Uncompetitive Competition: From Privatisation Ideals to the Big Six
Caroline Kuzemko, IGov Team, 2nd December, 2013
I have recently been re-reading some old academic articles on electricity markets – in particular by Professor Steve Thomas – in order to figure out how we got to this position in the UK. What is clear from his detailed analysis is that those economists and politicians tasked with the privatisation and liberalisation of the UK’s considerable energy assets envisaged a future where competition between companies would help to deliver affordable and secure energy. Early visions of what a competitive market would look like included the separation of generation and supply, liquid and transparent energy wholesale markets as well as real consumer choice between suppliers. Instead what has emerged in the UK are electricity and gas systems dominated by six, integrated energy companies who operate at both sides of a not-so-liquid wholesale market and who wield considerable political power. Moreover, many involved in the processes of policy-making and regulating electricity and gas markets, and Ofgem in particular, do not seem to have a clear vision of what a competitive market would look like.
This blog offers three explanations for this perplexing situation operating under the assumption that in order to change this system we must first understand its evolution as well as its structures. How did we get from a vision of useful competition to oligopoly despite the fact that the principle job of Ofgem has been to ensure competition? Not only did early visions of a liberalised energy market not include privatisation, they also stipulated that generation and supply should not be integrated.
Decisions taken, however, during the long process of liberalisation went against these early principles. Although the regional electricity companies (suppliers) were initially allowed to acquire only 15% of their generation from plants in which they had a significant stake this restriction was later lifted and it was also decided to allow National Power and Powergen to supply power to final consumers. These were initially compromises to facilitate liberalisation but ultimately, during the merger and acquisition period of mid to late 1990s, successive governments allowed further integration despite objections from the Monopolies and Mergers Commission.
This all appears rather like governments and regulators allowing energy markets to be designed by the private sector – what some might term ‘laissez faire’. Now each of the big six has considerable generation and supply assets – what this means is that they can operate at both sides of the wholesale market (i.e. sell to themselves). They have good price visibility which brings with it possibilities for control over pricing. Integration provides a serious barrier to entry, especially for those wishing to compete as solely electricity and/or gas suppliers.
Today rules and regulations currently in place, such as the Balancing and Settlement Code (BSC), further embed high barriers to entry that reduce competition. Ofgem like to point to the 18 supplier companies in the UK indicating that that is a sign of healthy competition – whereas only 6 of these companies have cornered 97% of the retail market. Lowering barriers to entry for new competition would involve serious change to the codes, but to do this Ofgem need the support of the big six thereby allowing them heavily influence over our energy future.
The last explanation here relates to the type of institutions that Ofgem now is. I would argue that there is insufficient ‘institutional memory’ and pragmatic energy expertise to allow Ofgem to stand its ground or even envisage a different future. Ofgem and DECC appear under-staffed, under-funded and under-whelming – not least in that they appear to have to defer not only to the big six but also to the Treasury in many dealings. Conversely the work of Stephen Littlechild, writing in Economic Affairs backing 1981, shows an in depth understanding of the economics and operations of energy utilities (as well, interestingly, as a warning that competition might be limited). He displays a far more thorough understanding of different types of companies – utilities do not make goods that one can chose not to use but provide a vital public service upon which most in society depend.
Government performance in governing for a sustainable future is a far cry from Mariana Mazzucato’s ‘entrepreneurial state’. As a result of high barriers to entry, existing rules and regulations and the oligopoly position of the big six they are in a position to successfully apply pressure on government bodies. Such pressure is evident in the recent Coalition decision to push ECO delivery out by 2 years. In this way the debate about high energy prices becomes not one of corporate profits and dividend payout ratios but about the costs of meeting sensible energy poverty and emissions reductions targets.
Explaining why UK gas and electricity markets are not competitive helps us not only to understand inconsistencies prevalent within policy and regulation – but also to start figuring out what to do going forward. Although I am not one of those that believe that real competition in gas and electricity markets will solve all our problems – it might well allow for reduced prices as well as provide greater possibility for innovative change as new supplier models (like that of Good Energy) gain greater market share. This might be achieved by thinking outside of the ‘market’ box which could be facilitated by Ofgem and DECC really listening to progressive thinkers on energy and starting to understand alternative regulatory models that have been used elsewhere. They might also consider lowering barriers to entry enshrined within the BSC, and by separating generation from supply in the UK thereby increasing liquidity in wholesale markets and allowing new suppliers greater access to these markets. All this will take firm commitment, changed or new institutions and the power and desire to stand up to the big six.