key areas:

• rules and obligations with which suppliers are required to comply. The principal concern here is the current “customer number threshold” for exemptions for small suppliers from complying with certain government programmes. The customer number threshold removes potential barriers to entry for small suppliers (compliance with certain regulatory requirements) but it may disincentivise suppliers from growing beyond the threshold
• market governance and infrastructure. Here the concern is around the complexity of industry codes, the credit and collateral requirements that arise from these and government requirements, the operation of switching sites and the poor quality of industry data
• departmental and Ofgem engagement with independent suppliers. The principal concern in this context is the difficulty smaller suppliers have in keeping up with policy and regulatory changes. The comparative lack of resource of smaller suppliers makes them unable to participate in industry working groups. Consequently, insufficient regard is paid to the impact of policy and regulatory changes on the smaller suppliers.

Against this background, DECC has made the following commitments:

• in autumn 2014 it will issue a call for evidence on the impact of the small supplier exemptions from participation in certain environmental and social schemes in order to establish a firmer evidence base upon which to consider any changes that might be needed
• it will review the Contracts for Difference (CfD) supplier obligation against criticism that it creates uncertainty for suppliers who are unable to know their liabilities in advance for pricing into tariffs
• it will assess options for resolving the issues arising from the use of non-UK Levy Exemption Certificates (LECs) in the Feed-in-Tariff (FITs) levelisation process so as to ensure that the levelisation process is sharing the cost of renewables deployment fairly
• it will consult on whether to amend the methodology for the Warm Homes Discount scheme in 2015/16
• it will consider whether an exemption on QR codes may be appropriate for the smallest suppliers
• it has commissioned an independent assessment of the impact on the credit and collateral arrangements on different market participants and the options for reducing the burden of these, and will discuss the options with relevant stakeholders, including independent suppliers, and develop an action plan to take forward agreed measures
• it will establish regular joint DECC/Ofgem forums to highlight upcoming policy initiatives and consultations, and will afford independent energy suppliers the opportunity to discuss issues of concern and to input at an early stage into policy development
• it will create a new page on GOV.UK for independent energy suppliers
• it will develop an Independent Energy Supplier Impact Toolkit, which will ensure that the impact of policies on independent energy suppliers is assessed from the outset of policy-making.

In turn, Ofgem is making the following commitments:

• it will report annually on the state of competition in the energy markets
• it will speed up the process for granting derogations from the four-tariff limit set by the Retail Market Review (RMR) reforms (which allow suppliers to offer up to four core tariffs per fuel and per meter type)
• it will look to extend the current temporary exemption for existing white labels currently included in the four-tariff limit and will consult on an enduring regime which accommodates white labels in the regulatory framework, including an additional four tariffs. “White labels” are suppliers who use their brand name to sell energy (such as Sainsbury’s Energy) but sub-contract the physical supply of energy to one of the main energy generation / supply companies (in Sainsbury’s case, to British Gas)
• it will review the Confidence Code, the voluntary code of practice which governs domestic price comparison sites and will consult on proposals to improve accuracy of comparisons and clarity of whether the whole market is being compared. It will also develop a code of practice for intermediaries, such as energy brokers in the non-domestic sector
• it will monitor how suppliers are objecting to consumers switching, thereby halting or delaying the process
• it has written to the industry code panels asking them to produce a joint report on data quality and, in particular, what measures should be taken to improve the quality of metering data that supports the switching process
• it will continue its work on modifying industry codes.

CMA issues statement on energy market investigation

The CMA issues statement – which will provide a framework for its investigation – shows that the CMA is under no illusions as to the importance of what will be a high-profile investigation into a market that is of fundamental importance to the wider economy as well as households and businesses.

The issues statement explains that the investigation will focus on the detrimental effects on gas and electricity consumers that might result from any adverse effect on competition, considering both short-term and long-term impacts (such as higher prices, reduced service quality, reduced choice, reduced innovation and insufficient future supply). The investigation will take into account market characteristics, including:

• the non-storability of electricity and the need to balance generation and demand in real time
• the natural monopoly characteristics of transmission and distribution and the fact that it is cheaper to have generators and customers connected via a single network as opposed to several networks
• the natural volatility of demand and generation costs
• small-scale customers do not respond to short-term wholesale price changes
• the presence of significant regulatory risks, and
• the increasing relevance of the external costs of climate change.

Account will also be taken of market changes, including:

• the impact of the roll-out of smart meters
• the increased use of renewables to generate electricity
• changes in the policies designed to incentivise investment in low carbon generation, such as CfDs
• reforms introduced by Ofgem designed to improve liquidity in wholesale power markets, and
• Ofgem’s RMR reforms.

CMA has identified four initial high level theories of harm. These are that:

• opaque prices and/or low levels of liquidity in wholesale electricity markets create barriers to entry in retail and generation, perverse incentives for generators and/or inefficiencies in market functioning
• vertically integrated electricity companies harm the competitive position of non-integrated firms to the detriment of customers, either by increasing the costs of non-integrated energy suppliers or reducing the sales of non-integrated generating companies
• market power in electricity generation leads to higher prices
• energy suppliers face weak incentives to compete on price and non-price factors in retail markets, due in particular to inactive customers, supplier behaviour and/or regulatory interventions.

The CMA has accepted Ofgem’s recommendation that it will not investigate (at least not yet) the following:

• wholesale gas markets
• gas interconnection and storage
• regulation of revenues from transmission and distribution.

The CMA has also set out a detailed indicative timetable for the investigation. As regards the two major milestones, it currently intends to notify provisional findings and possible remedies in May/June next year and the statutory deadline for the final report is 25 December 2015.

Comment

Despite a generally broad consensus of welcome across the industry for the CMA inquiry, the Government clearly is not prepared to sit back and await the outcome of the CMA process, which would mean a delay of at least 18 months to two years before remedies were implemented. Together with Ofgem, it is pushing the competition agenda and taking action now to increase scope for competition from smaller independent energy suppliers. We have seen in the context of the current CMA investigation into payday lending that the Government was prepared to legislate for a rate cap on high cost short-term credit, in advance of receiving even Provisional Findings from the CMA, let alone the outcome of the inquiry. It would be unwise to assume there will be no further significant (Government-led) changes in the energy sector pending a final report from the CMA.

If your business is likely to be affected by the CMA investigation and/or other measures to promote competition in the energy sector, Walker Morris can help. Our specialists advise in the energy sector and on competition market studies and investigations across disparate sectors, including currently acting before the Competition and Markets Authority on the in-depth inquiry into payday lending. We work together with in-house regulatory specialists and with the leading economics consultancies and have significant experience of external engagement with competition authorities, sector regulators, government departments and other stakeholders on sensitive and complex competition issues.

For further information, please contact Trudy Feaster-Gee, Partner (Barrister) in the first instance at trudy.feastergee@walkermorris.co.uk on +44 (0)113 283 4542.