Stephen Littlechild: Competition and the UK Retail Market

23 November 2017

In the UK, New Zealand and Australia the introduction of retail competition in the energy sector has generally worked well for business customers. Yet in both the UK and Victoria there is now talk of reimposing price controls for residential customers. Why is this and will it be good for these customers?

Until 2008, the UK regulator Ofgem (the Office of Gas and Electricity Markets) repeatedly affirmed that the
competitive market was developing well. Then suddenly it became concerned about “unfair price differentials”. The large incumbent retail suppliers were offering lower prices to attract customers outside their previous monopoly areas than the prices they charged their existing customers within their areas.

Ofgem imposed a non-discrimination condition to equalise these prices. But the retailers did not reduce their higher prices, they simply withdrew their lower prices. Ofgem observed that customer switching between suppliers fell, and supplier profits increased. It did not renew the non-discrimination condition.

Ofgem concluded that customers were not switching supplier because they were baffled by complex tariffs. So around 2012 it mandated Simple Tariffs. Retailers were not allowed to offer discounts and were limited to 4 tariffs each. But this did not help. In 2014 Ofgem asked the Competition and Markets Authority (CMA) to investigate.

In 2016 the CMA reported that Simple Tariffs had not increased switching but had reduced price competition, variety of tariffs and innovation. The CMA required Ofgem to withdraw the Simple Tariffs regime.

Why did Ofgem adopt measures that were ultimately against the interests of customers? The sudden doubling of domestic energy prices in the mid-2000s was a real problem for many customers. Ofgem was under great pressure to Do Something.

Although the media widely blamed the retailers, this was not a failure of retail competition. The real cause was the increase in world fuel prices. If anything, retail profits were on average negative over the preceding three years.

The CMA concluded that “Ofgem’s inability to address concerns about profitability ... led to Ofgem interventions that had an adverse effect on competition”. It recommended that the retailers routinely provide Ofgem with more information to assess profitability.

Thus, among the lessons we can learn from the UK experience is the importance of not responding to public pressures about energy prices without serious examination of what is determining these prices.

Increases in retail prices might reflect excess retailer profits and a failure of competition. Alternatively, they might reflect fuel cost or network cost increases or other issues. The remedy should reflect the nature of the problem. It should not be hurriedly concluded that retail competition is not working.

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