The CMA’s Energy Market Provisional Remedies: Right Direction but Inadequate, and Missing an Important Trick

(By Dr David Deller) Yesterday the CMA published its widely anticipated provisional remedies to its long-running energy market investigation. Overall there is a significant gap between the size of detriment claimed by the CMA and the scale of the provisional remedies proposed by the CMA. It is this inconsistency which is at the heart of a dissenting view regarding the provisional decision expressed by one of the decision makers.[1] Beyond highlighting this inconsistency, the purpose of this blog is twofold: to highlight the beneficial remedies; and to raise outstanding questions that the CMA should address in its final decision and report. While the proposed remedies have limited downside risks, they are also unlikely to reset the market for the majority of consumers. A lot hangs on the (probably questionable) assumption that smart meters will solve the competition questions.

Unfortunately, there is no easy solution to the core issue identified by the CMA, that of consumer non-engagement. Ultimately, there may be only an uncomfortable choice between non-intervention and significant intervention, such as opt out collective switching (see below) or full re-regulation. The CMA concludes there is substantial harm, so non-intervention is not an option, but offers solutions that are likely to change consumer engagement only marginally. The central problem is the inherent difficulty in separating satisfied consumers who consciously choose not to switch from those who are unhappy but for various reason still do not engage. The elephant in the room, and one which the CMA perhaps cannot be expected to address, is what happens if the proposed remedies and/or smart meters do not lead to a step change in consumer engagement? What then? Do we just accept the market outcome or do we consider more radical interventions?

Some of the proposed remedies will be beneficial

Before addressing the CMA’s overall package of proposed remedies, it is fair to highlight some proposals that should be commended

Removing the four tariff rule – The regulator’s current limitation on the number of tariffs each firm is allowed to offer has had little positive impact.  It restricts choice without delivering any significant boost to consumer engagement. This is not particularly surprising given there are still 150+ tariffs on offer across the market, despite the per firm cap.

Making single rate tariffs[2] available to those on restricted meters – From personal experience competition for those with non-standard meters can be very limited: I once had an Economy10 (this is different to Economy7!) meter and after 5 hours of searching discovered that Price Comparison Websites (PCWs) did not offer comparisons for this meter type and only two suppliers offered relevant tariffs. The CMA’s proposed measure should enable this group of consumers to benefit from the full range of competitive tariffs.

Enabling price comparison websites (PCWs) to continually monitor the market on behalf consumers[3] – This sounds like a very attractive proposition for consumers and one which at least one firm is already offering for a fee[4]. However, consumers may be falsely reassured if a PCW only monitors a subsection of the market.

Identifying that Pre-Payment Meter (PPM) consumers need additional protection – PPM consumers are often vulnerable or in a precarious financial position and so face a serious challenge if they try to switch. However, it is open to debate whether a dedicated price cap for PPM consumers is the most effective intervention.

A clear process for Ofgem to comment on government policies – This should stop ‘blame shifting’ by making it clear when government policies increase prices[5]; currently the regulator or market participants may be wrongly blamed for these price increases.

Prohibiting auto-rollover contracts for microbusinesses – an obvious, and probably unfair, contractual barrier to switching will be removed by giving wider time periods for switching supplier.

Increased powers for Ofgem to conduct research experiments in the market – Randomised control trials should enable better ‘road testing’ of proposed interventions thereby improving the quality of regulation and increasing knowledge of consumer behaviour.

But the remedy package appears insufficient to address the full extent of the harm

The CMA states that its headline estimate of detriment from high domestic retail market prices averaged £1.7bn per year over the period 2012-15 and in 2015 alone was £2.5bn.[6] If these estimates of harm are to be believed there is considerable room to justify interventions with large upfront costs if they reduce prices for non-engaged consumers. Of course, one may query whether actual harm is this large: if all consumers were ‘engaged’ then the ‘competitive benchmark price’[7] would adjust, possibly upwards. Nevertheless, it is surprising that the majority opinion of the CMA panel does not feel that stronger interventions are justified if they believe these detriment estimates are robust. Either the CMA has substantially overestimated the detriment of non-engagement or the majority of the panel are being excessively optimistic about their ability to raise consumer engagement[8].

