House of Commons - Trade and Industry

Select Committee on Trade and Industry First Report

Developing Competition

To promote or to secure?

74. Both energy regulators now have a statutory duty to develop competition.[140] Under the Gas Act 1995, the DGGS has a duty to "secure effective competition in the carrying on of the supply and shipping of gas".[141] Under the Electricity Act 1989, the DGES has a duty to "promote competition in the generation and supply of electricity."[142] During the course of our inquiry, considerable debate has turned on differences between these duties and, more precisely, on whether there is a practical difference between securing effective competition and promoting competition.

75. Mr Eggar told us that "it is a feature of the art of the parliamentary draughtsman ... that differences [in wording] do emerge from time to time and it is sometimes not very easy to explain them".[143] He believed that in, practical terms, there was little difference between the duties of the two regulators in regard to competition.[144] Professor Littlechild also told us that he was not aware of any practical difference between his duties and that of the DGGS in relation to competition.[145] Lord Fraser told us that the difference seemed "in principle to be essentially a stylistic matter rather than any attempt to confer upon the different regulators different powers".[146] It is clear, however, that this is not a universal opinion. Ms Spottiswoode told us "there is a very big difference ... promoting is less active than securing".[147] Indeed, OFGAS fought hard to have `secure' in the 1995 Gas Act, which indicates the importance it, at least, attached to having such terminology in the legislation.[148] The EIUG told us that the different terminology in the two Acts was "of great concern to energy intensive companies" and that "these phrases are vital to development of the markets to the benefit of customers".[149] Ms Waters, policy adviser to the EIUG, argued that the use of the word `secure' in the Gas Act offered "industrial customers the ability to turn round and say to the regulator `this is not effective competition'"[150] but that, in contrast, if that was said to the electricity regulator, "he has every right to say `but I am doing my best, I am promoting it'".[151]

76. While we have some sympathy with the argument put forward by the EIUG, we conclude that the argument is in reality over nothing more than semantics. Certainly, we have detected no sign that the Government, in passing the legislation, intended there to be any practical difference nor that in the event regulators have taken different approaches. As Mr Eggar told us "the basic message ... is that the regulator feels ... under a duty to promote competition. That always ranks very high in terms of their priorities".[152] Indeed, the EIUG, among others, conceded that interpretation of their duties was at the discretion of the regulators[153] and National Power did not believe that the DGGS's new duty to secure competition rather than to enable competition would make any practical difference.[154] Nevertheless, it seems to us to be an argument that could be easily resolved and we recommend that, the next time the Gas and Electricity Acts are amended, the Government consider defining the duties of the energy regulators with regard to the development of competition in a common form of words.

The role of the regulator in promoting competition

77. In the gas industry, at privatisation, competing suppliers were allowed access to British Gas's transport network to supply customers consuming more than 25,000 therms a year. In fact there was no development of competing suppliers and British Gas retained a de facto monopoly in the over 25,000 therms per year market together with a statutory monopoly in supply to the under 25,000 therms per year market. British Gas also retained a de facto monopoly in gas transportation and storage. In 1992, the Government reduced the threshold for competition in gas supply from 25,000 therms per year to 2,500 therms per year and, "after a slow start and much regulatory intervention"[155] to promote competition, British Gas's share of the over 2,500 therms market fell from 100% to 35% by April 1995[156] and to 29% by October 1996.[157] The DGGS pointed out that there are now over 40 companies supplying the over 2,500 therms per year market.[158] The Society of British Gas Industries told us that "competition has been introduced in the industrial and commercial markets - successfully in the large buyer market".[159]

78. In the case of the mainland electricity industry, at vesting, the 14 Public Electricity Suppliers (PESs) each had a local supply monopoly, known as `the franchise', covering customers with a peak demand of less that 1 MW. Other suppliers (including PESs outside their franchise areas) granted a licence by OFFER, known as second tier suppliers, were allowed to compete for customers with a peak demand greater than 1 MW. Thus the competitive market in supply at vesting was open to some 5,000 customers and, in England and Wales, 28% of them, representing 43% of demand in the over 1 MW market, chose to take supply from a second tier supplier in the first year.[160] It is estimated that, by 1996/97, these proportions have increased to 56% and 71% respectively.[161] On 1 April 1994, the franchise limit was reduced to 100 kilowatts (kW), extending supply competition to a further 50,000 customers. OFFER data shows that "the proportion of these customers taking second tier supply has risen from 25% in 1994/95, accounting for 32% of demand of 100 kW customers, to an estimated 38% of customers accounting for 48% of demand in 1996/97".[162] The ECCCG told us that "competition in supply for major users is now well established"[163] and London Electricity that "supply competition, thus far, has been an obvious success".[164]

