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Market investigation: just what UK energy markets need?

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It has been widely reported that Ofgem has referred the “Big 6” UK energy companies for investigation by the Competition and Markets Authority (CMA).  That is of course not strictly true, for three reasons.

  • First, and most trivially, the CMA, which will take over the functions of the former Office of Fair Trading (OFT) and Competition Commission, currently only exists in “shadow” form, and does not assume its statutory functions until next month.
  • Second, although the prospect of a market investigation reference has been canvassed for some time, Ofgem have not yet made a reference.  They are consulting on a proposal to do so.  The consultation ends on 23 May 2014.  As any administrative lawyer will tell you, a decision-maker must not consult with a closed mind, so we are probably still at least 3 months away from the start of a CMA investigation.  It would be possible for Ofgem to agree “undertakings in lieu of a reference” from players in the market if it felt that would adequately address the problems it is concerned about without the need for a market investigation – although at present that seems an unlikely outcome.
  • Third, as is normal with a market investigation, the proposed terms of reference do not refer to individual companies.  What Ofgem proposes that the CMA should investigate is no more and no less than the supply and acquisition of energy (i.e. electricity and gas) in Great Britain.

Market investigations are the oldest and in some ways the most powerful tool in UK competition law.  In their modern form they are governed by the Enterprise Act 2002, a piece of legislation enthusiastically promoted by the then Chancellor, Gordon Brown, as destined to make the UK economy more competitive by the more vigorous application of competition law.  They exist to deal with markets which appear to be insufficiently competitive, but whose problems do not appear to come from cartels or other anti-competitive agreements between firms, or the abuse of a dominant position – all of which obviously anti-competitive kinds of behaviour are prohibited under UK and EU law in any event.  A market investigation aims to find other features of a market which prevent, restrict or distort competition and then to devise a means or remedying, preventing or mitigating those effects, taking account of any incidental benefits which those features may bring to customers.  In a regulated market such as gas or electricity, the CMA may also need to have regard to the statutory functions of the sectoral regulator concerned.   The powers which the CMA can deploy in devising remedies for any problems it finds are extremely wide, and – unless Ministers legislate under the Act to give themselves a role – are formulated and imposed without any political sanction.  They can include everything from price regulation to divestment of a business – such as the forced sale of Stansted Airport that took place following a market investigation into airports.

Back in 2002, it was expected that there would be between two and four market investigation references a year.  In fact there have been slightly fewer: 17 completed investigations.  Back in 2002, some questioned whether economic sectoral regulators such as Ofgem would ever use the power that was being given to them to make a market reference in respect of their own sectors (otherwise, the power to refer a market rests with the OFT, or, in an extreme case, Ministers): would referring the market that it was their function to regulate not look like an admission of defeat?  Ofgem’s proposed reference, if made, will be the first to be made by an economic regulator into the very heart of the markets which it is responsible for regulating.

Ofgem have published a consultation on the proposal to make a reference and, separately, a state of the market assessment containing the fruits of its own investigation, with the OFT and CMA, into the current state of competition in energy markets.  Both are well worth reading (as is the Secretary of State’s statement to Parliament on the Ofgem announcement).  Don’t be put off by the apparent length of the state of the market assessment, as a large amount of its more than 100 pages is taken up with rather striking graphs and charts.  I particularly liked Figure 14, which shows that the proportion of consumers who said they have not switched supplier because they are “happy with their current supplier” fell from 78% in 2012 to 55% in 2013; the proportion who claimed to have checked prices and found that they were on the best deal rose from 9% to 12%; and the proportion of those honest enough simply to say that switching was too much of a hassle rose from 20% to 27%.

The points that Ofgem have highlighted as reasons for proposing a market investigation are mostly what economists would regard as potential symptoms of competition problems rather than the actual features of the market that are giving rise to those problems.  They are, however, symptoms traditionally associated with uncompetitive oligopolies, which is what market investigations are meant to be good at tackling: high levels of apparent customer dissatisfaction, but low levels of customer switching; static market shares of incumbent firms; possible “tacit collusion” (e.g. co-ordinating in the timing and size of price changes); possibly high profits; and potential barriers to entry.  The last of these is the most significant, but the assessment document is notably circumspect in its conclusions: “In the time available…we have not been able to examine in depth the claimed benefits and reasons for vertical integration for the suppliers and the implications for barriers to entry, and assess the net impact on consumers of vertical integration overall.”.

The big question of the effect of the Big 6’s high shares of both the supply and generation markets is therefore left for the CMA to consider in the greater depth that its procedures and wider powers to compel the provision of information allow.  Another big question in any regulated market is of course the effect that regulation itself has on competition.  Here, the CMA will really have its work cut out, because the regulatory landscape in the energy sector is in a more than usually fluid state just now, with various significant Ofgem reforms about to take effect and DECC in the process of finalising the radical upheaval that is Electricity Market Reform (EMR).  The CMA will have a ring-side seat as the first allocations of EMR Contracts for Difference take place and the EMR Capacity Market is launched, expected to be later this year.

That in turn raises the question of timing.  Some have been calling for an energy market investigation for some time.  Others suggest that with so much change, such an investigation can only add to uncertainty and further inhibit decision-making on new infrastructure that is sorely needed to keep the lights on.  What is certain is that market investigations can, and frequently do, take up to two years (not counting any further time taken up in legal challenges to the outcome).  There are often good reasons for that, but even apparently uncompetitive markets can change over time.  What appear to be problems at the start of an investigation may not still be there at the end.  How relevant will the CMA’s findings be in 2016, a year after an election that may be won by a Labour Party which has announced its intention of making a series of further regulatory changes, including the abolition of Ofgem and the separation of generation and supply businesses?  In any event, if the CMA do find that there are features of the regulation of energy markets that are part of the competition problem, that is one area in which it may not be able to impose remedies, and may instead have to limit itself to making recommendations to the sector regulator or the Government of the day.  So those welcoming Ofgem’s announcement as an end to “the politics” around the issues and the start of a dispassionate, technocratic process may have spoken too soon.

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