Comment: CMA – Flawed Analysis?

The Competition and Markets Authority (CMA) has just issued the full version of its Provisional Decision on Remedies for the UK energy supply market – and, at 750 pages, it is a monumental door-stopper.

Since the recent publication of the summarised version, the responses from the Big Six energy companies have been muted, although Centrica has re-affirmed its disagreement with the notorious 2013 £1.7 billion alleged over-charging figure promulgated by the CMA: the 2015 equivalent was £2.5 billion.

It seems likely, though, that Centrica will come out with both barrels and refute this figure – and highlight other flaws.

The CMA’s preferred ‘direct’ methodology to assess the numerical detriment from ‘Adverse Effective Competition’ (AEC) is based primarily upon using First Utility’s and Ovo’s retail selling prices as ‘benchmarks’ – a bizarre approach.

After all, their combined market share is c6 per cent – they are hardly ‘price-setters’. In the domestic gas market, Centrica unquestionably fills that role.

It would be almost as illogical to use the retail selling prices of Lidl and Iceland – also with a combined market share of c6 per cent – as ‘benchmarks’ in carrying out a similar exercise in the groceries sector.

Crucially, the 2013 £1.7 billion alleged over-charge figure is predicated on this flawed analytical base.

It is also relevant that market newcomers often offer eye-catching price deals as indeed Lidl does in the groceries market.

CMA argues that both energy companies’ price offerings are sustainable in the long-term. Although both are comparative minnows, Ovo Energy still chalked up a £30+ million loss in 2014.

Secondly, the CMA’s ‘direct’ methodology is further flawed by any material recognition of the Weighted Average Cost of Gas (WACOG) and its electricity equivalent; these inevitably have a major impact on the end-user price.

After all, energy companies need to maintain a portfolio of supply contracts of varying duration: they are struck on very different terms.

Inevitably, they will periodically get it wrong as British Gas famously did in the 1990s with its notorious ‘take or pay’ contracts.

But this does not mean that customers are necessarily over-charged.

After all, both Easyjet and Ryanair have faced challenging commercial decisions whether or not to hedge against fuel prices.

With the benefit of hindsight, a long-term hedge at pre-2014 oil prices would have been very imprudent; at the time, few people expected oil prices to plummet.

Assuming stable profit margins, whether or not to hedge fuel costs will inevitably impact end-user prices.

But it does not mean that, if Easyjet and Ryanair adopt very differing hedging strategies, one is over-charging its customers whilst the other is under-charging them.

Thirdly, the CMA’s less favoured ‘indirect’ approach is based partly on analysing profit margins and partly on incurred costs.

Interestingly, its alleged over-charge figure from this analysis could be below £700 million per year between 2007 and 2014 for domestic customers.

The difference between the two methodologies in 2014 was c£1.5 billion. These are not mere rounding errors.

It is questionable whether such apparently flawed numbers should be given house-room – or indeed wide circulation – by a public body.

Nigel Hawkins, director, Nigel Hawkins Associates