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Energy market investigation: summary of provisional findings released

What's happened?

The Competition and Markets Authority (CMA) has this morning published a summary of its provisional findings following its year-long investigation into the energy market. The CMA expects to publish the full provisional findings report on its website by 10 July 2015.

The report confirms press speculation that the CMA has no intention of breaking up the Big Six energy companies. In fact, the CMA has provisionally found that 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.

However, the report does indentify a number of problems hindering competition in the market. In particular, it focuses on the extent to which consumers are engaged and the lack of robustness and transparency in regulatory decision-making.

In addition to the provisional findings, the CMA has published a notice of possible remedies which sets out and invites comments on possible actions which the CMA might take to increase competition and ensure a better deal for customers.   

Key findings and remedies proposed

The provisional findings identify the following features that the CMA considers have an adverse effect on competition (AEC) in the energy markets:

1. The absence of locational prices for transmission losses and constraints: the CMA has found that the current system of uniform charging for transmission losses creates a system of cross-subsidisation that distorts competition between generators. In the short run, costs will be higher and in the long run, the lack of locational pricing may lead to inefficient investment in generation.

The CMA proposes in its notice of possible remedies that a new standard licence condition could be imposed to require that variable transmission losses are priced on the basis of location in order to achieve technical efficiency.

2. Contracts for Difference: the CMA considers that, while the introduction of CfDs by the Department of Energy & Climate Change (DECC) is a positive step towards an efficient competition-based process, the mechanisms for allocating CfDs give rise to an AEC. For example, some elements of the CfD allocation process currently in place potentially restrict the use of competition in setting the strike price in the future. The CMA also has concerns about the division of the technologies into separate 'pots'. It believes that it is important for the DECC to regularly monitor this division and provide a clear justification for the allocation of budgets between pots.

The CMA proposes that the DECC should undertake and consult on a clear and thorough impact assessment before awarding any CFD outside the CfD auction mechanism. This would prevent further CfDs being awarded at strike prices that overcompensate projects and should ensure transparency.

A second remedy also proposes that the DECC should undertake and consult on a clear and thorough assessment before allocating technologies between pots.

3. Weak customer response: the report identifies a combination of features of the markets for the domestic retail supply of gas and electricity that gives rise to an AEC, through an 'overarching feature of weak customer response'. This, in turn, gives suppliers a position of unilateral market power concerning their inactive customer base. 

An extensive range of remedies are proposed to address the issue of customer weakness, which the CMA group into three categories:

  • Remedies to provide a framework for effective competition between retail energy suppliers;
  • Remedies to facilitate widespread engagement by domestic and microbusiness customers; and
  • Remedies to safeguard the interests of disengaged customers and encourage longer-term engagement.

4. Retail Market Review reforms: Ofgem launched the Retail Market Review (RMR) in 2010 in order to promote customer engagement. The CMA's provisional finding is that the 'simpler choices' component of the RMR rules (including the ban on complex tariffs, the maximum limit on the number of tariffs that suppliers are able to offer at any one time, and the simplification of cash discounts) is a feature giving rise to an AEC. This is because retail suppliers are no longer able to innovate in designing tariff structures, and competition between price comparison websites (PCWs) is also softened as a result.

In view of the significant overlap between weak customer response and the 'simpler choices' component, the CMA has grouped these AEC's together for the purposes of considering the potential remedies.

5. Gas and electricity settlement: Two further AEC's concern the regulatory framework governing domestic and SME retail energy markets.

The CMA has provisionally found that the current system of gas settlement gives rise to an AEC through the inefficient allocation of costs to parties. It also creates scope for gaming, which reduces the efficiency of domestic retail gas supply. Remedies are proposed to address the current inefficiencies without delay and to introduce a licence condition on gas shippers to make monthly submissions of Annual Quantity updates mandatory.

