Competition in energy markets in Great Britain

Competition in energy markets in Great Britain

This Commons Library briefing paper looks at the history of political and regulatory intervention designed to increase the competiveness of domestic energy markets in Great Britain. The Paper sets out the timetable for the Energy Market Investigation and summarises the provisional findings that the Competition and Markets Authority (CMA) has published. The paper also summarises the main actions that Ofgem has undertaken in the past to tackle the level and complexity of tariffs.

This briefing does not include information relating to the energy market in Northern Ireland.

Recent changes

Since the CMA published its provisional findings and proposed remedies in July 2015 there have been a number of changes

• An extension to the timetable

In the light of the considerable volume of evidence received and the workload required to arrive at a long term solution, the CMA decided on 22 September 2015 that it needed to extend the inquiry.

The statutory framework allows the Competition and Markets Authority (CMA) to extend its timetable by 6 months from 25 December 2015 to 25 June 2016, although it aims to deliver well within this timeframe. It is now planning to publish its provisional decision on remedies in March 2016 with a view to reaching its final decision by June 2016.

• New possible remedies

In its provisional remedies the CMA proposed a transitional ‘safeguard regulated tariff’ for disengaged domestic and microbusiness customers (referred to as Remedy 11) – this was at the heart of the problem of customers who did not switch.

Two companies (Centrica and Scottish Power) separately proposed an alternative remedy. Their remedy would seek to increase customer engagement by phasing out the use of ‘evergreen’ contracts and moving to a system where all contracts have a fixed term, eg one year. Under this proposal (once implemented) customers would be encouraged to engage via end of fixed-term contract notifications.

The CMA has proposed further remedies to address competitive market issues in the prepayment segment (PPS) of the market.

• Reaction to earlier remedies

A great deal of written evidence and summaries of oral hearings have been published in response to the proposed remedies.

Challenges facing the energy industry

Domestic energy consumers grew accustomed to ‘cheap’ energy in the years after the liberalisation of the domestic gas and electricity markets around the turn of the century. But in more recent years, particularly since the recession, many households have been struggling with price increases.

The UK faces a challenge in delivering its future energy requirements. In the long term the Department of Energy and Climate Change (DECC) has estimated that electricity capacity will need to grow as demand is likely to increase by between 30 and 100 per cent by 2050

The UK is committed to reducing its greenhouse gas emissions by at least 80% in 2050 under the Climate Change Act 2008

In short, energy must become low carbon, while remaining affordable to consumers and attractive to investment.

Political and regulatory intervention

Potentially the impact of competition on gas and electricity prices is at two stages.

First there is an impact on wholesale energy prices, when energy is traded between suppliers and power generators or gas producers.

Second there is the impact on retail prices at the interface between suppliers and customers, when suppliers compete with each other for new customers or to retain existing ones.

The current Government’s position (and that of the previous Coalition Government and Labour Government) is to promote competition in the wholesale and retail markets.

Similarly Ofgem considers that energy supply works best if customers find it easy to switch supplier, to better deals.

CMA Energy Market Investigation

An extension to the timetable

Ofgem originally referred the matter of energy market competition to the Competition and Markets Authority (CMA) to conduct an Energy Market Investigation in June 2014. By referring the matter to the CMA, Ofgem intended there to be a once-and-for-all investigation into whether or not there are further barriers to effective competition because the CMA has more extensive powers that can address any long-term structural barriers to competition.

Originally the CMA signalled that it intended to publish a final report by 25 December 2015. But due to the volume of evidence and comments on its original findings and provisional remedies, the CMA has extended the inquiry to 26 June 2016. It is now planning to publish its provisional decision on remedies in March 2016 with a view to reaching its final decision by June 2016.

Original findings

The CMA’s provisional findings published in July 2015, suggested a range of ‘adverse effects on competition’ (AECs) as well as areas that did not give rise to AECs; it found:

a range of problems hindering competition in the market, including the extent to which consumers are engaged in the market and shortcomings in the regulatory framework.

customers are not taking advantage of switching suppliers. Dual fuel customers could save an average of £160 a year by switching to a cheaper deal. About 70% of customers are currently on the ‘default’ standard variable tariff (SVT) despite the presence of generally cheaper fixed-rate deals.

regulatory interventions designed to simplify prices, such as the ‘four-tariff rule’, are not having the desired effect.

lack of transparency that is hampering trust in the sector.

competition in the wholesale gas and electricity generation markets works well, and the presence of vertically integrated firms does not have a detrimental impact on competition.

