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UTILITY WEEK | 27Th FEbrUarY - 5Th March 2015 | 25 Customers Analysis Ofgem in the CMA's sights The first findings from the CMA suggest it's the regulator who may be at fault rather than the big six. Jillian Ambrose reports. I n June 2014 Ofgem played its trump card. At the time, the flames of public outrage over energy company profits had been stoked by political manoeuvrings from the opposition party. Headlines bayed for a break up of the big six while the Labour Party pledged a massive intervention if the regulator could not get the market in hand. By referring the entire energy sector to the highest competition authority in the land, Ofgem proved it was ready to play tough: both against a wayward industry and the politicians who claimed the regulator was too spineless to bite back. But has it backfired? Far from a damning indictment of the big six, the first clues from the Competition and Markets Authority (CMA) as to the direction of travel seem decidedly focused on the regu- lator itself. Ofgem called on the CMA to look into the key areas of discontent in energy competi- tion: an impenetrable wholesale electricity market; the unfair advantage held by the vertically integrated incumbents; and a retail market distorted by loss-leading tariffs and sticky customers. The CMA has duly included all of the above in its "theories of harm". But while its early work has shown that the big six might be less culpable than they seemed a year ago, the regulator is emerging as a more con- sistent area of interest. Only two of the CMA's theories of harm have undergone a significant overhaul from those set out last year. The first theory – regarding the "broken" wholesale market – has shied its focus from the perceived lack of liquidity and access, to the role regulatory frameworks themselves may play in distort- ing the market. The CMA says it will alter its investigation to include a probe into whether imbalance price reforms overcompensate generators in light of the capacity market, and into the absence of locational pricing of constraints and losses, which "may distort competition". On the other side of the supply stream, the CMA included a fih theory of harm to its original four to build out its investiga- tion into the notoriously uncompetitive retail market. Unsurprisingly, the national news agenda focused on the CMA findings that custom- ers could have saved between £158-234 a year by switching from a standard variable tariff, although more worrying is that so few customers seem willing to lay claim to those savings. The big six will have questions to answer over the "rocket and feather" tendency of prices to rise quicker than they fall, but the CMA's initial findings reveal that the regula- tory codes put in place by Ofgem may have helped to stifle competition in the first place. "Several parties have submitted to us that elements of the codes system risk affecting competition either through distorting incen- tives, increasing barriers to entry or stifling innovation," the CMA report said. The CMA says it will investigate first whether Ofgem's electricity regulation codes pose a barrier to entry, and second whether they stifle pro-competitive innovation and change. "It is not the big six, with the candle- stick, in the kitchen," analysts at Investec noted following the CMA's report. "Regula- tory interventions in the UK retail energy supply market have risen in recent years. We are unsurprised the CMA has identified 'sev- eral aspects of the regulatory regime' that may have a potential impact on competition between suppliers," Investec said. "We note that, at least in some key areas, arguments that the big six have been making for some time seem to have been accepted," the analysts added. The CMA's initial view is that the evidence does not suggest the big six have earned excessive profits from their generation busi- nesses, nor does the evidence suggest any actual or tacit "co-ordination" between them. Add to that the fact that the CMA does not, at present, see evidence that vertical integra- tion disadvantages independents, and much of the heightened speculation over a big six break-up looks a little deflated. The political threat to the regulator, on the other hand, may just be gaining traction. Theory of harm 1: Does regulation distort the wholesale market? Although the CMA approves of CfDs and capacity market, concern remains that imbalance in price reforms may overcompensate gen- erators and the absence of locational pricing of constraints and losses may distort competition. Theory of harm 2: Do generators drive market prices higher? The CMA says it does not appear likely, overall, that companies have the ability and incentive to increase profits by withdrawing capacity in generation. Theory of harm 3a: Does a flagging power market limit competition? The CMA thinks not. Based on the evidence it has reviewed to date, the CMA says current levels of liquidity appear to be sufficient to allow inde- pendent suppliers and generators to trade and hedge in the same way as the big six. Theory of harm 3b: does vertical integration disadvantage independ- ent players? The CMA says it is unlikely that a vertically integrated company has the ability and incentive to engage in activities that would disadvan- tage smaller players in the retail or wholesale market. Theory of harm 4: does the lack of consumer engagement reduce com- petitive incentive? The lack of consumer engagement made headlines across the UK press and the CMA says it will look closer at the reasons behind consumer behaviour including the likely impact of Ofgem's tariff reforms on competi- tion and consumer engagement in retail energy markets. Theory of harm 5: Does regulation limit retail competition? The CMA says regulatory codes fundamentally shape the market but it has not yet determined that the right balance exists between providing companies with a degree of insulation from regulatory risk on the one hand, and allowing for pro- competitive innovation and change on the other. Theories of harm