Don’t just blame energy giants: government is blunting competition

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 coordination 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.

This article was originally published by City AM.

Academic and Research Director, IEA

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.

2 thoughts on “Don’t just blame energy giants: government is blunting competition”

  1. Posted 28/03/2014 at 10:37 | Permalink

    Sooner or later enough scientists (or those with a first degree in a science) will make it into the House of Commons, BBC and quangoracy, such that the basic elements of Darwinism are known to them.

    Diversity + competition = selection > evolution.

    So, the best possible way to reduce power costs – for industry as well as private individuals – is to have NO regulations AT ALL.

    Just leave it to the consumers to buy their power from whomsoever they like (so making swapping suppliers easy IS useful).

    And then sit back and allow the Market (aka Darwinism) to ‘do its thing’ and when, not ‘if’ some problem arises, and the MSM are creating a fuss over it, all the politicians can simply say ‘nothing to do with us. We deal with Defence, Foreign affairs, Justice and tax collection. And that’s ALL we do. Everything else is up to you – individually and collectively – to decide.’

    Then there will be a small chance that the collective brains in The Establishment might, just might, make some decent decisions: after all, they’d have only four things to deal with, yes?

    One to 650 people making decisions for 65 million means they will ALWAYS be worse, for most, than 65 million people making individual decisions for themselves.

  2. Posted 28/03/2014 at 13:23 | Permalink

    One thing is more certain than all else: the corpoorate sector is able to spot any weakness that might exist in a regulated sector and to profit from it.

    John Major caused the weakness by allowing generators to retail and, once that opportunity for a cartel opened the sector abused it to the fullest.

    Whilst generators could only generate they were at the competitive mercy of the retailers but the Major move resulted in a very small number of generators who could then move prices in tandem.

    Non generating retailers were unable to move the market because the generating sector was able to maintain prices at a high level notwithstanding.

    Odd though it may seem Millibands idea of not allowing generators of power to retail is probably the best way of ensuring pressure from a diverse and competitive retail sector keep the generators on their toes.

    The move must be done properly if it is to succeed and generators must be forbidden to retail, even though it might be through a subsidiary company

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