Ofgem proposes a reference to the CMA to investigate the energy market

27 Mar 2014 02:13 PM

• Ofgem proposes the CMA investigates the market to consider once and for all whether there are further barriers to effective competition
• Profit increases and recent price rises have intensified public distrust of suppliers and highlight the need for a market investigation to clear the air
• Ofgem’s reforms come fully into force from April to protect consumers and help them get a better energy deal 
• Ofgem will continue to take action to protect consumers including higher penalties for firms breaking the rules

Ofgem has today acted to remove uncertainty from the energy market by proposing a market investigation by the Competition and Markets Authority (CMA). A market investigation will once and for all clear the air and allow the CMA to ensure that there are no further barriers to effective competition. An investigation would reassure consumers and complement Ofgem’s reforms for a simpler, clearer and fairer energy market. 

Today’s State of the Market assessment, prepared jointly with the Office of Fair Trading (OFT) and CMA, confirms Ofgem’s previous analysis of why competition is not working as well as it could. As well as reinforcing concerns about barriers to entry for independent suppliers and persistent high market shares of the largest energy companies, the report includes further evidence and shows:

• declining consumer confidence with 43 per cent distrusting energy companies to be open and transparent. This may deter consumers from engaging in the market and prevent them from getting a better deal for their energy
• continuing uncertainty over whether the vertical integration of the large energy companies is in consumers’ interests
• retail profits increasing from £233 million in 2009 to £1.1 billion in 2012, with no clear evidence of suppliers becoming more efficient in reducing their own costs, although further evidence would be required to determine whether firms have had the opportunity to earn excess profits, and 
• suppliers consistently setting higher prices for consumers who have not switched.

Given these problems Ofgem believes a referral to the CMA is timely and necessary because: 

• CMA’s more extensive powers can address any long-term structural barriers to competition
• A market investigation would conclusively determine whether vertical integration is in consumers’ interests or whether there should be more separation between the largest companies’ supply businesses and generation arms 
• Ofgem’s reforms for a simpler, clearer, and fairer market have created a safer space for consumers to shop around for a better energy deal while a CMA investigation takes place. 
• Major change is coming with the roll-out of smart meters. A CMA investigation will ensure that there are no further barriers that prevent consumers from making the most of the transformation smart meters will bring to the energy market.

Dermot Nolan, Ofgem Chief Executive, said: “Ofgem believes a referral offers the opportunity to once and for all clear the air and decide if there are any further barriers which are preventing competition from bearing down as hard as possible on prices. 

“The CMA has powers, not available to Ofgem, to address any structural barriers that would undermine competition. Now consumers are protected by our simpler, clearer and fairer reforms, we think a market investigation is in their long-term interests. 

“I want to make sure that consumers are put at the heart of this market, so we will continue to take action to help consumers. This includes from today putting the industry on notice that any new serious breach of the rules which comes to light will be likely to attract a higher penalty from Ofgem. I am determined that energy companies use our reforms to transform their relationship with consumers.”

Ofgem will continue with a range of projects aimed at improving competition and maintaining security of supply. We will launch a consumer engagement campaign to help consumers take advantage of the simpler, clearer, fairer reforms to get themselves a better energy deal. We are continuing with our work to increase transparency and have today published our latest look at retail and wholesale prices for consumers. We have also today announced that we will substantially increase the level of penalties we impose for breaches coming to light in the future. We will continue to make timely changes to protect consumers’ interests, in parallel with any CMA investigation. 

-Ends-

Notes to editors:

1.   The first annual competition assessment has been carried out by Ofgem, the OFT and the CMA. It analyses the state of competition in the household and small business markets.  You can read the assessment report on our website. 

By law Ofgem must consult with stakeholders before making a final decision on a referral to the CMA for investigation. The consultation is available on our website. 

2. The headline findings of the assessment are:

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% of consumers did not trust energy suppliers to be open and transparent in their dealings with them in 2013, compared to 39% 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 larger 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 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 5 per cent there are barriers to entry and expansion which may prevent them from posing a disruptive competitive threat. 

Profitability: The average profits for the six larger suppliers for supply and generation have 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 5% is a fair margin. While the evidence on profitability is not conclusive, the rise over the last few years allied to no clear evidence of increased efficiency is indicative of a possible lack of effective competition. 

3. Penalties 

Ofgem has today issued a letter setting out that we will substantially increase the level of penalties we impose. This decision has been taken to ensure regulatory compliance is given sufficient focus within businesses and to deliver strong deterrence. This change will come into effect where evidence of rule breaking comes to our attention on or after 1 June.

4. Further work by Ofgem

In the meantime Ofgem will continue with the range of regulatory projects that we have in hand aimed at improving competition and maintaining security of supply. In addition to those mentioned above these include our work to improve the speed and reliability of switching, our programme of work on third party intermediaries (brokers, switching sites etc), initiatives to support the most vulnerable and sticky customers and our support for the smart metering rollout. To make the energy market clearer for consumers, Ofgem has published a new commentary on recent and possible future cost trends for energy suppliers. The commentary also estimates suppliers’ pre-tax margins for supplying gas, electricity and dual fuel.

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