New provisional findings and remedies

Since the initial findings and remedies were published in July 2015, the CMA has published further findings and remedies that are summarised below.

Prepayment segment

On 16 December 2015, the CMA published new findings on the pre-payment segment (PPS) of the domestic energy market as follows:

[ ] the inquiry group has provisionally found that a combination of features of the markets for domestic retail supply of gas and electricity in Great Britain, relating specifically to the PPS, give rise to an AEC. These features, in combination, reduce retail suppliers’ incentives (and, for some, their ability) to compete to acquire PPM customers (in particular, customers with an outstanding debt or a poor credit history) and to innovate by offering tariff structures that meet customers’ demand. As a result, the tariffs available in the PPS are not competitively priced compared with the DD segment. These features are as follows:

Technical constraints that limit the ability of all suppliers, and in particular new entrants, to innovate by offering tariff structures that meet demand from PPM customers who do not have a smart meter.

Softened incentives for all suppliers, and in particular new entrants, to compete to acquire PPM customers due to:

actual and perceived higher costs to engage with, and acquire, PPM customers compared with other customers; and

a low prospect of successfully completing the switch of indebted customers, who represent about 15% of PPM customer

The CMA’s proposed additional remedies are as follows:

• Remedy 19 – facilitating sharing of data relating to prepayment meter customers
• Remedy 20 – removing the barriers that prepayment meter customers without a debt face when attempting to switch to a credit meter
• Remedy 20a – prohibit the charging of a security deposit in circumstances when a customer is not in debt and has not incurred any fines, charges or interest for late payment in the last six months
• Remedy 20b – Suppliers are prohibited from charging customers upfront for the cost of a new meter when switching away from prepayment
• Remedy 20c – Require suppliers to provide annual notifications to prepayment meter customers setting out their right to switch and highlighting any potential restrictions or charges that may be payable
• Remedy 21 – reform the protocol for assignment of debt on prepayment meters
• Remedy 22 – A transitional ‘safeguard price cap’ for domestic prepayment customers

Alternative incentives to switch

An additional remedy proposal – based on the proposals submitted to the CMA by Scottish Power and Centrica – which the CMA believe might be effective in addressing the provisional AEC arising from a weak customer response on the part of domestic customers. The CMA note that, although Scottish Power and Centrica have proposed this remedy as an alternative to Remedy 11 (see below), the CMA’s current view is that it provides a means of prompting customers to engage with the retail energy markets and, as a result, should be considered as a specific proposal in the context of Remedy 10 (see below) –that referred to Measures to prompt customers on default tariffs to engage in the markets.

The CMA published its proposed alternative remedy on 26 October 2015 and this is summarised as follows

• Alternative Remedy 11 Remedies to encourage customer engagement by prohibiting the use of evergreen tariffs

Reaction to earlier remedies

There have been nearly 90 written responses to the provisional remedies covering the whole range of proposed remedies put forward by the CMA together with comments set in oral hearing sessions before the CMA (see CMA Energy market investigation website).

In particular there were critical comments on the proposal to reintroduce a ‘regulated safeguard tariff’ (Remedy 11).

In its hearing on 6 August 2015, DECC said:

[ ] but DECC felt that the safeguard tariff [Remedy 11] could entrench disengagement if people felt that the safeguard tariff was approved by the regulator and once on it they would be less inclined to switch.

DECC suggested it was worth considering whether it would be possible to target the remedy in such a way that it favoured vulnerable customers or those who were inherited by a supplier.

A range of different industry participants and interested parties also raised concerns about the operation, unintended consequences, and the practicality and proportionality of a regulated tariff.

