Make all administrative energy codes competitive

The energy sector could save significant sums of money by opening up all code administration activities to competition, says Tony Thornton.

With only half of code administration bodies in the energy market exposed to competitive pressures, do all organisations delivering these code-related services strive for exceptional quality, while keeping costs low? Should they all be exposed to competitive tendering? These are some of the key questions that need addressing.

Industry codes are multilateral agreements that underpin market interoperability. They ensure fair and equitable competitive market practices (a level competitive playing field), and ultimately, support the delivery of services for customers. Codes are an intrinsic part of the governance infrastructure to ensure energy markets work. This is an aspect also recognised by the Competition and Markets Authority (CMA), which highlighted within its provisional remedies that codes are critical for the functioning of the regulatory framework.

In its Cutting Red Tape of the Energy Sector publication, the Department for Business, Innovation and Skills (BIS) suggested four code administration bodies had a total operating budget of around £70 million in 2013/14. In addition, the CMA noted during its investigation into the retail energy market that the complexity of codes and the related governance arrangements created  significant compliance costs for industry participants.

At a time when energy costs are under such scrutiny, the regulatory and governance framework should also be exposed to driving out inefficiencies and securing value for money for customers.

Gemserv is one of the four code administrators mentioned by BIS, administering two major industry codes: the Master Registration Agreement (MRA), and the Smart Energy Code (SEC). Both codes play a fundamental role in governing energy market practices. The former supports electricity retail governance practices across Great Britain; the latter lies at the heart of national smart metering rollout programme. Despite their significance, these two combined operating budgets only account for 7 per cent of the total £70 million suggested by BIS. In other words, the bulk of the costs in 2013/14 as quoted by BIS relate to the three remaining code administration bodies.

While all industry codes are different in terms of their complexity and what they cover, undoubtedly behaviours change where there is a real risk of competitive pressure placed on those codes and their administrators.

Competition in code administration ensures that organisations that look after codes remain focused on the quality of service; it ensures efficient pricing of goods and services; and it drives organisations to innovate in order to stay ahead of its competitors. But not all codes and their code administrators are open to competitive pressures, as they are in the case for the MRA and SEC.

All Gemserv’s code administration work is secured on a competitive tender basis. The MRA (the electricity market retail code) has seen a 55 per cent cost reduction in core service charges since its inception in June 1998. The SEC, a new market code, applies similar efficient benchmarked practices.

If this was the case across the board for all industry codes, that is, if they were open to competitive tender for code administration services, there could be significant cost savings on the £70 million quoted by BIS.

With half of the current 11 energy industry codes and agreements providing monopoly services on a non-tenderable contract, improving competition in code administration would provide a more cost-effective framework. It would change behaviours, ensuring that all code administration bodies were focused on the value and outcomes.

The very nature of competitive threats bears down on costs. Indeed, the CMA proposes a remedy for the Department of Energy and Climate Change (Decc) to make the provision of code administration (and delivery) services a licensable activity. For this to achieve the outcome of high quality code administration at a low cost, all codes and their administrative services should be open to full competition.

The right incentive-based model is one where there is no guarantee of future revenue other than under a competitively won contract, where a code administrator is able to reap the rewards of success but suffer the consequences of failure.

Indeed, to do otherwise runs counter to the CMA’s objective to ensure that the imposition of sanctions delivers strong accountabilities and to ensure that incentives placed on code administrators are aligned with those of customers.

It is difficult to see how a licensing regime could be fully effective unless the two go hand-in-hand, that is, where licensing ensures there are strong accountabilities against which performance can be measured and enforced, and a fully competitive code regime ensures the licensing impacts are felt by the code administrators themselves.

The CMA is due to publish its final remedies before 26 June 2016. The CMA should ensure that there is a level playing field when it comes to code administration, by requiring the full contestability of code administration services across all industry codes before sanctions under a licensing regime are applied.

Tony Thornton, head of transformation, Gemserv