Forget energy companies: blame the regulator for distorting competition

Ofgem, the Office of Fair Trading (OFT) and the Competition and Markets Authority (CMA) will shortly issue an assessment of how well competition in the markets for gas and electricity is serving the interests of households and small firms. But as I argue in the March/April 2014 edition of the European Competition Journal, Ofgem’s regulatory policy is more problematic than the conduct of Britain’s energy suppliers.

Ofgem’s approach is now quite different to what it used to be. It once regarded the many discounts offered to energy consumers – for direct debit, prompt payment, online accounts, dual fuel and so on – as beneficial aspects of competition. It now regards them as harmful complexities that discourage customers from engaging in the market. Ofgem’s simplified tariffs policy is now to suppress tariff variety and to prevent suppliers from tailoring their products to the different needs of different customers.

Last week, the press reported on the intensification of a supermarket petrol price war, after Tesco announced discounts of up to 20p on a litre of fuel for shoppers buying their groceries in its stores. The RAC commented that ‘Tesco has created one of the most powerful fuel discount schemes we have ever seen as it has the potential to help everyone who shops with it on a regular basis.’ Could this happen for other energy products like electricity and gas? No, because Ofgem has just prohibited it. Because it would confuse customers.

British Gas is to begin giving away free electricity on Saturdays, to stop customers leaving and to reduce peak demand. This offer will be for customers with smart meters. But if it could find some other way to measure Saturday consumption, would British Gas be allowed to offer this deal to customers with ordinary meters? No, again because Ofgem says customers won’t understand such tariffs.

There is now accumulating evidence that Ofgem’s previous policy of stopping suppliers offering price cuts outside their local areas has reduced competition and led to higher prices. Despite this, and the latest regulatory restrictions on competition like those mentioned above, the framework proposed for the forthcoming competition assessment makes virtually no mention of regulation as a potential source of harm to competition. This is Hamlet without the Prince.

Ofgem has focused on designing a policy to increase customer engagement in the market. Customer switching between suppliers has indeed increased recently. But is that a result of Ofgem’s simplified tariffs policy or despite it? Which? found last week that the majority of people still find energy tariffs confusing, as two thirds fail to identify the cheapest deal.

The longer-term effect on customer engagement remains to be seen. But Ofgem fails to acknowledge the serious adverse impacts its policy has already had on competition and customers. Its recent proposals for monitoring and evaluating its policy amount to asking ‘apart from that, Mrs Lincoln, are you more likely to engage in the market?’

There is growing concern about the withdrawal of tariffs with zero standing charge, particularly for gas customers with zero or low consumption. Ofgem has requested information as to why this has happened and whether it is fair. To anyone else, the answers are clear. Ofgem’s new policy (with suppliers limited to a maximum of four tariffs and only one unit price allowed) makes it uneconomic for suppliers to continue to offer tariffs with zero standing charge. Is that policy fair to smaller customers, many of them elderly, who want a zero standing charge? No.

Ofgem is unable or unwilling to recognise that its policies over the last five years are likely to have seriously and adversely restricted and distorted retail competition, to the disadvantage of customers. It would be unreasonable to expect Ofgem to independently assess the impact of its own regulation on competition. A market investigation by the CMA is therefore required.

But why has Ofgem so badly lost its way? A significant explanatory factor has been the gradual removal of economists from key senior positions at Ofgem and its parent body the Gas and Electricity Markets Authority. From its inception in January 1999 until December 2007, both the head of markets and one non-executive director were trained economists. For the first five of those years, the chairman/chief executive was an economist too. But in the six year period from January 2008 to earlier this month, the chairman, chief executive and the head of markets have none of them been economists, and for over half that period no non-executive director was an economist either.

This provides an even stronger argument for the CMA to carry out a market investigation. Regrettably, Ofgem is not at present capable of carrying out a competition assessment.

This article was originally published by City AM.

Member of the Advisory Council

Prof Stephen Littlechild is a Fellow in Privatisation, Regulation and Competition, at Cambridge Judge Business School, and Emeritus Professor at the University of Birmingham. He is a member of the  Academic Advisory Council at the Institute of Economic Affairs.