79. The DGES has also taken steps to develop competition in generation. The possibility of competition in generation was established at vesting, with a trading system covering England and Wales, known as the Pool, created. The output share of National Power and PowerGen, the two largest generators, was 78% immediately before vesting, but had fallen to 54% in 1995/96, following intervention by OFFER to reduce prices and force the disposal of 6 gigawatts (GW) of capacity. At the same time, the output share of existing competitors (Nuclear Electric, the Scottish generators and the French generator, EdF) has risen from 22% to 34% and new entrants since vesting now account for 12% of output.[165] "According to one measure, the extent of competition in generation has doubled since Vesting".[166] We examine this issue further in paras 85 and 86 below.

80. Operation of the electricity transmission and distribution networks remained monopolistic at vesting. Transmission in England and Wales was in the hands of the NGC, then jointly owned by the RECs, but subsequently floated separately on the Stock Exchange. Transmission in Scotland remained the responsibility of the then, and still, vertically-integrated ScottishPower and Scottish Hydro-Electric. Distribution was maintained in the hands of the 14 PESs. Since then, the DGES has introduced competition to some aspects of transmission and distribution, such as metering in the over 100 kW market and connections to the transmission and distribution networks but, nevertheless, transmission and distribution remain largely monopolistic operations and are generally considered to be natural monopolies.

81. Several witnesses pointed out that, in some of the areas where competition had been introduced, there were still concerns regarding its effective operation.[167] The National Consumer Council (NCC) believe that "competition is still at a very embryonic stage in gas supply"[168] and London Electricity told us that "it remains uncertain whether sufficient competition in [electricity] generation will develop without further intervention by the regulator".[169] Enron, in particular, were dissatisfied, stating that "the regulators have failed to create competitive markets for electricity and gas commodities"[170] and that they have not yet achieved their statutory mandate to create a competitive energy commodity market.

The operation of the Pool and the Regulator

82. One area of concern noted by witnesses was the operation of the Pool. The Pool is a half-hourly spot market in electricity, intended to maintain the benefits of an integrated network in a competitive market open to new entrants. The Pool is not a physical entity, being rather a set of contractual agreements, but virtually all electricity in England and Wales is deemed to flow through it.[171] It is designed to cope with the fact that no significant volume of electricity can be stored and that supply and demand must always be in balance. Its two main purposes are to determine which generating stations run, based on prices bid by the generators, and to determine the cost and price of electricity traded. In practice, a substantial proportion of trading is covered by contracts, but contract prices and average Pool prices are closely related over time.[172]

83. The Pool has succeeded in maintaining security of supply and promoting competition but we have heard a number of criticisms regarding its operation. ICI told us that, without reform to the operation of the Pool, competition would have no effect on the wholesale market.[173] Concerns centre on the perception that "the Pool over-rewards generators";[174] that the weighted voting structure "simply vests power in those who have a particular interest";[175] and that the pricing mechanisms and governance of the Pool could be inhibiting competition.[176] The ECCCG estimate that weaknesses in the operation of the Pool maintain generation prices 20% higher than they would otherwise be,[177] although the DGES commented that he did not "see any logical calculation that [the ECCCG] ... had done to substantiate that 20%".[178] Current mechanisms for Pool reform are widely seen as "slow and cumbersome".[179]

84. Several witnesses called for greater regulatory invention in the Pool to remedy these faults.[180] However, the DGES has no statutory authority to intervene in the operation of the Pool. The authority which he does have derives from the Pooling and Settlement Agreement (PSA), which covers the trading and governance of the Pool. This arrangement could create difficulties for those wishing to challenge his decisions regarding the Pool as a recent court ruling maintained that similar non-statutory powers held by the Director General of Telecommunications are not subject to judicial review.[181] The DGES may require changes to the PSA, but only in the wake of a MMC finding that the Pool operates against the public interest; and he may propose amendments to Pool members' licences. The EIUG told us that "OFFER is ... ineffectual in influencing the workings of the Pool".[182] We recommend that the Government conduct a thorough review of the relationship between OFFER and the Pool, to establish whether the DGES needs more extensive powers to ensure that consumers receive the maximum potential benefits of competition and that the Pool operates efficiently, transparently and in consumers' interests.

