CMA publishes its provisional decision

On 10 March 2016, the UK Competition and Markets Authority (CMA) published its provisional decision on remedies in relation to its energy market inquiry. While the CMA's focus has, to a large extent, been on the energy supply market, the CMA's recommendations will, potentially, have a much wider impact on the UK gas and electricity industry.

WHAT YOU NEED TO KNOW

• The CMA is consulting on its recommended remedies, with the consultation closing on 7 April 2016.
• The proposed remedies will have a direct impact on all gas and electricity companies operating in Great Britain, with the greatest impact on gas and electricity suppliers, and electricity generators.
• The most significant proposals include a transitional price cap for certain domestic customers; recommendations relating to the new Contracts for Difference regime for generators; and Ofgem's role within the regulatory framework.

Background

In recent years, concern had been raised that the competitive energy market structure set up under the Electricity Act 1989 and the Gas Act 1986 may not be functioning as effectively as it should be. Following various reviews and consultations, in June 2014 Ofgem, the gas and electricity markets regulator, made a market investigation reference (MIR) to the CMA in respect of the supply and acquisition of energy in Great Britain (GB).

The CMA published its provisional findings report in July 2015 (and an addendum was published in December 2015), provisionally finding that there are features of the markets for the supply of energy in GB that result in an adverse effect on competition (AEC). Where the CMA finds that there is an AEC, it has a duty to decide whether it should take action itself and/or whether it should recommend others to take action to remedy, mitigate or prevent the AEC or any resulting detrimental effects on customers.

Remedies relating to the wholesale electricity market

The Contracts for Difference (CfD) regime
The CMA recommends that before deciding to allocate CfDs on a non-competitive basis, the Department of Energy and Climate Change (DECC) should set out clearly in an impact assessment why it considers that it is not feasible for the project to compete in the competitive auction process and why the benefits to customers of non-competitive allocation are likely to exceed the costs.

The CMA also makes the following recommendations in relation to competitive CfD allocation rounds:

• that DECC undertake an impact assessment and consult before allocating technologies between pots and the CfD budget to the different pots; and
• DECC should finalise its proposals for the allocation of technologies and budgets at least one year ahead of the auction, to ensure that potential bidders are able to make informed decisions about whether to progress a project in advance of the auction.

Given that the second CfD allocation round, originally scheduled for 2015, has already been postponed to 2016, DECC will need to consider to what extent the CMA's recommendations will impact the second allocation round.

Locational adjustments for transmission losses
The CMA considers that variable transmission losses should be priced on the basis of location, and that 100 per cent of losses should be assigned to generators, rather than the 45 per cent under current charging arrangements. This remedy is to be implemented by means of an order imposed on National Grid, as system operator, to calculate imbalance charges taking into account transmission losses calculated on this new basis.

Retail market remedies

The CMA's decision includes a very detailed package of proposed remedies aimed at reforming the retail gas and electricity supply markets. In particular, the CMA has focused on the problem of weak customer response, and the remedies are designed to stimulate a change in customer behaviour, in particular, encouraging a greater number to benefit from switching to more competitively priced deals. The CMA identifies that 70 per cent of the domestic customers of the six largest energy firms are still on standard variable tariffs (SVT), which tend to be higher priced. The CMA's analysis indicates that the average SVT customer could save over £300 by switching to a cheaper deal.

Interestingly, the CMA has gone beyond the "information-based" remedies which have been seen in previous market investigations (e.g. payday lending) and proposes to oblige gas and electricity suppliers to give Ofgem the details of their longstanding SVT customers (i.e. customers that have been on a default tariff for three or more years) unless those customers opt out. Ofgem will create a database that rival suppliers can then access in order to offer these customers better deals. This is a bold step and views differ on whether the so-called "disengaged" customers will respond to an increase in marketing, even if, as the CMA suggests, it is targeted and designed to raise awareness of potential savings. Concerns have also been raised about customers being bombarded with unsolicited mail.

The CMA also proposes a safeguard price control for a transitional period until the end of 2020 to protect "vulnerable" customers with pre-payment meters, whose options the CMA considers to be more limited and who make up 16 per cent of households. This proposal does not go far enough for dissenting panel member Martin Cave, who argues that the price cap should apply to all customers on SVTs. Although Mr Cave agrees that a cap is only required for a transitional period, he suggests that it should apply to a larger proportion of customers in order to "reset the market". The majority view, however, is that this would discourage customers from searching for better deals resulting in even less pressure on suppliers to lower prices and improve service.

