Supplementary evidence submitted by energywatch
PAPER FOR ENERGYWATCH BY DR PHILIP MARSDEN,[199]
BRITISH INSTITUTE OF INTERNATIONAL AND COMPARATIVE LAW
IT IS
TIME FOR
AN ENERGY
MARKET INVESTIGATION
BY THE
COMPETITION COMMISSION
In recent years, governments and the European
Commission have become increasingly concerned about anti-competitive
activity in the energy sector. Several inquiries have made clear
that it is a "market that is not working fairly for consumers
or many providers. The European Commission's sector inquiry identified
five core problems of market concentration; vertical foreclosure;
lack of market integration; lack of transparency; and price formation.[200]
To try to address some of these problems, Ofgem and other national
regulators keep the sector subject to regulatory review; while
national competition authorities and the European Commission's
DG-Competition have increased use of their competition law enforcement
powers, including:
— reviewing mergers more strictly[201];
— reviewing state aid and other government
support; and
— launching dawn raids that have uncovered
further evidence of price-fixing and abusive foreclosure of competitors.[202]
These newly discovered anticompetitive practices
are particularly troubling, as one would not expect further anti-competitive
arrangements to keep arising in a sector under regulatory scrutiny.
This strongly suggests the need for more work in this sector.
It is energywatch's view that apart from the recently announced
probe into the energy supply markets,[203]
Ofgem have not held serious investigations into these markets
since 2004 and have made very little intervention at both wholesale
and retail levels of the markets.[204]
In particular, due to its limited resources and primary focus
on monopoly infrastructure, Ofgem has paid limited attention to
the relation between the retail and wholesale markets. Our current
regulatory and competition law review of the energy sector in
the UK need to be supplemented if they are to be effective. Fortunately,
help is close at hand. In the UK we are in the unique position
of being able to benefit from the added scrutiny and remedies
available through a Competition Commission market investigation.
We will identify the key benefits of such an
investigation, and submit that the Secretary of State should call
for such an investigation without delay.
Only a market investigation by the Competition
Commission can ensure that OFGEM and the other authorities are
assisted in their crucial role of making this market work fairly
for consumers in the UK.
Background to the regime
The Enterprise Act created the UK market
investigation reference regime, whereby the OFT has the power
to refer markets to the Competition Commission for further investigation
where it has reasonable grounds for suspecting that any feature,
or combination of features, of a market is preventing, restricting,
or distorting competition.[205]
Under this system the Competition Commission will decide whether
competition is indeed prevented, restricted or distorted, and
if so what, if any, action should be taken to remedy the adverse
effect on competition or any detrimental effect on customers arising
from the adverse effect. According to the legislation "detrimental
effect" can take two forms: (a) higher prices, lower quality
or less choice of goods or services in any market in the United
Kingdom (whether or not the market to which the feature or features
concerned relate); or (b) less innovation in relation to such
goods or services.[206]
Examples of Market Investigation References: in
the energy sector, comprehensive review and remedial powers
In 2002-03, the Competition Commission reviewed
the acquisition by Centrica plc from Dynegy Inc of two companies
that owned and operated the Rough gas storage facility.[207]
A major issue for the inquiry was whether, as a result of the
merger, Centrica would be likely to withhold sources of flexible
gas in order to force up wholesale gas prices. The Competition
Commission found that Centrica could be expected: (a) to discriminate
between customers in giving access to capacity at Rough; (b) to
use to its advantage sensitive information gained from the operation
of Rough; (c) to withhold information about the operation of Rough;
(d) to be less innovative in marketing Rough products than another
owner; and (e) to invest less in expanding Rough's capacity than
another owner. As a result, the Competition Commission determined
that competition in the markets for flexible gas and domestic
gas supply would be weakened, with the likely consequence of price
increases will be higher than in the absence of the merger. To
prevent these adverse effects, the Competition Commission required
that Centrica give statutory undertakings regarding its behaviour
as owner of Rough. The major elements of the undertakings were
that Centrica would: sell Rough's full capacity on non-discriminatory
terms; auction all capacity remaining unsold no less than 30 days
before the start of each storage year, with no reserve price;
maintain legal, financial and physical separation between its
storage business and all other parts of the group; ensure that
no commercially sensitive information arising from the operation
of Rough is passed to other parts of Centrica; and make any disclosure
of information relating to the storage operations to all market
participants simultaneously; facilitate the efficient operation
and development of the secondary market in Rough capacity; offer
at least 20% of Rough's capacity on annual contracts. The Competition
Commission maintained the power to divest assets if Centrica did
not comply with these commitments.
