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30 Mar

UK energy market to be investigated by the new competition watchdog

Energy Market Review

This week Ofgem reported its findings on the state of the UK energy market, and concluded that there was sufficient evidence for a referral to the new Competition and Markets Authority (CMA), including excess profits, soaring prices (which increased by 24% between 2009 and 2013 – 10% above the CPI), and increasing consumer distrust. This assessment was jointly undertaken by Ofgem, the OFT and the CMA.

In its findings, Ofgem were particularly concerned with what it called a ‘weak customer response’ – namely, that energy customers do not appear to alter their behaviour in the way they would if shopping in a highly competitive market. Such actions would include switching or threatening to switch suppliers. In their research Ofgem found that over 60% of energy consumers had not switched supplier, and of those that did, 25% said they would not do so again as they did not perceive any gains from switching. In fact, despite the odd spike, switching rates have fallen consistently over the last five years.

In addition, the energy market (particularly electricity) is heavily vertically integrated, with the big six electricity suppliers controlling 70% of the generation capacity. While Ofgem noted that integration can provide benefits, in terms of greater security of supply, it also had potential costs in terms of reduced competition.

In terms of barriers to entry to smaller suppliers, Ofgem observed that credit and collateral costs presented perhaps the biggest single barrier to entry, with smaller suppliers finding credit conditions restrictive, and the collateral required to trade on the wholesale markets excessive. In addition, the social and environmental obligations associated with participation in the energy market were seen as substantial deterrent to entry.

Ofgem also found that the existing large suppliers were benefitting from consumer’s ‘stickiness’ and unwillingness to switch, and this gave the existing players in the market considerable ‘incumbency advantage. New entrants would not have the advantage of a customer base of ‘sticky’ customers, and this would put them at a considerable disadvantage in the market.

Finally – and most tellingly - Ofgem found strong evidence of the possibility of tacit co-ordination (collusion). It was noted that, when markets are stable and competitors interact repeatedly they are likely to accurately anticipate each other's future actions, and hence becoming effectively interdependent while acting independently, and in their own interest. This enables energy companies to co-ordinate their policies and behaviour without the need for any direct communication, as would happen with overt or covert collusion. This, indeed, is classic game-like behaviour and while not, in itself, illegal it is indicative of a market with low levels of competition and high levels of tacit co-operation.

On the basis of this evidence Ofgem’s provisional decision is that it is satisfied that the test for it to be able to make a Market Investigation Reference (MIR) is met. Ofgem will now undertake a period of consultancy, with a final decision being taken in July 2014. Meanwhile, the CMA, which becomes operational this week, has been given new powers to make the energy market work more effectively, including increased penalties for abuse of market power.

 

 


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