Regulation
Click here for an introduction to utility regulation.
The main battleground in energy regulation is the regulation of retail energy:- the gas and electricity that is delivered to voters' doors. The regulator, Ofgem, decided in 2002 that there was sufficient competition to allow it to step back and allow prices etc. to find their own level. This strategy was initially pretty successful as profit margins fell and the suppliers introduced innovative new tariff structures. But then the difficulties which face the regulators of this industry became obvious once again.
The first problem is that the energy industry has three tricky features:
But the 2002 liberalisation of the market added new problems, in that the retail industry became concentrated in the hands of only 6 suppliers (British Gas, EdF, E.ON, NPower, Scottish & Southern, and Scottish Power). There was little or no new entry and the complex new tariffs - with cheap deals aimed at those willing to switch suppliers - were soon perceived to be confusing and obfuscatory rather than liberalising. Those 'switchers' who shopped around and switched suppliers found that they could generally save 10% of their energy bills, but many consumers - and particularly vulnerable consumers - failed to switch and were thus in effect penalised yet further. The pressure slowly grew to do something to help those vulnerable customers, whose behaviour happened to be indistinguishable from those who couldn't be bothered (or were too well-off to be bothered) to shop around.
Eventually, in 2008, Ofgem decided that they would impose non-discrimination clauses on the energy companies - i.e. force them to offer the same prices to switchers and non-switchers. Unfortunately, however, this decision will have had the perverse effect of reducing the competitive pressure on all 6 companies. This is because the companies will know that there is now very little to be gained by reducing prices in order to attract new customers, as such price reductions now have to be offered to all their existing customers, at great cost to the bottom line. Even worse, such price reductions would probably be copied by competitors (through what economists call 'tacit collusion') and so might not attract any new custom at all. All in all, therefore, it no longer makes much sense for any company to compete by lowering its prices. The regulator has thus chosen to help the vulnerable (as well as those who can't be bothered to shop around) by promoting equal treatment between customers - but at the expense of effective competition and hence lower prices for all. It could even be that the vulnerable will end up paying more for their energy than before - but at least they will have the satisfaction of paying the same as everyone else!
The second problem is that prices appear to be 'sticky downwards'. Ofgem has been under pressure, for many years, to look into why energy companies appear to increase their prices quite quickly when oil/gas prices rise, but reduce them rather more slowly when oil/gas prices fall. The industry claims that this is a false perception, resulting from their entering into long-term prices to buy gas, thus protecting their customers from excessive price fluctuations. On the other hand, as noted above, the retail industry is concentrated in the hands of only 6 suppliers, these 6 don't need to worry about new companies entering the market, and most customers are reluctant to switch suppliers. There thus appears to be plenty of scope for tacit collusion - i.e. the 6 companies will be slow to reduce their prices because such reductions would not gain them market share and would soon be copied by competitors. Price reductions would not therefore leave anyone any better off - apart from their customers of course, whom they regard as somewhat less important than their shareholders.
As noted above, Ofgem did eventually take a close look at the energy market following which they announced that they had found no evidence of anti-competitive behaviour. In practice, this meant that they had found no evidence of illegal price-fixing (which nobody had suspected anyway) but they did not have the information-gathering powers and/or resources to carry out the rather more detailed investigation which might have found evidence of tacit collusion. The obvious answer was to refer the market for investigation by the Competition Commission (CC) but, like most utility regulators, Ofgem were decidedly reluctant to do so.
Critics therefore continued to complain about Ofgem's inaction, until the regulator announced another probe beginning in November 2010, having noted sharp increases in retail profit margins and having gained access (via changed licence conditions) to more detailed company accounting information. But (unlike the CC) the regulator still could not find out what the companies pay for their imported gas, which rather hampers any serious investigation. Despite this, there was no mention in Ofgem's press statement of a possible CC reference, nor to the fact that the CC already had much stronger information gathering powers and could have carried out a deeper investigation two (or four - or six) years previously.
Ofgem announced the result of its probe in June 2011, noting that "Our latest report on prices also gives even more impetus to the need for radical reform as it shows that turmoil in global energy markets during 2011 has pushed up wholesale costs by 30 per cent since December 2010. Now more than ever, consumers need to have confidence that competition can operate effectively in setting energy prices." Despite this, the regulator merely announced moves which would "sweep away complex tariffs" and "encourage more firms ... to enter the energy market and increase the competitive pressure on the Big Six." It remains to be seen whether Ofgem will be shown to have been over-confident in their ability to promote effective competition, but it did still seem disappointing that they again declined to take advantage of the potential power of a reference to the CC.