The state of competition in generation

85. A second area of major concern was the effective level of competition in electricity generation.[183] In 1995, we recommended that the two dominant generators, National Power and PowerGen, should be obliged to dispose of 6,000 MW of generating capacity to promote competition.[184] This happened in July 1996. There is debate, however, over how effective such measures have been. The EIUG told us that "competition in the generation market has not been the slightest affected by numerous small competitors entering the market".[185] SWEB argued that the sale of plant capacity to Eastern Group had only had a marginal effect, pointing out that in the period 1 April 1996 to 30 September 1996, National Power and PowerGen had set the Pool price 77% of the time, but that this figure had fallen by only 1%, to 76%, in the period from July to September 1996, after the sale of capacity. On the other hand, Eastern Group told us that more recent figures indicated that the percentage of time that the two major generators set the Pool price had fallen to 65% in the nine months to the end of December 1996 and that they had set the price themselves 21% of the time in that period.[186] The extent to which Eastern Group has set the price in the Pool has increased from 8% in the period from July 1996 to September 1996 to 17.5% in October 1996 and to 22% in November.[187]

86. We are pleased to note the declining influence of National Power and PowerGen and the entry of new generators, but we are not yet convinced that sufficiently robust competition exists to guarantee that consumers will obtain the best possible prices. As PowerGen pointed out "it is too early to make a definitive judgement about the impact of Eastern on price setting" but Eastern will be a substantial additional influence in the market.[188] The DGES told us that he was not satisfied with the current level of competition in generation, but pointed out it was increasing as fast as was possible in what is a very long-term industry.[189] We recommend that the Director General of Electricity Supply keep the development of competition in electricity generation under active review and that he consider adopting further measures to accelerate the development of effective competition. The possibility of further sale of capacity by the two main generators should not be excluded.

The Pool, the Network Code and the regulators

87. Just as the DGES has a role in overseeing the electricity Pool, the DGGS has a similar role with regard to the gas industry's Network Code. The Network Code is a series of contractual agreements governing the use by gas shippers of the monopolistic transportation and storage system operated by British Gas TransCo. The EIUG suggested that the DGES should, by playing a more active role in the Pool, follow the example of OFGAS, who, they claimed was pro-active with regard to the Network Code. "OFGAS is currently running the Network Code, which is being modified as the new market develops and we see no reason why OFFER should not lead in developing the electricity market".[190] We do not consider that such a comparison is fair or helpful. The Pool was created at privatisation, unlike the Network Code which came into operation on 1st March 1996.[191] The DGGS told us that OFGAS had a key role in "facilitating discussions which led to the successful introduction" of the Code.[192] As the Code is still developing, and OFGAS has a role in co-ordinating modifications, it is understandable that OFGAS may be seen as adopting a more pro-active approach than OFFER has to the already established Pool. Furthermore, OFGAS has been given greater powers, under the 1995 Gas Act, to intervene in the workings of the Network Code than OFFER has in the Pool. OFGAS has the power to impose a change in the rules of the Network Code at short notice, albeit subject to consultation and industry ratification later. OFFER has no such power. We recommend that the Government, as part of its review of the relationship between the DGES and the Pool, consider granting powers to the DGES similar to those of the DGGS over the Network Code.

