Competition in energy markets - assessment framework

On 25 November 2013 Ofgem published an open letter from Ofgem, the Office of Fair Trading (OFT) and the Competition and Markets Authority (CMA) to the Secretary of State on Competition in Energy Markets. The letter outlined how the authorities would work together to assess competition in energy markets and to deliver annual reports on the state of those markets, building on Ofgem’s commitments to the Energy and Climate Change Committee and the Government’s subsequent announcement, confirmed in its Annual Energy Statement. See our Law-Now alerts on this letter and on the Government’s Annual Energy Statement 2013.

On 19 December 2013 the authorities published their joint State of the market report - Assessment framework. Ofgem and the OFT will use the framework to produce the first annual review of the market in March 2014. The CMA was launched in shadow form on 1 October 2013 and will formally replace the OFT (and the Competition Commission (CC)) in April 2014.

The aim

The aim of the assessment is to determine how well competition in the markets for gas and electricity is serving the interests of households and small firms in GB.

The context

The report is being compiled in the context of Ofgem’s Retail Market Review (RMR), aimed at making the market simpler, clearer and fairer for consumers. Ofgem is also at the final stage of consultation on its liquidity reforms, aimed at making it easier for independent suppliers and generators to access and compete in the market. The rollout of smart metering may also have a part to play in giving consumers the possibility of higher visibility and control of energy use and faster switching, and in encouraging innovation in services.

The approach to assessment in this first annual review therefore needs to recognise that the market may change.

Ofgem plans to issue an open letter in January 2014 on its draft framework for evaluating the RMR, and to publish the finalised Framework for RMR evaluation in summer 2014, alongside baseline results of new consumer research that is being designed to underpin that RMR framework.

Annual reports from 2015 onwards will be able to consider both the scope of this new market assessment framework and the impact of RMR measures.

The framework

The framework is designed to be an enduring model which can be used or adapted in future years. There will be three stages:

• a description of a well functioning market and how competition should work to deliver desired outcomes;
• an explanation of the potential sources of harm (the broad categories of reasons why competition may not be working as it should); and
• an explanation of how the authorities will use data and information to identify the relevant features of the market and their effect on consumers.

The framework has been refined to take into account feedback from a stakeholder event of 2 December. The data gathering and analysis is based on CC guidelines to review evidence against a range of indicators in the areas of:

• unilateral effects - market concentration, switching rates and outcomes for consumers;
• weak competition - the extent of competition between the Big Six, patterns of price changes, switching levels, customer segmentation and barriers to switching;
• barriers to entry and expansion - low levels of penetration by new entrants in the domestic market;
• vertical integration - common ownership of generation and supply, access to wholesale markets, transparency of wholesale pricing, trading models of integrated suppliers, levels of profit at different levels of the supply chain; and
• weak customer response - updating of evidence in Ofgem’s RMR, which identified high levels of customer confusion, poor supplier behaviour and complexity of tariffs.

The assessment will consider both the domestic and SME markets.

The authorities welcome views from stakeholders and plan to meet interested parties in January and February 2014.

Potential outcomes

The first annual assessment is to be completed and published before the end of March 2014. Following publication each of Ofgem, the OFT and the CMA will separately consider appropriate next steps. These could include further assessment of particular issues, or proposing no further action, or specific reforms, or the opening of a market investigation.