Competition: a failed experiment

In the wake of RMR and the SSE mis-selling fine, Roger Barnard urges Ofgem to stop pretending that competition is working or still applicable to modern energy challenges

As someone much wiser than most of us (let's call him Anon) once said, there's no point in flogging a horse when it's dead. You would never know the truth of this from looking at Ofgem's last-ditch efforts in recent weeks to mend the worst failings of the so-called competitive market in energy supply.

A day before its offices closed down for the Easter weekend, Ofgem proudly published the new licence conditions that it intends to impose on suppliers to make it "easier" for domestic consumers to make better choices about their gas and electricity supply. This manual of legal text (all 126 pages of it), drafted in a style that sits somewhere between the unintelligible and the comical, marks the weary end of the exercise called the Retail Market Review, which began life at Ofgem nearly five years ago and has been proceeding in fits and starts ever since.

Then, as soon as the office opened again for business after Easter, there was Ofgem strutting its stuff on the media stage with a bold decision to hit SSE with a fine of £10.5 million (payable to the Treasury) for mis-selling gas and electricity to domestic consumers over a prolonged period, in breach of its licence obligations. For comparison, Network Rail was fined £3 million after the Office of Rail Regulation's prosecution of the company for health and safety offences resulting in the Potters Bar derailment, which killed seven people and injured 76 others.

An unbiased observer might conclude that a market that is unable to deliver consumer benefit except on the basis of an impenetrable cat's cradle of rules about its tariff offerings, backed up by ludicrously inflated financial penalties for supplier misconduct, is a market so dysfunctional that it needs to be closed down in the public interest. Yet, in the aftermath of these events, no evidence has emerged from Whitehall or Westminster of any inclination to challenge Ofgem's continuing promotion of competitive markets as the best guarantor of consumer protection - even though that regulatory paradigm was already broken by the time Ofgem launched its supply market probe in 2008.

The privatisation of the energy industry opened a Pandora's Box of financial engineering, foreign ­takeovers, and corporate consolidation. But the history of energy supply during that period has also been the history of regulation, and of the way in which Ofgem's values and personalities have moulded the industry's operations and activities. Ofgem has consistently been at the forefront of utility regulation throughout this period in terms of innovation, vision, and intellectual leadership. Though a creature of statute, it has had its own discretionary agenda in favour of competitive market principles, reaching into and shaping almost every aspect of national energy policy, with a forward momentum that neither the industry nor the institutions of government have been able to roll back.

This domination of the energy landscape has had many beneficial outcomes. Ofgem's regulation of the industry has shown an admirable attention to economic efficiency, final price levels, and the need to minimise abuses of market power. This has enabled the industry to attract substantial investment at a reasonable cost of capital. Ofgem's regulatory process has generally delivered good value for consumers, has had a positive impact on productivity and growth in the economy at large, and has been a model followed extensively by other countries. No other agency has better embodied the moral intention, at the heart of the British regulatory system, to deliver an equitable settlement between consumers and owners.

Despite these plaudits, however, the market-based approach to energy regulation has been an increasing problem in the overall policy mix. It might have served a useful purpose in the immediate post-privatisation years, when we were still living on the fat of an inherited infrastructure in which the state's investment was largely sunk. That was a time when we could afford to experiment with market principles and the drive to discover short-run efficient cost levels. But it is most unlikely to deliver the expensive decarbonisation and security goals of national energy policy in today's much more risky and dangerous world.

In fact, redesigning the energy industry while maintaining security of supply and system resilience has been made significantly more difficult by the legacies of the regulatory focus on competition. That focus has persisted virtually unquestioned within Ofgem despite its legal duty under the Energy Act 2010 to satisfy itself, before promoting competition, that there is no other manner of performing its regulatory functions that would promote consumer interests better than competition would. The ongoing ideological extension of the market orthodoxy into areas where the benefits do not justify the costs has left the industry ill-equipped to handle the formidable challenge of securing essential utility infrastructure while also adapting sensibly to climate change.

The regrettable truth is that the market-based approach to energy regulation was adopted because it fitted in with a particular pattern of academic and administrative wisdom on the subject that happened to be in vogue at the time, not because it was shown to be correct on the basis of some serious objective test. It is impossible to reflect on the events of the past two weeks without recognising that the dogged pursuit of competition in energy markets has been essentially a contrivance, sustained only by regulatory artifice and the sometimes egregious spin of the industry itself. Consumers themselves have never been fully engaged with this vision, and there is not a single benefit they have gained from it that could not have been delivered at lower cost and with greater speed and less complexity by direct regulation.

As ministers prepare to install successors to Lord Mogg and Alistair Buchanan, soon to leave Ofgem after ten years at the helm together as chairman and chief executive, they need to accept that the energy market in the normal sense of the word is finished. It cannot meet the challenge of supplying decarbonised power on a secure and sustainable basis, and at a price that can be tolerated by both society as a whole and individual consumers. That awkward reality has significant implications for the conduct of energy regulation by a new regime. It is time to acknowledge that the great experiment has failed, and that regulation in future must be focused single-mindedly on the only question that matters - how to keep the lights on at affordable cost.

Roger Barnard is a legal consultant and was formerly head of regulatory law at London Electricity and then at EDF Energy

This article first appeared in Utility Week's print edition of 12th April March 2013.

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