However, Citizens Advice, in its written response on 2 September 2015, said on Remedy 11:

Citizens Advice warmly welcomes the CMA finding that some form of price regulation is needed to protect disengaged consumers from relatively expensive evergreen tariffs. The GB energy market has for too long allowed regressive cross subsidisation by suppliers that takes away from their poorest customers and gives to their most affluent, even in the face of extensive research highlighting both the high level of disengagement in the market, and this disengagement being both more pronounced and more detrimental among vulnerable consumers

Five former energy regulators [1] commented in detail on the CMA’s provisional findings and proposed remedies; the main points were as follows:

We welcome the CMA’s finding that numerous important aspects of the energy sector are generally not a problem. We note the finding that other aspects do have an adverse effect on competition, and with some important exceptions we consider that the proposed remedies are appropriate.

The CMA finds that the “simpler choices” aspect of RMR regulation has had an adverse effect on competition. We believe that this finding is justified, and we welcome the proposed remedy to remove these obligations on suppliers.

But we have grave concerns about the CMA’s analysis of customer engagement and over-charging, and about its recommended reintroduction of price controls [Remedy 11].

This is yet another change in regulatory policy, and in an even more interventionist direction than the regulatory policy of the last 7 years. The notion that customer engagement is insufficient for a competitive retail energy market to work is out of touch with competitive retail energy markets around the world.

Original proposed remedies

The CMA’s original proposed notice of remedies set out 20 proposed remedies in its proposed notice of remedies that are designed to address the ‘adverse effects on competition’ (AEC) that it set out in its provisional findings.

• Remedy 1 Introduction of a new standard condition to electricity generators’, suppliers’, interconnectors’, transmission, and distribution licences to require that variable transmission losses are priced on the basis of location in order to achieve technical efficiency
• Remedy 2a DECC to undertake and consult on a clear and thorough impact assessment before awarding any CfD outside the CfD auction mechanism
• Remedy 2b DECC to undertake and consult on a clear and thorough assessment before allocating technologies between pots and the CfD budget to the different pots
• Remedy 3 Remove from domestic retail energy suppliers’ licences the ‘simpler choices’ component of the Retail Market Rules (RMR) rules
• Remedy 4 Possible measures to address barriers to switching by domestic customers; this includes penalties for failing to switch in the required time, and possible cooling off period when suppliers required to switch next day in 2019
• Remedy 5 Requirement that energy firms prioritise the roll-out of smart meters to domestic customers who currently have a prepayment meter
• Remedy 6 Ofgem to provide an independent price comparison service for domestic (and microbusiness) customers
• Remedy 7 Measures to reduce actual and perceived barriers to accessing and assessing information in the SME retail energy markets; including the introduction of a new requirement in the licences of retail energy suppliers to provide price lists for microbusinesses on their own websites and to make this information available to Price Comparison Websites (PCWs); rules governing the information that third party intermediaries (TPIs) are required to provide to microbusiness customers
• Remedy 8 Introduction of a new requirement into the licences of retail energy suppliers that prohibits the inclusion of terms that permit the auto-rollover of microbusiness customers on to new contracts with a narrow window for switching supplier and/or tariff
• Remedy 9 Measures to provide either domestic and/or microbusiness customers with different or additional information to reduce actual or perceived barriers to accessing and assessing information
• Remedy 10 Measures to prompt customers on default tariffs to engage in the market
• Remedy 11 A transitional ‘safeguard regulated tariff’ for disengaged domestic and microbusiness customers
• Remedies 12 and 13 set out suggested technical changes to deal with issues concerning meter reading cycles
• Remedy 14 Remedy to improve the current regulatory framework for financial reporting
• Remedy 15 More effective assessment of trade-offs between policy objectives and communication of impact of policies on prices and bills
• Remedy 16 Revision of Ofgem’s statutory objectives and duties in order to increase its ability to promote effective competition
• Remedy 17 Introduction of a formal mechanism through which disagreements between DECC and Ofgem over policy decision-making can be addressed transparently
• Remedy 18a, b, c Recommendation to DECC to make code administration and/or implementation of code changes a licensable activity; .granting Ofgem more powers to project-manage and/or control timetable of the process of developing and/or implementing code changes; appointment of an independent code adjudicator to determine which code changes should be adopted in the case of dispute

[1] The former regulators are Mr Stephen Littlechild, Sir Callum McCarthy, Eileen Marshall CBE, Stephen Smith and Clare Spottiswoode CBE