CMA report splits the difference between Conservative and Labour energy policy

July 7, 2015

Today the Competition and Markets Authority (CMA) released a long-awaited report on its investigation of the energy market. The investigation was launched in the wake of Labour’s pledge in 2013 to “freeze energy bills”, and to fix what they saw as a “broken energy market”. The CMA’s report has raised a number of substantive issues, and the Labour team has already sought to claim an ‘I told you so’ moment.

However, in reality the CMA has produced a set of recommendations which fall somewhere between what Labour and the Conservatives have been proposing.

Labour’s proposals to fix the energy market were largely about increasing regulation of energy companies. As set out in a Green Paper, Labour proposed a freeze on energy bills (or was it a cap on prices?), the break up of the Big 6 (ring-fencing of supply and generation businesses within vertically integrated companies), the reintroduction of a ‘pool’ trading mechanism, simplification of tariffs, and tougher regulation. These proposals were based on the assumption that vertically integrated players were abusing their position, that there was a lack of transparency, and that markets were functioning poorly.

The CMA report has dismissed most of these propositions. Their analysis has found that vertical integration is not having a detrimental impact on competition in gas or electricity markets, that the Big 6 carry out extensive external trading , and that pricing information is readily available.

On the other hand, the Conservatives’ solutions are to promote competition and switching, and to simplify tariffs. The CMA report finds that switching is having a beneficial effect in the active segment of the market, but this still represents a minority of customers. On the question of tariff simplification, the CMA has recommended that the recently introduced measure to simplify tariffs (Ofgem’s ‘four tariff rule’) should be abolished on the grounds that it has stymied competition and innovation.

The CMA’s report is far from a clear bill of health for the energy suppliers. The key issue identified by the CMA is the problem of inactive or ‘sticky customers’ who are largely disengaged from the market and are on Standard Variable Tariffs. Whilst there is significant competition in fixed price and discounted tariffs, there is limited if any competitive pressure in Standard Variable Tariffs, which according to the CMA gives suppliers a position of unilateral market power.  The CMA report finds that the average domestic energy prices offered by the Big 6 were about 5% above a fully competitive level, which equates to domestic consumers paying around £1.2 billion per year over the odds.

The key question is what to do about this.

Part of the answer may be to increase switching and customer engagement. The CMA has made a whole series of recommendations to this effect, such as: the provision of more information by suppliers, specific measures to make switching easier, the prohibition of auto-rollover contracts, introducing more prompts for people to switch, and even for Ofgem to establish an independent price comparison website. But these reforms are ultimately limited by the level of customer disengagement – particularly the 70% of customers who are on Standard Variable Tariffs.

The game changing recommendation by the CMA is the introduction of a ‘safeguard regulated tariff’. This looks quite a bit like ‘price freeze’, although there are some differences. The CMA has clearly sought to find a solution which effectively protects the consumer whilst at the same time allows competition to continue. Its proposal is for the CMA or Ofgem to set a maximum price for default tariffs, but to continue to allow suppliers to compete below the cap, and to offer fixed price deals on an unregulated basis. In their view a fully regulated price control would destroy competition, but the model they propose would not. However, the CMA’s proposal still represents a seismic shift from the status quo, and has already been dismissed by the Prime Minister’s office.

One elephant in the room is that unlike a ‘price freeze’ the safeguard regulated tariff can go up or down, depending on what is happening to underlying costs. There are good reasons to believe that electricity prices in particular will increase further in the future. The CMA report suggests that over the period 2009-13, the main drivers of domestic price increases were the cost of networks (cables and pipelines), and policies (e.g. renewable energy and energy efficiency subsidies, carbon taxes, and the rollout of smart meters). DECC’s own modellingforecasts an 18% (real terms) increase in electricity prices between 2014 and 2020, almost entirely due to further increases in policy costs. In this scenario the safeguard tariff would not be frozen, but would need to increase by a similar amount. This is completely absent form the narrative around energy bills at present.

On policy costs, the CMA report also makes an interesting read. It sets out the benefits of moving to competitive allocation of renewable energy subsidies under the Contract for Difference (CfD) model, but is highly critical of DECC’s decisions to allocate contracts on a non-competitive basis (e.g. FID enabling), and to divide the CfD into different technology pots. These are points which Policy Exchange has been making for some time: our report Going, Going, Gone advocated the use of auctions to allocate renewables subsidies, and we have made a number of recommendations on how to further improve the auction design, including through the removal of technology pots.

Overall the CMA report is towing a difficult line somewhere between greater regulation and greater competition – and between the Labour and Conservative visions of the energy market. As always, the devil will be in the detail, particularly in terms of the regulated tariff proposal.

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