A wider price cap is unlikely to provide the solution

At first glance a universal price cap for Standard Variable Tariff (SVT) consumers (as proposed in the minority opinion) appears attractive. However, there is the risk of unintended consequences if it is linked to an average of ‘competitive prices’ because the cap is likely to prompt companies to alter their ‘competitive’ offerings. Also, a price cap will place an upper limit on the maximum savings available from switching. CCP research consistently shows that larger monetary savings drive switching. As a result the switching rate is likely to fall after the imposition of a widely applicable price cap[9].

But an ‘Opt-Out Collective Switch’ could provide a solution that directly targets the source of the problem: inactive consumers

A possible alternative to a price cap, which avoids these downsides, is what is termed an ‘opt-out’ collective switch. In an opt-out collective switch, the opportunity to supply large blocks of SVT consumers would be auctioned.  The winning firm would be the one offering the lowest price of supply subject to minimum quality criteria. The system would be similar to the auctions used for rail franchises. The main advantage of this approach over a price cap is that unengaged consumers will benefit from the full force of competition without incurring the costs of searching and switching, while unintended consequences on the rest of the market should be limited. Crucially, before the auction takes place, consumers would be sent a letter giving them the option to opt out of the auction so that they could either remain with their existing supplier or conduct their own search of the market. The opt-out and auction process could then be repeated perhaps once every two years. Such an intervention is probably the most direct solution to the problem of persistent consumer non-engagement identified by the CMA.

We should be clear that this scheme would be a very significant intervention. However, the compulsion imposed on consumers is limited by the opt-out mechanism and, as the CMA is willing to impose a price cap for some consumers, it is clear that the CMA does not consider intervention per se to be a problem. Also, while the auction process will involve significant setup and ongoing running costs, the scale of harm identified by the CMA is such that these costs would be outweighed by the potential gains.

Furthermore, opt-out collective switches have been implemented in the USA[10] and the proposed process has similarities with the ‘single buyer’ model in Italy. The one disadvantage of opt-out collective switches, given the CMA’s logic, is that they may have a relatively lengthy implementation timescale. However, the need for a rapid roll out is related to the CMA’s rather Panglossian assumption that any significant intervention will be temporary as, following the smart meter roll out, consumer non-engagement will disappear. While smart meters introduce considerable uncertainty, it seems heroic to assume that they will solve the current issues in the energy market. The truth is we simply don’t know the extent of smart meters’ impact.

Appendix: more questions that need answering in the final report

As the provisional decision on remedies document stands there are a range of questions which one hopes the CMA will address in their full provisional remedies report:

  1. How plausible is it that the price cap on prepayment meters will be temporary? Is it not likely that significant consumer and political pressure will mean it remains in place? What happens if there are delays in rolling out the price cap beyond 2017? Would the CMA then suggest it is abandoned entirely?
  2. How do the proposed remedies benefit ‘vulnerable’ consumers who are not on PPMs? How do they consistently gain the benefits of PCWs if they do not have access to the Internet?
  3. How will the consumer database proposal increase switching if the underlying reason for limited switching are high switching costs rather than high search costs? Mailing offers of deals to consumers only deals with search costs.
  4. If the capped price for PPMs is below the price of SVTs in the wider market[11], might we see increased installations of PPMs? If a price cap for PPMs is needed precisely because there are inherent issues regarding PPMs that limit competition, might increased take up of PPMs be considered undesirable?
  5. The CMA has rejected an Ofgem run, information only, PCW on the grounds that Citizens Advice already provides such a service.[12] The CMA proposes that in the future PCWs will not have to provide ‘whole market’ coverage. If ‘whole market’ coverage is no longer routinely available in the PCW market, is it credible that Citizens Advice will be able to provide (and potentially finance) a function equivalent to an Ofgem information only site?
  6. If PCWs are to be the central driver of energy market competition, would it not be appropriate to have a more robust regulatory framework for them? In particular, would a robust mystery shopping exercise to verify that the deal ‘at the top of the list’ is in fact the cheapest[13] on a PCW not be a sensible and proportionate regulatory activity?[14]
  7. If the roll out of smart meters slips significantly, will any of the proposed remedies need to be revisited? Will stronger and longer lasting interventions be justified?
  8. Is there a risk of ‘prompt’ overload for consumers who are part of the contact database provided to rival suppliers? Is it the case that increasing the number of prompts (postal offers of savings) always increases engagement?
  9. If significant numbers of SVT consumers do not switch, even after being sent a large number of letters and prompts to switch, what are we to conclude? That they are happy with their existing supplier and happy to pay ‘high’ prices? Or that consumers dislike being sent large quantities of direct marketing?
  10. With the complete removal of restrictions on tariff complexity is there a risk of deals emerging which deliberately exploit consumption uncertainty? For example, a firm might offer a tariff which is very competitive if a household consumes an amount of energy identical to their previous year’s consumption, but which is very expensive if consumers increase/decrease their consumption by 5%.
  11. Given the inherent uncertainties surrounding the impact of smart meters, should it be recommended that Ofgem conduct an extensive review of the retail market 3-5 years after the smart meter roll out is complete? If consumers currently do not respond ‘optimally’ to basic metering is there a risk that their decisions could worsen/they could be exploited once more complex meters are introduced?
  12. Why will firms using the Ofgem consumer database be restricted to sending offers by post? While doorstep selling and phone calls may impose undue harm on consumers, why are emails ruled out? Surely the effort of deleting an email is the same as throwing a letter in the bin?
  13. What is the CMA’s view regarding additional barriers to consumer engagement in the rented sector? Despite conducting a consumer survey specifically targeting those in rented accommodation, there is no mention of this issue in the provisional decision. Was no specific harm identified in the rented sector? Or were the barriers to engagement considered insurmountable?

[1]Martin Cave, Paragraph 196, page 43. All references refer to the following document unless stated otherwise: ‘Energy market investigation: Summary of provisional decision on remedies’, Competition and Markets Authority, 10 March 2016

[2] Single rate tariffs involve a fixed fee and a single per unit price, Economy7 involves two unit prices, and Economy10 involves three unit prices. Economy7/10, while using ‘dumb’ meters, enable peak and off-peak pricing.

[3] Paragraph 103, page 24

[4] See http://flipper.community/

[5] Paragraph 172, page 38 states DECC estimates climate and energy policies will add 37% to the retail price of household electricity by 2020.

[6] Paragraph 59, page 14. Even using the indirect method (see paragraph 64, page 15) detriment is estimated at £660m-£1.1bn per annum.

[7] Paragraph 58, page 14

[8] CCP research highlights that many consumers do not switch even in a heavily simplified switching environment. See Deller, D., M. Giulietti, J.Y. Jeon, G. Loomes, A. Moniche and C. Waddams (2014), ‘Who switched at the Big Switch and Why’, a report for Which?, available at: http://competitionpolicy.ac.uk/documents/8158338/8194340/Big+Switch+-+Results.pdf/2e01588d-6564-4e28-b06d-233eaad389c4

[9] Deller et al (2014) contains clear examples of this finding.

[10] See Littlechild, S. (2008), ‘Municipal aggregation and retail competition in the Ohio energy sector’, Journal of Regulatory Economics, 34(2), pp.164-194

[11] See paragraphs 139 and 141 on page 31. Paragraph 141 states: “In determining the overall level of the cap, we have provisionally decided to include headroom of £25 per fuel per year (i.e. £50 headroom in a dual fuel cap). Also, paragraph 41 on page 11 implies that the CMA considers PPM customers to be overpaying relative to direct debit customers

[12] Paragraph 105, page 24

[13] ‘Cheapest’ means the cheapest subject to the particular choice restrictions that a consumer chooses to impose on their search.

[14] See Deller, D., M. Hviid and C. Waddams (2015) consultation response to House of Commons Energy and Climate Change Committee’s ‘Energy Price Comparison Websites Inquiry’, available at: http://competitionpolicy.ac.uk/documents/8158338/8261716/CCP+Consultation+Response+-+Price+Comparison+Websites+Inquiry.pdf/5fe76392-7759-4f7b-b7d3-cc90fc1d477c

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