Tuesday, July 5, 2016
ENERGY MARKETS INVESTIGATION. MISSING THE WIDER PICTURE. (AND THE ELEPHANT IN THE ROOM.)
Even in the aftermath of the referendum, there are two power sector stories that (almost) stand on their own. The first is a report on the retail energy market (gas and electricity), and the second is on the case for breaking up National Grid. In each case important issues are raised but both reports fail to take proper account of the impact we should expect from commitment to a low or zero carbon economy. The market and competition paradigms that have dominated since the 1980s now need re-examination and if necessary re-interpretation. This is the elephant in the room. A new system architecture, especially for the power sector, will lead us to more effective competition in some parts of the market, but a greater reliance on the virtues of coordination in others.
This blog comment deals with the first of these questions – the need for more effective competition in the retail supply market. A forthcoming comment will deal the second – the future role in the power sector for National Grid.
The Market in Retail Supply
The report of the Competition and Markets Authority (CMA) on its Energy Markets Investigation was published on 24th June. It was suggested unkindly that the date was chosen to bury bad news on the day of the referendum result, but the main criticism of the report has been that this was not so much bad news as no news; ie the report, despite its painstaking analysis of a range of questions, was a mouse.
The investigation covered a lot of ground, but, to concentrate on a core issue, a major symptom of discontent with retail markets has been the wide variation in the prices paid by different consumers. This is for a commodity, where there is (mostly) little or no means of differentiating between suppliers on the basis of quality or the type of service offered. Price is everything, but, for a commodity, suppliers all face the same costs. Suppliers, it is alleged, have often been only too happy to exploit consumer inertia, or to confuse consumers over what should be a simple choice with a multiplicity of tariffs.
There are of course other elements to the investigation, including the operation of wholesale markets and the vertical integration of suppliers and generators, but overall the findings of the report have been widely criticised by Dieter Helm and others as a failure to deal adequately with the position of the large energy companies. One of the problems for the CMA is that its terms of reference focus on competition, and a heavy emphasis on “adverse effects on competition” (AEC). A consequence of reliance on such a narrow criterion for the public interest is that the energy suppliers can mount a relatively simple defence, namely that what might be perceived as a market abuse or a less than honest treatment of consumers is unfortunately exactly what happens in some other “competitive” markets. In other words if competition can be assumed to be automatically in the public interest, then in the absence of clearly identified AECs nothing more can or should be examined. Dr Pangloss was Voltaire’s eternal optimist. No matter how badly the market might appear to be serving consumers, “all is for the best in the best of all possible worlds”.
Some of these criticisms may well be unfair, and the report does have some solid recommendations for improvement. However a more fundamental criticism is that the focus is too narrow for an industry that is about to face unparalleled and transformative change. There are much bigger issues to be considered, probably beyond the remit of the CMA, of which the most important is the role that retail supply competition should be playing in the promotion of new models for the ways in which customers purchase electricity. This is discussed in more depth on the LOW CARBON POWER page of this blog. The fundamental problem for current retail market structures, notably in electricity, is that they are incompatible with allocative efficiency and the role for consumers envisaged in most low carbon scenarios.
The biggest single problem does not lie in the behaviour of the energy companies but in the “load profiling” arrangements which were imposed on the market, largely for administrative convenience, when retail competition was first introduced in 1998. This eliminated at a stroke the incentives for suppliers to develop innovative approaches to consumer tariffs, and probably set back the cause of “smart metering” for a generation. The CMA places considerable faith in the UK's smart metering programme to resolve what should be seen as yesterday's issues, when the much bigger question is whether it is adequate for the future challenges of a low carbon economy.
The Oxford Martin Programme on Integrating Renewable Energy will be addressing some of these issues, but many of them are already the subject of lively debate. Difficult questions include:
· how to sustain reliability of supply with a high proportion of intermittent sources of generation, and the role of the consumer, through demand management, in maintaining system reliability.
· whether the conventional assumption of a common standard of supply reliability is either sustainable or desirable, and whether consumers should have the option of choosing different standards for different components of the service they receive.
· whether simple time of day, or even real time, tariffs will be acceptable to consumers.
· the extent to which increased pressure on local distribution networks, with more battery charging and heating loads, as well as more decentralised generation, will propel the power sector towards new system and market architectures.
Retail electricity supply is therefore an area where competition and innovation should be playing a major role in promoting the transformation of the power sector, and indeed of the energy sector as a whole, but are not currently doing so. The biggest criticism of the CMA report is therefore that it is looking backwards at the operation of a set of market models that will be increasingly seen as obsolescent, and ignoring, in public policy terms, the future directions of the sector.