WIREDGOV

• Investigation is the best way to ensure there are no barriers to effective competition in the energy market
• It will help to rebuild consumer trust and provide confidence for investors
• Ofgem will continue to protect consumers as planned major changes to the energy market are introduced

Ofgem is referring the energy market to the Competition and Markets Authority (CMA) for a full investigation. This follows on from Ofgem’s proposal in March and the following consultation. An investigation should ensure, once and for all, that competition works effectively for consumers, by bearing down on prices while driving improvements in customer service and innovation. It will also help provide the confidence that is needed for investment in the energy sector and complement Ofgem’s recent reforms to make the market simpler, clearer and fairer for consumers.

The recent assessment of the energy market, prepared by Ofgem with the Office of Fair Trading (OFT) and CMA, showed that competition isn’t working as well as it should for consumers. It showed increasing distrust of energy suppliers, uncertainty about the relationship between the supply businesses and the generation arms of the six largest suppliers, and rising profits with no clear evidence of suppliers reducing their own costs or becoming better at meeting customer expectations.

Dermot Nolan, Ofgem Chief Executive, said:  “Now is the right time to refer the energy market to the CMA for the benefit of consumers. There is near-unanimous support for a referral and the CMA investigation offers an important opportunity to clear the air. This will help rebuild consumer trust and confidence in the energy market as well as provide the certainty investors have called for.

“The energy market is also going to change rapidly over the next few years with the roll-out of smart meters, the government’s electricity market reforms, and closer integration with European energy markets. A CMA investigation should ensure there are no barriers to stop effective competition bearing down on prices and delivering the benefits of these changes to consumers.”

As well as playing a full role assisting the CMA, Ofgem will continue its work to protect consumers. These include pushing forward on next-day switching, improving the support available for vulnerable consumers in finding the best energy deal, developing new rules for brokers to follow in the non-domestic market, and continuing to ensure that consumers make the most of recent reforms to make the market simpler, clearer and fairer.

The CMA will begin its investigation immediately and is likely to publish final decisions by the end of 2015. The CMA can decide which features of the market to focus on in its investigation and use its powers to address any structural and behavioural issues that would undermine competition. Ofgem would fully expect the CMA to consider the action it has taken to intensify competition and protect consumers. The main areas that Ofgem would also expect the CMA to look at include:

• the relationship between the supply businesses and generation arms of the six largest suppliers
• barriers to entry and expansion for suppliers
• the profitability of the six largest suppliers
• whether or not there is sufficient competition between the large energy suppliers
• the trend of suppliers consistently setting higher prices for consumers who have not switched
• low consumer engagement that contributes to weak competitive pressure in the market.

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Notes to editors

1. Further information

By law Ofgem had to consult with stakeholders before making a final decision on a referral to the CMA for investigation.

View our 'decision document' on our consultations page: Decision to refer the energy market to the CMA.

The first annual competition assessment was carried out by Ofgem, the OFT and the CMA. It analysed the state of competition in the household and small business markets. View the report at: State of the Market Competition Assessment

2. The headline findings of the assessment were:

Weak customer response: Switching has fallen over recent years. There was a brief spike in late 2013 but no indication of a permanent increase. Consumer trust has also fallen significantly: 43 per cent of consumers did not trust energy suppliers to be open and transparent in their dealings with them in 2013, compared to 39 per cent in the previous year. This low level of consumer engagement is not consistent with a competitive market.

Continued evidence of incumbency advantages: The market shares of the six largest suppliers in gas and electricity have not changed significantly over time and they all have a high proportion of customers who never, or rarely engage in the market. They are able to charge higher prices to these "sticky" customers while making cheaper deals available to more active customers.

Possible tacit co-ordination: The assessment has not found evidence of explicit collusion between suppliers. However, there is evidence of possible tacit coordination reflected in the timing and size of price announcements and new evidence that prices rise faster when costs rise than they reduce when costs fall. Although tacit coordination is not a breach of competition law, it reduces competition and worsens outcomes for consumers.

Vertical integration and barriers to entry and expansion: The six larger suppliers all own energy infrastructure such as power stations and supply businesses. This makes it difficult for new entrants (who don’t own such assets) to compete against them, particularly in the electricity market. Ofgem’s reforms to open up the wholesale power market aim to tackle this. However there are wider issues with vertical integration which need a close review. While the market share of independent suppliers has grown in the last year to five per cent there are barriers to entry and expansion which may prevent them from posing a disruptive competitive threat.

Profitability: The average retail profits for the six larger suppliers have increased from £233m in 2009 to £1.1bn in 2012. The average overall profits for supply and generation increased from £3bn in 2009 to £3.7bn in 2012. The assessment does not come to a conclusion as to what is the appropriate profit margin for the industry but notes the recent increases and questions the suppliers’ contentions that five per cent is a fair retail margin. While the evidence on profitability is not conclusive, the rise over the last few years allied to no clear evidence of increased efficiency indicates a possible lack of effective competition.