IT IS not entirely unwelcome that the energy industry has been referred to the Competition and Markets Authority (CMA) by Ofgem. It may lance a festering boil; it may do some good. However, this will only be the case if the investigation is handled correctly. Too often, competition inquiries have created huge uncertainty and disruption. This raises the cost of capital, discourages new entry and investment – as Centrica suggested yesterday – and ultimately raises prices to consumers, while solving none of the underlying problems.
Two premises must be accepted if the CMA inquiry is to be a success. The first is that trying to achieve the outcome implied by the textbook model of perfect competition is futile. Instead, we should try to achieve a reasonable degree of workable competition given the huge economies of scale involved in energy production. There are natural barriers to entry for new firms, but the outcome of the market process could still be satisfactory. Any attempted cure could well be worse than the disease.
The CMA must also realise that there are dangers in imposing particular structures on complex industries. When the railway industry was privatised, for example, it was widely believed that you could have more competition if the trains and tracks were operated by different companies. The reality was that the increases in costs outweighed any benefits from more competition. The CMA may well conclude that the current energy industry structure is an historical relic from the days of nationalisation and that it should be broken up. There is a perfectly reasonable case for this, but it should tread carefully.
Secondly, the CMA needs to be aware that many competition problems have been caused by the regulator Ofgem and by the government. Indeed, it is curious that Ofgem itself has referred the industry to the CMA. It was Ofgem that reduced competition in 2008, by making it more difficult for energy companies that wanted to develop a presence out of their traditional operating areas to undercut the established firms on price. Amazingly, Ofgem complains about the results of that policy – low levels of switching – in its reference. It is true that switching has halved since that time, but whose fault is that? Since 2008, the average price cut offered by Big Six entrants into other areas has halved, and Ofgem has observed possible tacit co-ordination of price changes. That is hardly surprising given its policy.
With the aim of simplifying the market, the government and Ofgem together have also reduced competition by limiting the number of tariffs energy companies can offer. This has had a chilling impact on innovation, to the detriment of consumers. E.On has now withdrawn its Staywarm tariff, which was geared to the needs of the over-60s who wanted a fixed price per month, regardless of how much energy they used. Tariffs with no standing charge, for which old age pensioners have canvassed, are effectively prohibited.
Further, some would argue that the main impediments to competition come from the collusion between regulators, government and energy companies through the implementation of climate change policy. The focus on renewables obligations and subsidies; the pressure from big companies to increase carbon allowances; and the subsidies directed through incumbent energy companies for insulation and the like all make the market less transparent, and can benefit incumbents at the expense of new entrants.
But there is no silver bullet. The energy industry involves large up-front investments and high fixed costs. There are certainly impediments to competition, but many of them come from government. The period after privatisation saw liberalisation, huge price cuts and low prices relative to the rest of Europe. More recently, however, the industry has progressively been bound up in more and more regulation, and the regulator has been given increasingly diverse objectives which often work against competition.
David Currie – chairman of the CMA – has always been aware of the dangers of using regulation too high-handedly. He is also aware that the government is often the most serious impediment to competition. The CMA is now the monopoly competition regulator. This inquiry is its first major challenge. It is to be hoped that all restraints on competition in the energy industry will be investigated. Often it is the government which is the biggest problem. That may be the case here.
Philip Booth is editorial and programme director at the Institute of Economic Affairs, and professor of insurance and risk management at Cass Business School, City University.