THE COMPETITION
COMMISSION WAS
THE ONLY
GOVERNMENT BODY
ABLE TO
RECOMMEND THE
INTRODUCTION OF
COMPETITION INTO
THE ENERGY
SECTOR IN
THE EARLY
1990'S
In 1992 the then Director General of Gas Supply
asked the then Monopolies and Mergers Commission (MMC) to investigate
whether the operation by British Gas plc of its pipeline system
and other facilities for the transportation, and storage of gas,
operates against the public interest.[208]
Related references were sent to the MMC at the time by the Secretary
of State into the supply of gas to tariff customers and to non-tariff
customers, and into the conveyance or storage of gas by public
gas suppliers. reports. The MMC found that because BG was both
a seller of gas, and owner of the transportation system which
its competitors have no alternative but to use, this dual role
gave rise to an inherent conflict of interest which makes it impossible
to provide the necessary conditions for self-sustaining competition.
The MMC recommended modification of BG's Authorisation so as to
establish its businesses as separate units. The Secretary of State
(whose final decision it was) chose not to implement the MMC's
recommendation, but British Gas decided to establish "Transco"
as a separate unit in 1994 and the formal demerger that led to
the creation of Centrica took place in February 1997. It was only
after this MMC report, that competition actually became possible
in the gas sector in the UK.
OTHER MARKET
INVESTIGATIONS: NO
FEAR TO
ACT
Excessive prices
In Store Cards the OFT referred the supply
of store card services to the Competition Commission following
its conclusion that there are features of the sector, both in
the supply of store card credit to consumers and in the supply
of store card services to retailers, that appear to prevent, restrict
or distort competition.[209]
In paragraph 1.13 of its report the OFT stated that "there
is insufficient competition to ensure that consumers get good
value from store cards and that such lack of competition may
lead to increased profits for retailers and store card providers".[210]
For the OFT then, the possible harm to consumers resulting from
the perceived lack of competition in this sector revolved around
the concept of value for money. The idea of "good value"
brings to mind the definition of an "unfair price" in
the case United Brands Co. v Commission; it concerns a
price that is "excessive in relation to the economic value
of the product supplied".[211]
In other words the OFT is formulating the possible consumer detriment
in this sector in terms of unfair or excessive prices for consumers.[212]
In its investigation the Competition Commission tried to quantify
this consumer detriment by comparing the prices actually paid
by cardholders who pay interest and insurance charges on store
cards with the prices they would have paid had these reflected
costs, including the cost of capital.[213]
Subsequent market investigation references submitted
to the Competition Commission have also concerned the impact of
(weak) competition on prices paid by consumers; see for example
Supply of Liquefied Petroleum Gas[214]
or Northern Ireland Banking[215]
In the former case the OFT suspected that "the high switching
costs [between different gas companies in the market for the supply
of domestic bulk liquefied petroleum gas] may form a barrier to
entry, so that competition is restricted and many consumers
face higher prices overall than they would in a similar market
without switching costs".[216]
In the latter case, the OFT held that the conditions for a referral
were met as high levels of concentration, significant entry barriers,
price parallelism and consumer inertia appear together to result
in limited price competition and weak switching competition
between the big four banks in Northern Ireland.[217]
Both investigations are ongoing.
In Home Collected Credit[218]
the Competition Commission actually attempted to quantify the
overcharge suffered by customers in the relevant market; according
to the CC customers suffered from "substantial overcharging":
[overcharging] may have amounted to as much as
£100 million a year over the last five years across the whole
market, which would imply that a home credit customer pays over
£25 too much for an average loan, or £9 per £100
borrowed, and that home credit lenders have been able to earn
more than £500 million in profits in excess of the cost of
capital in the last five years.[219]
This case thus highlights that the Competition
Commission: (i) considers overcharging as a form of consumer detriment;
and (ii) is willing to quantify the extent of the overcharge when
possible. Home Collected Credit also demonstrates that
the CC will consider the effects of weak competition on particular
categories of consumers as well as consumers in general. Indeed,
on the facts before it the Competition Commission expressed its
belief that the overcharge may have more of an effect on single
mothers under 35:
Home credit customers were more likely than the
population as a whole to be female, to be under 35, to have young
families, to fall into socio-economic groups D and E, to live
in a low-income household and to live in housing rented from a
local council or housing association.[220]
It is not just about price . . .
