CMA Theories of Harm Round-up

Issues affecting electricity generators and the energy market as a whole.

The Competition and Markets Authority (CMA) energy market efficacy investigation rumbles towards its conclusion in just over three months’ time. Next is the Distribution Network Operators (DNOs) versus British Gas price control probe, set for a ruling on 30th September. For more on that read our next post. So while we wait for that we thought it made sense to look at the results so far against key ‘Theories of Harm’ which the CMA is rigorously testing in its 18-month long investigations.

Theory of Harm #1: “Opaque prices and low levels of liquidity in wholesale electricity markets create barriers to entry in retail and generation, perverse incentives for generators and/or other inefficiencies in market functioning”

The CMA’s query is whether current market rules and regulatory framework distort competition and lead to inefficiencies in wholesale electricity markets. The CMA, after a lengthy investigation of the wholesale markets, has found no conclusive evidence as yet that specific aspects of the wholesale markets are failing.
The CMA clearly approves of Contracts for Difference (CfDs) and capacity auctions. However concern remain that the imbalance in price reforms which may be over- compensating generators. The absence of locational pricing of constraints and losses may distort competition.

According to Utility Week, one of the easiest fixes that is likely to be proposed by the CMA in this area is the implementation of locational charges of transmission losses. PwC reckons that license changes or Balance & Settlement Code (BSC) modifications are not complicated and could be easily implemented.

Other remedies that are likely to be proposed by the CMA include removal of the four-tariff cap imposed by the Retail Market Reform which has been widely criticised during the consultation process. Finally, the CMA recognises that Small and Medium-sized Businesses as well as micro-businesses have been fleeced by suppliers (SME market makes up 10% of revenues earned by suppliers but they contributed a quarter of total profits of the Big Six over the last five years).
One possible response is prohibition of auto-rollovers for SME customers who are generally put onto flexible contracts which are significantly more expensive for the customer.

Theory of Harm #2: Market power in generators naturally leads to higher market prices.

The CMA says it does not appear likely that companies have the ability and incentive to increase profits by withdrawing capacity in generation Enron-style. Not guilty!

Theory of Harm 3a: Does a flagging power market limit competition?

Again the CMA is unconvinced. Based on evidence it has reviewed to date the CMA thinks current levels of liquidity appear to be sufficient to allow independent suppliers and generators to trade and hedge in the same way as the big six. Case dismissed!

Theory of Harm #3b: Vertically integrated electricity companies harm the competitive position of non-integrated firms to the detriment of customers, either by increasing the costs of non-integrated energy suppliers or reducing the sales of non-integrated generating companies”

Or to put it another way: Does vertical integration disadvantage independent players? The CMA has already declared that it is unlikely that a vertically integrated company has the ability and incentive to engage in activities that would disadvantage smaller players in retail or wholesale market. To some extent just sitting back and observing the poor performance of vertically integrated businesses over recent months (as they are increasingly exposed to lower wholesale energy prices) disproves this one. Cleared on all counts!

Theory of Harm #4: Does the lack of consumer engagement reduce competitive incentive?

The CMA has agreed to look more closely at the reasons behind consumer behaviour including the likely impact of Ofgem’s tariff reforms on competition and consumer engagement in retail energy markets. The maximum four-tariff limit imposed by Ofgem was attacked by energy firms at the time, saying it hindered competition and led to the withdrawal of tariffs benefiting particular groups, such as the vulnerable and elderly. It looks like the CMA may back their view on this after all.

Theory of Harm #5 argues that "the broader regulatory framework, including the current system of code governance, acts as a barrier to pro-competitive innovation and change".

The CMA is therefore looking at whether industry codes could act as a barrier to entry and/or pro-competitive innovation and change, because it has received submissions that the codes may be distorting incentives, increasing barriers to entry or stifling innovation.

In particular, it has indicated there may be too many codes, which increase compliance costs, in particular for smaller companies, and that there are often no fixed deadlines for taking decisions under the codes, which can unduly hold up potentially beneficial reforms.

But the CMA has not yet determined if that the right balance between providing companies with a degree of insulation from regulatory risk on the one hand, and allowing for pro-competitive innovation and change in the other.

In summary, the CMA has not yet found evidence that generator businesses have earned excessive profits, nor that wholesale prices have been above a competitive level. It also appears to conclude that there is no coordination between the Big Six at the wholesale level and that it is unlikely that they could use market power to withdraw capacity and increase profits.

The CMA's focus in respect of the Big Six's own incentives and behaviour therefore seems to have largely shifted to the retail markets. The CMA Energy Market investigation report has a statutory deadline of Christmas Day. We hope by then a new model for future UK energy retail market will already be taking shape. There is no doubt that deeper engagement with energy usage (and saving) is one of the keys to stimulating increased switching and that smart meter-enabled data analytics and new smart device-ready energy usage reporting & energy control tools, offer at least part of the solution. More on likely innovation in this area will be covered in one of our posts next month.

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