The Competition and Markets Authority (CMA) has published a summary of its provisional findings, as well as a list of possible remedies, twelve months into its investigation of the UK's energy market.
The final report is not due until December, but the provisional findings already show the lines along which the CMA is thinking. The full provisional findings report (with 36 appendices) is to be published later this week on the CMA's Energy Market Investigation page, where the summary findings and suggested remedies can also be found.
Retail energy markets
The retail markets have stolen most of the headlines, although only the supply of households and microbusinesses are included within the retail part of the reference. The CMA has provisionally found that the six largest energy firms have market power over their "inactive" customer base, a position which they can exploit through their pricing policies.
Interestingly, the "four tariff rule" introduced at the beginning of 2014 has actually reduced competition by reducing retail suppliers' ability to innovate in designing tariff structures to meet customer demand. Some innovative tariffs were withdrawn, various discounts were removed, and retailers were not able to offer attractive tariffs for low volume users. One of the CMA's recommended remedies is to remove this rule.
The CMA is mainly concerned with customer inertia in the retail market, i.e. the high numbers of customers that have not, and are unlikely to, switch to a cheaper tariff and are therefore sitting on the standard tariff. It recommends that switching tariffs be made much easier. In the summer budget the Chancellor said the Government would work with Ofgem to introduce 24-hour switching by the end of 2018. Having an independent price comparison website run by Ofgem is another suggestion.
Another remedy the CMA suggests is to introduce a transitional "safeguard regulated tariff" for customers who refuse to switch despite the process being made easier; in other words, a temporary cap on bills. The Government have said they are prepared to consider this.
Wholesale energy markets
There is better news for the wholesale energy market.
Provisionally, the CMA has not found any features in the wholesale gas markets that lead to an adverse effect on competition. In wholesale electricity markets, its provisional view of the profitability analysis it conducted does not provide evidence that, overall, the six largest firms earned excessive profits. The presence of vertically integrated companies has not, contrary to expectations, had an effect on competition. It therefore seems that concerns about the break-up of the largest six firms were premature.
Contracts for Difference have come under close scrutiny. The CMA found that the competitive allocation process has seemed to work well in driving down prices, but it is critical of the FIDeR process – the early forms of CfD that were awarded without competition. These, says the CMA, have resulted in costs to consumers that are between 30% and 60% higher than the competitive CfD awards, and equate to between £250 and £310 million per year for 15 years, or equivalent to a 1% increase in RPI. It suggests that DECC should undertake and consult on a clear and thorough impact assessment before awarding any CfD outside the CfD auction mechanism in future.
Provisionally finding that allocating particular technologies to particular pots under the CfD has the potential to have an adverse effect on competition, the CMA recommends that again DECC should undertake and consult on a clear and thorough impact assessment before such allocations.
The other part of Electricity Market Reform, the design of the Capacity Market mechanism, was found to be broadly competitive.
The CMA provisionally found that the current system of uniform charging for electricity transmission losses creates a system of cross-subsidisation that distorts competition between generators and is likely to have both short-run (higher costs) and long-run (inefficiencies in location of generation plants) effects on generation and demand. Introducing locational charges for losses could lead to an efficiency benefit of £160-£275 million over ten years. The CMA suggests introducing a new standard condition to electricity licences to require that variable transmission losses are priced on the basis of location. The details are in the Notice of Possible Remedies (it is Remedy 1).
The CMA also provisionally found that smaller suppliers being exempt from the ECO and Warm Home Discount obligations does not distort competition due to the relative strength of larger firms, compared to new entrants.
Ofgem has come under a surprising amount of criticism, with the CMA noting some decisions that Ofgem took that did not have the effect of promoting competition: not approving the introduction of locational charging of transmission losses; prohibiting regional price discrimination between 2009 and 2012; and introducing the four-tariff rule.
In Ofgem's defence, the CMA also noted that the latter two of these decisions were taken against the backdrop of DECC stating its readiness to use its powers to implement changes in primary legislation if Ofgem did not act, so there is at least a perception that Ofgem is not as independent as it is supposed to be. The CMA proposes giving Ofgem more "teeth" by measures including: revising its statutory objectives and duties to increase its ability to promote effective competition; introducing a formal mechanism to address disagreements with DECC over policy decisions; improving the accounting framework so that Ofgem has a better, more consistent set of data from suppliers to work with; and giving Ofgem more powers to develop and implement code changes.
Interested parties have until 31 July to comment on the CMA's provisional findings and suggested remedies. The CMA will be consulting with all interested parties. The final report should be published in November or December 2015.