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The CMA’s final report in the energy market investigation

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08/07/2016


Amidst the din and chaos of the past few days it would be easy to have missed the publication by the Competition & Markets Authority (CMA) of its measures to drive reform in the energy sector.  These are contained within its final report following its industry-wide investigation into the supply and acquisition of energy in Great Britain.

The headline remedies are:

  • the creation of an Ofgem-controlled database of customers who have been on a standard variable tariff (SVT) for more than three years to enable rival suppliers to market to those customers
  • the introduction of a temporary price control for customers on prepayment meters, pending the roll out of smart meters.

Summary of the reports’ findings

The CMA has identified features of the wholesale and retail markets for gas and electricity that it considers give rise to an adverse effect on competition.

Wholesale markets

In relation to wholesale markets, the CMA did not find any competition problems in relation to gas, nor did it consider that electricity generators have unilateral powers or that vertical integration might harm competition. However, the CMA concluded that there are aspects of the market rules that give rise to an anti-competitive effect, notably:

  • the absence of locational pricing for transmission losses. This has led to a system of cross-subsidisation that is likely to distort competition between generators with both short- and long-run effects on generation and demand
  • the mechanisms for allocating Contracts for Difference (CfDs) are giving rise to an anti-competitive effect through increasing the risk of inefficient allocation of financial support to generation capacity.
Retail markets

The CMA has identified three specific areas in which domestic retail markets may not be working well for customers:

  • weak customer response and lack of engagement with domestic retail energy markets. The CMA found that retail customers were disengaged from the market and were not seeking to make savings by switching suppliers. This was particularly true of SVT customers, who had the greatest opportunity to make savings. The CMA identified a number of barriers to engagement, including the lack of quality differentiation; a lack of confidence in price comparison websites and a perception that the switching process is costly
  • supplier behaviour. The CMA found that the ‘Big Six’ energy companies (British Gas, Eon, EDF, nPower, Scottish Power and SSE) enjoy unilateral market power over their respective inactive customer base, which they had been able to exploit through their pricing policies. The CMA did not, however, find, evidence of tacit coordination between the suppliers in relation to price announcements
  • the regulatory framework governing domestic retail market competition. In particular, some of the Retail Market Review (RMR) reforms restrict the behaviour of suppliers and constrain the choices of consumers in a way that may have distorted competition, and also elements of the settlement systems of both gas and electricity lead to inaccuracies and delays that distort competition between energy suppliers.

The CMA also identified particular supply-side constraints affecting supply to customers on “dumb” (i.e. non-smart) prepayment meters and which limit the extent of competition in the prepayment segments.

Microbusinesses

The CMA found that a combination of features of the markets for retail supply of gas and electricity to SMEs gave rise to an adverse effect on competition through an overarching feature of weak customer response from microbusinesses which, in turn, gave suppliers a position of unilateral market power concerning their inactive microbusiness customer base which they could exploit through pricing policies or otherwise.

Remedies

Wholesale markets

The CMA’s remedies are:

  • to propose that the Department of Energy and Climate Change (DECC) undertake and consult on a clear and thorough impact assessment before awarding any CfD outside the CfD auction mechanism. DECC should also undertake and consult on a clear and thorough assessment of the appropriate allocation of technologies between pots
  • to order the National Grid, as system operator, to calculate imbalance charges taking into account transmission losses calculated on a locational basis.
Retail markets

The CMA’s remedies are:

  • to withdraw the simpler choices component of the RMR, including the removal of the “four-tariff limit” imposed by the RMR, which has been criticised as stifling innovation in energy supply. The CMA is going to recommend to Ofgem the removal of a number of standard licence conditions relating to the simpler choices of the RMR rules
  • to reform the settlement systems for gas and electricity
  • to encourage switching by customers on SVTs – the CMA investigation found that 70 per cent of domestic customers of the six largest energy firms are on the more expensive SVT – the CMA will be instructing suppliers to provide to Ofgem details of all customers who have been on a the SVT for three years or more to enable the establishment of a database by which competitors will be able to contact customers by letter and offer cheaper and easy-to-access deals based on actual energy consumption. Customers will be able to opt out of the database at any time
  • to introduce a transitional price cap for customers on prepayment meters – who pay around £300 per year more than their direct debit paying counterparts. The intention is that the price cap will remain in place until the introduction of smart meters removes the restrictions on the ability of such customers to access better deals
  • to enhance the ability of price comparison websites to improve customer engagement by removing the confidence code that undermines their incentive to participate in the retail energy market. Price comparison websites will also be given more access to customer data
  • to mitigate the impact of tariff codes on competition for customers on “dumb” prepayment meters by recommending a change to Ofgem standard licence conditions
Microbusinesses

For microbusinesses, 45 per cent of whom are on the more expensive default tariff, the CMA will require suppliers to publish their prices and prohibit them being locked into expensive “rollover” contracts.

Ofgem

The CMA has also decided to confer more influence on Ofgem over the detailed codes of practice that govern the market and which, the CMA considers, currently afford undue influence to established participants over decisions that impact customers.

What remedies are not included?

The remedies package does not include any of:

  • price control regulation of all domestic and microbusiness retail energy tariffs
  • a requirement for energy companies to inform customers about the cheapest tariff on the market
  • an opt-out collective switching of disengaged customers
  • the introduction of a single price for gas and electricity customers
  • the introduction of price non-discrimination provisions
  • a transitional safeguard regulated price structure (save as to the proposal for the introduction of a “default” regulated tariff for those disengaged customers who do not switch)

Next steps

The CMA will shortly publish a timetable setting out the process for implementing its remedies over the coming six months.

Comment

The CMA investigation was launched against a background of criticism of the “Big Six” energy companies who were accused of profiteering at the expense of customers. In fact, energy companies can be pleased with outcome of the investigation on the whole. The CMA has found that competition is working well in the wholesale gas and electricity markets, despite the presence of vertically integrated firms. The CMA’s findings regarding the retail market make for less happy reading, notably around the lack of customer awareness as to their ability to switch, but the measures designed to tackle this are comparatively light touch, certainly when compared with earlier fears that the CMA might order the break-up of the “Big Six”.

If your business is likely to be affected by the CMA’s remedies or if you require further information, please feel free to contact any member of our Competition or Energy teams.

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