1. www.ccp.uea.ac.uk The deregulation of British residential energy markets: time for a reassessment? Michael Harker ESRC Centre for Competition Policy and Norwich Law School, UEA

2. Overview (1) Overview of deregulation – focus on regulation of prices (2) A sketch of competitive conditions on the demand and supply-side - search and error on the demand-side - incumbent market power on the supply-side (3) Evidence of politicisation (4) Looking forward - a market investigation - a safety valve (5) Postscript – the European dimension

3. A brief overview of deregulation Littlechild (1983): -[C]ompetition is indisputably the most effective means - perhaps ultimately the only effective means - of protecting the consumers against market power. Regulation is essentially a means of preventing the worst excesses of monopoly; it is not a substitute for competition. It is a means of holding the fort until competition arrives(para.4.11). Privatisation: - 1986 - National gas market incumbent - 1990 - 14 regional electricity markets (Ofgem 2004) - No ex ante division of markets Regulation and competition: -RPI-X price-caps for electricity and gas (incumbents only, not entrants) -Main entrants other incumbents -Gradual deregulation from 2000 to 2002, all caps removed April 2002 -Significant industry consolidation – foreign entry through acquisition of incumbent firms -Companies sensitive to regulator, consumer watchdog, media, public relations – political pressure increases with prices -Obliged to publish tariffs – listed by watchdog and accredited sites

4. Deregulation of retail energy: timeline Market share of new entrants – gas Market share of new entrants - electricity Full national domestic competition New regulator OFGEM Competition Act into force DD Price controls withdrawn All price controls withdrawn Source: graph from Ofgem (2007) SSE-Atlantic merger Powergen (E.ON) – TXU merger New SLCs UA 2000:New duty Windfall tax Gov. review

5. Competition in British retail energy Demand-side: consumer search and switching - Actual switching costs are low, but perceived switching costs high: - Despite an (apparently) simple product, transparent market, consistent empirical evidence that consumers perceive high switching costs - No conclusive evidence on number of consumers who have switched (Ofgem: could be 50 or 80%) - Search (and error): - early evidence that significant proportion of consumers believed erroneously incumbents would match entrants offers - more recent evidence for electricity (Waddams and Wilson (2007)): - small proportion of consumers switched to best deal (8-19%) - on average only between 28-51% of max gains appropriated (only marginally better than switching randomly) - 20-32% consumers appear to be worse off as a result of switching (of consumers who stated that they switched only to save money) - concludes that the failure to maximise savings was due to consumers making poor decision – simple exhortations from regulator / consumer groups to switch may not be enough

6. Competition in British retail energy Supply-side: incumbents high market shares / relative prices - New entry – predominately by other energy suppliers - Significant consolidation through mergers and acquisitions - Electricity (five incumbents + gas incumbent (British Gas) + others (<1%)) - Gas (gas incumbent + five electricity incumbents + others (<1%)) - Market shares of incumbents being eroded over time (BG – 47%); electricity incumbents have regional market shares (40-80%) (cf. national market share) - Incumbents have the ability to charge significant price premiums over entrants (up to 20% more than best offers) - Coordinated effects: high concentration; homogenous product; multi-market contact etc.

7. Politicisation Despite deregulation of retail being almost complete, we still have a regulator and the sector is becoming politicised again - Rising (wholesale) prices and allegations of anticompetitive practices - Ofgem called in by Chancellor to explain (January 2008) - Alistair Buchanan (Ofgem CEO): Ofgem wants to reassure customers that we constantly monitor the competitive market and regularly publish our analysis. Obviously, we look even more closely during periods when prices are rising, but we have no evidence of any anti- competitive behaviour. We see companies gaining and losing significant market share, record switching levels and innovative deals. - Ofgem announces probe into retail energy markets (Feb 2008) - Ofgem announces record switching rates in energy (April 2008) - BERR Select Committee currently investigating the energy sector and raising energy prices - in evidence CEO BG predicts 40% increases in coming year (June 2008)

8. Where next? A market investigation? Ofgem conducting a market investigation under the Enterprise Act covering the following areas: - the customers perspective and barriers to switching supplier - suppliers market shares - the economics of new entry Alistair Buchanan Ofgem CEO: - The decision to conduct the probe is in response to public concern about whether the market is working effectively…. …[R]ecent events in the market have increased public concern and have damaged customers confidence that competition is working well and giving them a good deal. Customer confidence is vital for a well-functioning market. So we shall replace our magnifying glass with a microscope and take a more detailed look at the retail market and the influence of global wholesale market developments. The role of a sectoral regulator conducting an inquiry into the success of its own project? Safety valve, especially if reference to CC?

9. Market Investigations: summary OFT / Sectoral Regulator Competition Commission Refer if… reasonable grounds for suspecting … any feature or combination of features of market…prevents, restricts or distorts competition (AEC) (1) Initial Market Inquiry (2) Full Market Investigation (3) Remedies undertakings in lieu (4) JR by CAT AEC? licence mods (cf. s.168 price controls divestiture informational remedies recommendation (non-binding)

10. Rationales for the rejection of price controls ERGEG (2007): Fully open markets with well-functioning competition cannot in the long-term coexist with regulated end-user energy prices. Need to protect consumers in the short-term Tendency to distort the market / undercut other policy goals: -deters new-entry and consumer switching -upstream distortion of the generation market where tariffs are not cost-reflective (lack of liquidity in national generation markets impediment to internal market: EC Commission) -inefficiencies resulting from low tariffs – may increase demand artificially (climate change, security of supply) -targeted price controls may be justifiable for vulnerable consumers in the transitional period (CEC 2007)

11. Post-Script: the European Perspective EC law required that all retail gas and electricity markets opened to competition by 1 July 2007 -with liberalisation, some Member States took markets into custody by the use of price controls -unintended consequences: trade-off between encouraging entry (dynamic) and controlling incumbents market power (static) In 2006, 17 out of 28 countries (EU27 + Norway) had end-users tariffs on electricity (9 countries in respect of gas) (ERGEG 2007) -in most countries, over 80% of customers remained on these tariffs -in many cases, the tariffs were seen to distort the market: some cases of below-cost tariffs (Spain and France), and more broadly, elements of cross-subsidies -in a number of cases, tariffs set by Ministers rather than independent regulators (e.g., France and Spain)