As regards electricity settlement, the CMA considers that the absence of a plan for moving to half-hourly settlement for domestic customers gives rise to an AEC through the distortion of suppliers' incentives to encourage their customers to change their consumption profile. The CMA proposes by way of remedy that electricity suppliers and relevant network firms should agree a binding plan for the introduction of a cost-effective option to use half-hourly consumption data in the settlement of domestic electricity meters.

6. Microbusinesses: as for the domestic retail market, the CMA's finding is that there is an overarching feature of weak customer response from microbusinesses, which in turn gives suppliers a position of unilateral market power concerning their inactive microbusiness base which they can exploit through their pricing policies.

The remedies considered have also been grouped with the consideration of weak customer response (see above).

7. Lack of robustness and transparency in regulatory decision-making: The features which the CMA considers increase the risk of poor quality decisions which have an adverse impact on competition are as follows:

  • the lack of a regulatory requirement for clear and relevant financial reporting concerning generation and retail profitability;
  • the lack of effective communication on the forecast and actual impacts of policies over energy prices and bills;
  • Ofgem’s statutory objectives and duties which, in certain circumstances, may constrain its ability to promote effective competition; and
  • the absence of a formal mechanism through which disagreements between DECC and Ofgem over policy decision-making and implementation can be addressed transparently. 

The CMA proposes that improvements should therefore be made to the current regulatory framework for financial reporting to improve the robustness of information available to Ofgem. This will increase the overall transparency of generators' and suppliers' revenues, costs and capital employed.

8. Industry codes: the CMA states that its central concern is that Ofgem has a limited ability to influence development and the implementation phases of a code modification process.

Three potential remedies are proposed, including a recommendation to the DECC to make code administration a licensable activity. The CMA also proposes that Ofgem's statutory objectives and duties should be revised in order to increase its ability to promote effective competition. The introduction of a formal mechanism through which disagreements between DECC and Ofgem can be addressed transparently is the final proposal.

TLT comment

The CMA's updated issues statement from earlier this year gave an early indication that it did not consider that vertical integration (of energy generators and suppliers) or the operation of the wholesale electricity markets were problematic. This is confirmed by the provisional findings though there are some interesting new proposals relating to:

  • the administration of CfDs – to ensure that any contract for difference entered into by DECC provides good value for money, reducing the subsidy effectively paid by consumers;
  • locational adjustment for transmission losses - reforming the current system of uniform pricing for transmission losses which the CMA says "creates a system of cross-subsidisation" that distorts competition between generators.

The CMA's concerns are focussed in relation to the operation of the retail market and particularly as that operates for "sticky" customers – those typically on default tariffs (that they have not chosen) and who seem to get a less good deal than those who are more active.

The CMA response is to look at "enabling measures", to assist that class of customers to engage, and in "protective measures", to protect those who do not engage from getting a bad deal. The most eye-catching of the proposed protective measures is the "safeguard regulator tariff" which will effectively mean a maximum price for default tariffs being set by the CMA or Ofgem. However, the CMA recognises the challenges and potential anti-competitive effects that can be caused by price regulation.

Some larger suppliers had identified the burden of administering and collecting "green tariffs" (like CfDs, Feed-in Tariffs, Renewable Obligation and the Energy Company Obligation) to act as a barrier to entry and expansion for new/smaller suppliers. They had encouraged the support mechanisms to be included in general taxation measures rather than be collected through operation of Supplier Licence Conditions. In its provisional findings the CMA makes no finding that this combination of green tariffs collected in this way currently has an adverse effect on competition.

Next steps

The CMA now invites interested parties to submit reasons in writing as to why the provisional findings should not become final, or how they should be varied. Unless a specific date is given to an interested party, the reasons should be received by the CMA by no later than 5pm on 31 July 2015.

In relation to the Notice of possible remedies, suggestions for additional or alternative remedies that parties may wish the CMA to consider are also being invited by 31 July 2015.  

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at June 2015. Specific advice should be sought for specific cases. For more information see our terms & conditions on www.TLTsolicitors.com

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