What are the limits of competitive pressure?

Competition in the energy market can achieve a lot, but it can’t achieve efficient delivery of energy efficiency schemes through the Energy Company Obligation (ECO). That appears to be the message from DECC at the Energy and Climate Change select committee this month, blogs Peter Broad, policy manager at Consumer Futures.

The rationale behind a supplier obligation like ECO is that market forces will ensure efficient delivery. Yet, at the Committee, a DECC official confirmed they cut ECO because of pressure from those suppliers who had been uncompetitive in delivering their obligation. There was a big gap between the highest and lowest cost suppliers, and it is now clear that it was those with higher costs who lobbied for the scheme to be revised. If the issue was high costs for certain suppliers, rather than high costs across the board, it begs the question: why did government not let competitive pressures play out? Isn’t that the whole point of obligating the suppliers to deliver ECO?

There are three possible explanations. They are not mutually exclusive and all are likely to have played a part:

The first is that ECO distorts the market for energy suppliers’ core business: buying and selling gas and electricity. Under this system, an otherwise excellent supplier who happens to be terrible at delivering energy efficiency will be forced to raise their prices, eventually going out of business, and depriving consumers that choice. This is a plausible argument but not one DECC have been making. After all, while the review has reduced the size of ECO, the supplier obligation has not been fundamentally challenged.

The second relates to the broader issue of (lack of) competition in the retail market, which is linked to customer inertia in the face of a system that discourages switching. The impending Competition and Markets Authority enquiry is the latest response to this. If competition in the supply market is flawed then it is illogical to rely on this market dynamic to ensure that policies like ECO, or, for that matter, the smart meter roll-out, are delivered cost effectively.

For both these reasons it is crucial that the CMA enquiry covers ECO alongside the mainstream market issues.

Finally, the change shows that suppliers have been able to exploit a lack of political commitment: It appears some firms find it easier to – by leaning on DECC – adapt the regulatory environment to accommodate their lack of competitiveness than they do to adapt their behaviour in response to competitive pressure. This creates political risk for all market participants, which will ultimately increase costs for consumers.

When scoping the policy, did DECC consider how they would respond to the pressure that would inevitably come from inefficient suppliers?

The solution for ECO is relatively simple: take responsibility for energy efficiency schemes away from suppliers. If DECC are going to lose their bottle in the face of pressure from suppliers, any efficiency benefits from such a model will evaporate.

If distribution networks were given the obligation it could, in the right circumstances, be made to work alongside incentives to reduce demand across their networks. By contrast, there is a widely acknowledged tension in asking suppliers to reduce demand for their own product. Taking responsibility for the delivery away from suppliers would also facilitate roll out of a local delivery model, which research increasingly suggests is the most cost effective way of delivering energy efficiency.

More preferable still would be to move the cost of energy efficiency off energy bills, which is notoriously regressive, and on to general taxation.

The broader issues of competition and political risk are more complex and will be more difficult to solve. But we should start by recognising the possibility of their existence. And, when designing policy, government policy-makers need to be clear about the limits of what competition can achieve.