Liberalisation

88. The Government expects that "as competition develops in the markets in which the utilities operate, the consumer's interest will increasingly be served"[193] and believes that "arguably the most significant guarantor of quality and variety in the provision of energy and related services is the availability of an alternative in a competitive market".[194] Hence, both the gas and electricity industries are in a time of transition; both industries are scheduled further to liberalise supply markets by 1998. For the mainland gas industry, this means offering a choice of suppliers to all customers who do not currently have a choice - that is most customers who consume less than 2,500 therms a year. For the electricity industry it means offering the same choice to consumers with a peak demand of less that 100 kW (see para 2). The vast majority of these consumers are domestic customers, although liberalisation will also extend supply competition to numerous commercial and industrial customers with consumption levels in these ranges.
Domestic gas supplies

89. Competition for some gas consumers in the below 2,500 therms a year market is already a reality. Since April 29th 1996, half a million customers in the South West consuming less than 2,500 therms a year have had a choice of supplier. On the first day, customers had a choice of 10 suppliers, including the incumbent supplier British Gas, and just under 30,000 (or 6%) switched to an alternative supplier.[195] By November 1996, customers in the South West had a choice of 13 suppliers and 72,000 (or 15%) had switched.[196] This year competition has been extended to a further million and a half customers in the South West and South East. By 1998, it is intended that all 18 million domestic gas consumers on the mainland will have a choice of supplier.

Domestic electricity supplies

90. Preparations are also under way for the liberalisation of electricity supplies to consumers with a peak demand below 100 kW (see para 2). It was originally intended that competition in electricity supplies would be extended to all such consumers on 1st April 1998 but recent proposals from the DGES envisage phasing in competition over a number of months on the basis of customer postcodes.[197] Nevertheless, the proposals envisage that all mainland consumers will have a choice of supplier by September 1998.

Regulation post-liberalisation

91. The liberalisation in the small gas and electricity supply markets, together with the extension of competition in other areas of the industries, inevitably has a fundamental impact on the role of the regulator. As the DTI told us "when competition has successfully developed there will be less need for special regulation under sectoral legislation".[198] For instance, the DGGS told us that "as barriers to entry have been removed [in the over 2,500 therms market] and customers have been offered an effective choice of supplier, so regulation of this sector of the gas supply market has been progressively reduced".[199] Thus, price controls in the 2,500 to 25,000 therms a year range were removed in 1994 and regulations designed to promote competition, such as the requirement on British Gas to release wholesale gas to its competitors and to publish prices in the size range, have been largely removed. Similarly in the domestic and other small user supply markets, as competition is established "eventually the scope of regulation should be able to be reduced, for example, by removing price control".[200]

92. Similarly, with respect to the electricity industry, OFFER told us that the DGES "considers that customers are more effectively protected by competition than by regulation" and that consequently he has "looked for opportunities to reduce the scope of regulation as competition has developed".[201] Since 1994, price controls have not applied to second tier suppliers or PESs supplying customers with peak demands over 100 kW. The latest consultation document from OFFER on price restraints in the domestic supply market post-liberalisation proposes a continuation of price controls for at least two years.[202] The DGES told us that there was a possibility that price controls could be abandoned in this market but that it was not possible to say when this might be.[203]

93. Most witnesses agreed that, despite the declining need for regulatory intervention in competitive markets, there would always be a need for specific regulation in both industries. There are no proposals to introduce competition into functions of the industries that are seen as natural monopolies (see paras 95-103). Consequently, there will be an on-going need for regulatory intervention in such functions to prevent any abuse of monopoly position.[204] Furthermore, as the DGGS pointed out, there will continue to be a need for regulatory supervision of competitive markets to ensure that market players deliver services which they might find financially unattractive but which are socially or environmentally desirable.[205] Thus "the regulator's role is likely to remain significant" (see paras 189-191).[206]

94. However, we believe that the expected decline in the role of the gas and electricity regulators lends weight to our argument for a single regulator for the energy industries. This is an argument we have advanced on previous occasions and one to which we turn our attention in more detail below (see paras 189-191).[207]

140 Before the passage of the Gas Act 1995, the DGGS had a duty only to assist competition. Back

141 Gas Act 1996, (Section 4(1)). Back

142 Electricity Act 1989, Section 3(1). Back

143 Q.288. Back

144 Ibid. Back

145 Q.1011. Back

146 Q.1101. Back

147 Q.866. Back

148 QQ.448, 866. Back

149 Ev. p.110. Back

150 Q.448 Back

151 Q.448 Back