Ofgem finally gets smart

Ofgem has finally buckled under consumer and political pressure and is now going to refer the energy market to the Competition and Markets Authority (CMA).It says that “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”.

So why now?For years, despite the protestations of some, Ofgem did next to nothing to boost competition.The outgoing regulator trusted the market, on its own, to be the best solution.Although admirable from a “hands off” market point of view, energy bills have been rising (partly because of the cost of low carbon measures but also because there is no effective competition in the generation, wholesale and retail markets).Regulatory interference was seen as a confidence threat to investors in the market.

So why a probe now?Rising bills and a forthcoming General Election have played their part.There is also a new regulator who is perhaps trying to seize the opportunity of the market re-design uncertainty period, which has stalled investment decisions, to also carry out an unsettling market probe.

Competition in energy retail has not really worked out as planned.Bills have gone up.There has been very little technical innovation.In January 2002 analysts at UBS Warburg showed that the Herfindahl–Hirschmann Index (HHI) (a measure of competition) for the Great Britain market, which then had eight competitors, stood at 2,133 – and so was already deemed highly concentrated under US anti-trust guidelines.Since then further mergers have taken place leaving just six large suppliers in the market.

The introduction of the New Electricity Trading Arrangements (NETA) benefited vertically-integrated players rather than merchant generators by introducing an artificial risk for each player – that of matching its generation output with its supply off-take – the balancing risk.The introduction of two balancing prices under NETA was deliberate – it was designed to encourage forward trading because it would be very difficult to manipulate imbalance prices.

However, this has not worked to the benefit of all players.Size is important when it comes to trading under NETA.Companies with large and flexible generation portfolios and large (and hence relatively predictable) demand bases are better protected against the imbalance prices than smaller players (such as new entrants) who have a tough time forecasting customer demand, and might not have their own round-the-clock trading desk to trade the imbalance position at the latest minute.

With an election on the cards and voters paying through the nose they, and political operators, are seeking answers.Perhaps vertical integration could be unpicked?Some people have been questioning the role of Ofgem.Perhaps it needs to be scrapped and replaced with something new and smarter?Interesting times.

Dominic Maclaine is an EPG Associate and used to be the editor of New Power before he sold the business. He conducted PhD research into electricity supply competition in the UK and Norway at SPRU. He was previously the editor of the monthly newsletter Power UK published by Platts (and previously the Financial Times). He is currently writing a book about recent developments in the UK electricity market, to be published by Routledge.

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