The focus of the CMA on vulnerable customers as a segment requiring tailored remedies mirrors the approach of other regulators; for example, the FCA as part of its various reviews of retail financial markets, and Ofcom which announced as part of its Digital Communications Review that people in vulnerable circumstances were of particular concern as regards access to information and ability to act by switching provider.

The other remedies aimed at domestic and microbusiness consumers include the following:

• requiring all suppliers to make all their single-rate tariffs available to domestic customers on any type of restricted meter, without making switching conditional on a restricted meter being replaced and to provide additional information to customers on restricted meters. Restricted meters include any metering arrangement whereby a domestic customer's consumption at certain times and, in some cases, for certain purposes (for example, heating) is separately recorded;
• improved price transparency for microbusiness customers, and ending auto-rollover contracts with certain restrictions (such as termination fees) that impede microbusiness customers' ability to switch; and
• strengthening the ability and incentives for third party intermediaries, such as price comparison websites, to help customers find better deals by giving them access to relevant information like customer meter numbers and allowing them to negotiate exclusive deals with suppliers.

Amendments to the regulatory framework

The CMA proposes remedies which are intended to address aspects of the existing regulatory framework which have been found to undermine effective competition, in particular: (i) the withdrawal of the simpler choices component of Ofgem's "retail market reform"; and (ii) reform of the settlement systems for gas and electricity.

Removing Ofgem's "four tariff rule"
The CMA has concluded that the rules introduced by Ofgem to simplify tariffs for consumers by limiting the number of tariffs suppliers can offer have had a detrimental effect on suppliers' ability to provide innovative and competitive tariffs to their customers. Therefore, the CMA considers that suppliers should be free to once again provide a wide range of tariffs and discounts. The CMA expects that this will enable suppliers and price comparison websites to offer tariffs designed for certain customer groups.

Electricity settlement reform
The CMA notes that while electricity settlement takes place every half hour, the majority of domestic and microbusiness customers do not have meters capable of recording half-hourly consumption. This means that suppliers have no incentive to encourage such customers to change their consumption patterns, and to offer innovative time-of-use tariffs. Therefore, the CMA recommends that:

• DECC should consult on amending the provisions of the Smart Energy Code to allow suppliers to have better access to information about their customers' energy use;
• Ofgem should conduct a full cost-benefit analysis of moving to mandatory half-hourly settlement for all customers, and consider options for reducing the costs of elective half-hourly settlement; and
• DECC and Ofgem should consult jointly on plans for the introduction of half-hourly settlement.

Gas settlement reform
Similarly, the CMA considers that the current system of gas settlement leads to an inefficient allocation of costs to parties and creates scope for gaming, which reduces the efficiency and, therefore, the competitiveness of domestic retail gas supply. The CMA therefore recommends that:

• Ofgem should implement its Project Nexus by 1 October 2016. Project Nexus relates to the replacement of the UK Link system, which is operated by Xoserve for energy settlements. It is intended that the new system will have various enhancements, including the ability to receive and store more meter readings;
• gas suppliers should submit all meter readings for non-daily metered supply points in GB to Xoserve as soon as they become available and at least once a year, except for smart meters where meter readings must be submitted monthly; and
• Ofgem should take responsibility for the development and delivery of a performance assurance framework concerning unidentified gas as soon as reasonably practicable.

Remedies relating to the governance of the regulatory framework

The CMA also makes a number of recommendations that relate to the overall regulatory structure and Ofgem's role within it. The aim of this package is to improve the policy and regulatory framework to provide a clear division of responsibilities and transparency in relation to policy creation and implementation and changes to industry codes. In particular, the CMA recommends that:

• legislation be enacted to establish a clear process requiring Ofgem to publish opinions on all draft legislation and policy proposals that are relevant to its statutory objectives and that are likely to have a material impact on the GB energy markets;
• DECC and Ofgem should publish detailed joint statements setting out action plans for the implementation of proposed DECC policy objectives that are likely to necessitate Ofgem interventions, with clear responsibilities and timetables;
• existing legislation should be amended to clarify Ofgem's statutory objectives and duties, and thereby remove any constraint (actual or perceived) on Ofgem's ability to pursue its principal objective (protecting the interests of existing and future customers) by promoting effective competition where it considers this appropriate; and
• Ofgem should take a more proactive role in industry code development, by setting a "strategic direction" and engaging actively in the code modification process. Ofgem should be given powers to initiate code modifications where these are necessary to deliver the strategic direction and take substantive control of any ongoing strategically important modification proposals.

Next steps

Any comments on the CMA's provisional decision on remedies must be submitted to the CMA by 7 April 2016. A final decision will be published in June 2016, following which the remedies are to be implemented.