Suppliers under the spotlight

After months of phoney war, Ofgem has finally unleashed the CMA on the energy market. Mathew Beech reports.

And so it begins. Ofgem gave the sector plenty of notice that it faced an inquiry by the Competition and Markets Authority (CMA), and on 26 June it became official.

The CMA’s inquiry is expected to take 18 months, and will put the retail market under forensic scrutiny to measure just how competitive it is – and whether consumers are getting a fair deal.

Announcing the inquiry, Ofgem chief executive Dermot Nolan said there was “near-unanimous support for a referral” and that it would “help rebuild consumer trust and confidence in the energy market”.

He said: “A CMA investigation should ensure there are no barriers to stop effective competition bearing down on prices.”

The CMA has been given a mandate to examine the following key areas: weak customer response; the impact of vertical integration; barriers to entry and expansion for smaller suppliers; the incumbency advantages of the larger suppliers; and the possibility of tacit co-ordination.

Alongside this, Ofgem said the CMA could look at “any issue connected with the supply or acquisition of energy”, including the role of third-party intermediaries, and other goods and services linked to retail supply – such as the bundling of boiler services with a tariff.

Not deemed problematic by Ofgem, and therefore not part of the referral, are the wholesale gas market, transmission and distribution, gas storage, interconnection, and settlement reform.

Only the domestic and small-business retail markets will be investigated, because Ofgem found “little evidence of harmful features” in the large customer segment.

As far as the consumer market is concerned, Ofgem said it had observed weak consumer response and engagement in the market “for some years” . This is a “harmful feature” because the less engaged the consumer, the less likely they are to switch.

The CMA has been asked to assess whether consumer apathy harms competition and, if so, how it can be addressed.

Vertical integration, acknowledged by Ofgem as “an important feature of the electricity market”, is also in the CMA’s crosshairs. It “contributes to weak competitive dynamics between the largest suppliers”, according to the referral, because self-supply reduces liquidity and the transparency of wholesale prices.

Tacit co-ordination will also be a big area of inquiry. The CMA has been pointed towards the fact that the suppliers have matching hedging strategies, announce tariff changes at the same time, and have “signs of converging” profitability.

Of course, before it can address tacit co-ordination, the CMA must first establish that it exists.

The big six also have an incumbency advantage over smaller competitors, and the CMA will examine how much of a problem this is, if at all. Related to this is whether incumbents are using the large numbers of disengaged consumers they inherited to effectively subsidise the better deals offered to active switchers.

The final area of concern is the barriers to entry and expansion for new and smaller suppliers.

The money needed to enter the market, and to sign up to industry codes, is prohibitive for some potential new entrants and a significant cost for existing small suppliers – and it is set to get worse with the introduction of Electricity Market Reform. The obligations put on suppliers by the government are also potentially harmful to competition, in particular the 250,000 customer account threshold of the Energy Company Obligation.

Finally, the CMA will look into the toxic reputation of the energy sector and how the reputational risk of being part of the market is putting off potential new entrants.

It’s a long leash that Ofgem has given the CMA. Essentially, the CMA is free to probe the market and unearth the truth – for better or for worse.

With the general election fast approaching and the CMA inquiry now underway, change is the only certainty for the retail energy market.