(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON, March 28 Britain's major gas and
electricity suppliers shrugged off the threat of a market
investigation by competition regulators as investors concluded
it is unlikely to recommend changes that could significantly
affect their profitability.
Of the country's Big Six gas and electricity suppliers, only
Centrica and Scottish and Southern Energy are
directly quoted on the stock market.
Centrica's share price closed up marginally, though its
shares have been hit hard since speculation about future
regulatory reforms began in September 2013.
SSE's shares fell 2 percent but the company is still trading
close to its highest levels for the last decade.
The other four big retailers are part of large diversified
groups so the impact of Thursday's report from the Office of Gas
and Electricity Markets (Ofgem) on their share prices cannot be
But if the proposal to refer gas and electricity suppliers
for a full-scale competition review was meant to signal a
revolution in the country's energy business it seems to have
left investors unmoved.
The report's scathing tone may have taken some in the
industry by surprise, however the decision to refer the gas and
electricity supply business for a competition review has been
Some within the industry have actually been calling for a
competition reference in the hope it would take the issue out of
the political arena and enable it to be settled once and for all
by a thorough and technocratic process.
The bottom line is that it is not clear whether the
competition review will or could recommend changes that would
significantly alter the returns available to investors in the
country's gas and electricity businesses.
For all its damning language, Ofgem's report struggles to
explain exactly what the problem is that a competition
investigation is meant to solve.
There are plenty of flaws in Britain's energy markets.
Customers have been deliberately confused by a bewildering
array of complicated tariffs.
Former regional monopolies remain dominant in their old
areas and continue to charge higher prices to their legacy
Few customers switch supplier so the threat poses little
real constraint on the prices gas and electricity suppliers
charge. The number of customers who say they do not trust their
energy supplier hit a record 43 percent in 2013.
Retail prices tend to rise quickly when wholesale prices go
up, but fall slowly when wholesale costs go down. Price
increases tend to be synchronised and Ofgem says there may be
"tacit coordination" among the major firms although it has no
Entry barriers remain formidable. Centrica, the country's
former gas monopoly, still has a gas market share of more than
40 percent. The former regional electricity monopolies have an
average market share of 37 percent in their home areas. Small
independent suppliers have grown rapidly in recent years but
their total share of the market is still just 5 percent.
In electricity, vertical integration between generation and
retail distribution has left small independent suppliers at a
disadvantage and led to suspicions that the Big Six are hiding
their true level of profitability by shifting profits from
distribution into the less transparent generation business by
manipulating transfer pricing.
Ofgem lays out all these concerns in convincing detail in
But the real political problem is that prices have risen
much faster than inflation over the past decade, squeezing
household budgets at a time when incomes have stagnated owing to
the financial crisis and recession.
The causes of price increases are not hard to find.
Wholesale gas prices have risen sharply. The country's
ageing and carbon-emitting coal-fired power stations must be
replaced with cleaner gas-fired power plants and wind farms to
comply with EU directives and the government's own climate
change targets, which is expensive.
Most of the country's nuclear generating capacity was
designed and built in the 1960s and 1970s and is rapidly nearing
the end of its service life and must be renewed or replaced. The
bulk of the transmission network is even older, dating from the
1950s and 1960s, and needs a major overhaul.
To reduce carbon emissions and encourage generation from
nuclear, wind and solar in future, governments from all
political parties have provided a range of generous subsidy
programmes, all of which are being charged to utility customers
through their bills.
On the demand side, Britain's housing stock is mostly old,
poorly built and thermally inefficient. Government programmes to
improve weatherisation and energy efficiency are being paid for
by levying additional charges on utility bills rather than
through general taxation.
For all these reasons, there is no question energy bills
would have risen significantly since the turn of the century.
In real terms, household energy bills are still below the
level in the 1970s and 1980s. In retrospect it is the low
utility bills in the 1990s that look like the anomaly rather
than the high bills of the 2000s.
But the combination of rapidly increasing bills, economic
stagnation and falling real wages since 2008 has proved a
The real question for politicians, regulators and customers
is whether the Big Six have made the rise in bills worse by
exploiting their dominant position in gas and the generation and
distribution of electricity.
On this point, Ofgem's report is least convincing. Ofgem
points to lots of flaws in the way that the market is working
but is unable to show any evidence that they have allowed the
Big Six to inflate prices and profits.
All the matters which Ofgem is now proposing to refer to the
new Competition and Markets Authority (CMA) have already been
considered by the regulator before in its own 2008 Energy Supply
Probe and 2010 Retail Market Review.
The sceptical observer might wonder whether yet another
review will uncover any more evidence that has not already been
unearthed by the two previous inquiries.
Many of the problems, such as the bewildering array of
tariffs, have already been addressed by reforms arising out of
the earlier probes. But the fundamental question of excess
profits remains unanswered and undefined.
Overall profits earned by the Big Six from their retail and
generation businesses have risen moderately since 2009.
But while profits earned from supplying residential
customers have risen more than four-fold, profits from the
non-residential supply business and generation have shrunk.
There is an enormous amount of variability among the Big Six
in where they earn their profits (gas versus electricity, retail
It is therefore far from clear that anyone is earning a
significant amount of excess profit.
One persistent concern is that vertical integration has
allowed retailers to hide excess profits in their unregulated
generation businesses, as well as making it hard for independent
retailers to acquire the wholesale gas and electricity supplies
needed to enter the market.
Some commentators have suggested the Big Six should be
broken up and that no firm should be allowed to operate in both
generation and retail. But it is not clear if this would lower
prices for consumers.
Britain currently needs more generation capacity. For all
commentators claim generators are making excess profits, the
government is struggling to encourage new investment in
generation capacity at the moment.
In future, the government will probably have to give
generators more incentives, not fewer, to build and run new
capacity in a bid to ensure the lights remain on.
Small independent suppliers claim they are much cheaper than
the Big Six. But most are able to cherry pick their customers
and mostly serve affluent and informed households.
Small suppliers do not have the same environmental and
social obligations as the Big Six (including supplying
subsidised energy to vulnerable low-income, disabled and elderly
customers, dealing with customers with poor credit histories,
and insulating old homes).
So it is not clear small independent suppliers could deliver
gas and electricity to the average household much more cheaply
than the Big Six do at present.
(Editing by Keiron Henderson)