Ofgem answers its critics

How should the energy regulator respond as the market evolves? David Gray, Ofgem chairman, identifies some trends from the past few years, and describes what Ofgem is doing in response.

The past year has seen more scrutiny of and more debate about energy than ever before. The debate is healthy, but it also has disadvantages. There is an understandable lack of trust from consumers, which becomes self-feeding: the media and political commentary turns hostile, which makes consumers trust companies less. Not surprisingly, Ofgem has faced criticism too.

We’ve been accused of doing too little too late, in the face of unacceptable behaviour by some energy suppliers. We’ve been accused of failing to prevent price rises – something over which we have no powers. But behind this there’s been a more interesting debate about our interventions to simplify the market for consumers. A group of former regulators has argued that Ofgem’s interventions are themselves responsible for increasing prices and profits. They argue that the market was working well before 2008 but then Ofgem started interfering and prices and margins rose.

I’d like to suggest that real life is rather more complicated than either line of argument recognises.

First, some background. The two big features of the past ten years have been rising prices and poor customer service and mis-selling by the big six.

Price rises have been driven by increases in the price of gas on the international wholesale markets and by government measures to support decarbonisation and fuel poverty objectives, which are paid for by energy consumers. Rising network costs have also had some impact.

There was nothing Ofgem could do about rising wholesale gas prices but this is the essential backdrop to events since about 2004, and it contrasts markedly with the period from privatisation until 2004, when prices were falling.

Opening the domestic market to competition pushed the energy companies into the consumer-facing world, but they have not kept pace with customer expectations. Customer service has improved, but not fast enough. There have been serious failures, especially with the introduction of new IT systems and mis-selling by the big six. Doorstep selling drove much of the switching in the early stages of retail competition, but this was beset by malpractice.

It has also been difficult for new players to enter the supply business and to grow once established. There are lots of reasons for this, which include the complexity of the network codes and market rules; risk and capital requirements; and perhaps structural issues relating to the vertically integrated model of the big six.

After we stepped in and contributed to the end of doorstep selling, consumers began to use price comparison sites for switching. This brought a new issue into focus – tariff complexity.

Ofgem research showed consumers were confused and switching sites were overloaded by the range of tariffs on offer. Complex pricing structures are not unique to energy. It is a feature of the modern world and one I would like to see the Competition and Markets Authority (CMA) look at. You may disagree with Ofgem’s approach in this area, but it’s hard to argue that there isn’t an issue to address.

The energy sector is inherently complex, because of the need to balance supply and demand in real time over a national system. So there is a need for the complex system of market rules. But there are other aspects of increasing complexity: our duties have expanded in number and in scope, and include environmental objectives, security of supply and alleviating fuel poverty, and new duties under European rules.

Complexity is not going to go away.

In energy regulation, as in anything else, there is always scope for improvement, and for learning from mistakes. I believe the CMA has an important role to play in this process, precisely because the issues facing the energy sector are so complex. Addressing complex problems should benefit from the insights of a fresh and independent second pair of eyes.

My personal view is that it would have been better to refer the market to the CMA earlier. This would have allowed a wider examination of the features that may be reducing the effectiveness of competition in the sector. However, many decisions Ofgem takes are finely balanced and at the time there were good reasons why the market was not referred. In particular, concerns about the impact a market reference might have had on investment and security of supply and concerns about how best to protect vulnerable consumers. I believe the arguments for independent regulation are clear. I thought Stephen Littlechild captured the essence of them elegantly at an event last year, when he said that the purpose of independent economic regulation was to protect consumers from exploitation by the privatised companies and to protect investors in those companies from interference by government.

The deal underpinning independent regulation should be for Parliament to delegate specific tasks to an expert body. That body, the regulator, can say no if the executive arm of government seeks to undermine that delegation. Companies play their part by not running to government whenever they disagree with the regulator’s decision, and the regulator does its utmost to operate as an expert body and remain impartial to the interests of the industry it regulates.

If this works, there are advantages all round. Government should feel less need to intervene; companies should be confident enough to plan long-term investment, the cost of capital to finance that investment should reduce, and consumers should gain.

But for independent regulation to be effective, the regulator cannot put itself in an ivory tower. It needs to be engaged with and responsive to consumer experience, the public’s concerns, and the business realities of the energy industry.

I very much hope that at the end of the CMA inquiry we will see a reaffirmation of the principles of independent regulation, perhaps reinforced against some of the erosion we have seen in recent years.

This is all difficult to achieve, but it’s an ideal worth striving for. If the CMA review helps us reach it, that will be very good news for British energy consumers.