In Home Collected Credit signalled how
the Competition Commission will also consider different forms
of consumer detriment where relevant:
We shall determine whether any effect on advertisers
or users [ie consumers] in the form of higher prices, lower
quality or less choice of goods and services, or less innovation
has resulted from, or may be expected to result from, any
adverse effects on competition in the relevant market or markets.[221]
Indeed, if the Competition Commission decides
that there is an adverse effect on competition it must "take
action to `remedy, mitigate or prevent' the adverse effect on
competition and to `remedy, mitigate or prevent any detrimental
effects on customers' so far as those effects have resulted from
the adverse effect".[222]
By definition "any detrimental effects" must also include
those detrimental effects that cannot be classed solely as effects
on the prices paid by consumers.
In the ongoing Groceries Market Investigation,
the Competition Commission has recently published its Provisional
Remedies notice, which recommends a number of competition policy
solutions, including the introduction of a "competition test"
when local planning authorities are assessing planning applications
for new large grocery stores, and A requirement on grocery retailers
to lift existing exclusivity arrangements that have been in place
for more than five years, where these have been identified as
a barrier to entry by a competing retailer in areas of high concentration.
In addition, however, the Competition Commission has recommended
remedies that go beyond what competition law itself could do:
namely that the Department for Business, Enterprise and Regulatory
Reform amend the Land Agreements Exclusion Order so that agreements
which restrict grocery retailing should no longer benefit from
exclusion from the Competition Act.[223]
What can the authorities do?
Ofgem
Of course, Ofgem is the port of first resort
in examining the energy sector. It is energywatch's view that
apart from the recently announced probe into the energy supply
markets, Ofgem has not held serious investigations into these
markets since 2004 and has made very little intervention at both
wholesale and retail levels of the markets. It has also only paid
limited attention to the relation between the retail and wholesale
markets.
The Competition Commission
Although all of the UK authorities have considered
consumer detriment in its many different forms, it appears that
the OFT, at least, seems to concentrate primarily on price related
consumer detriment. The Competition Commission, by contrast, will
consider more readily the other aspects of consumer harm (viz
the negative impact of conduct on innovation, quality and
choice for consumers) especially when considering a particular
market in the context of a market investigation reference. The
Competition Appeal Tribunal also takes a more dynamic approach
to the market. For the CAT consumers may be harmed through the
higher long-run price levels, reduction in choice and decreases
in quality, which, in general, significant distortion of competition
brings.
Greater powers than DG-Competition
In contrast, the type of sectoral inquiry employed
at EC level can only be used to enforce the competition law rules
enshrined in Articles 81 and 82 EC. In other words the EC Commission
is not empowered to adopt any remedies that would aim to resolve
the particular market failure in question; rather, it must bring
competition law based cases against undertakings if it wishes
to use its administrative powers to solve the problem identified.
It is obvious then that the above arguments concerning potential
benefits are more relevant for the UK market investigation regime
The Competition Commission, in contrast to its
counterpart in Brussels, has a wide discretion, and the necessary
power to adopt a wide range of measures designed to remedy an
identified defect in the market. Such remedies available under
Competition Commission guidelines can:
— make a significant and direct change
to the structure of a market (eg, through divestment and unbundling);
— change the structure of a market
less indirectly (eg, by reducing entry barriers or switching costs,
by requiring the licensing of know-how or intellectual property
rights, or by extending the compatibility of products through
industry-wide technical standards);
— direct firms to discontinue certain
behaviour (eg, giving advance notice of price changes) or to adopt
certain behaviour (eg, more prominently displaying prices and
other terms and conditions of sale);
— restrain the way in which firms would
otherwise behave (eg, the imposition of a price cap); and
— monitor (eg, a requirement to provide
the OFT with information on prices or profits).
This is an impressive array of potential remedies.
The European Commission, in contrast, can only pursue formal competition
law cases using its powers to enforce Articles 81 and 82.
Competition Commission Plus
In most cases action to impose the remedies
can be taken by the Competition Commission. In other cases (such
as changes to industry regulations), the Commission can only recommend
such action to government departments or other bodies. The government
has committed that it will respond publicly to any such recommendation
within 90 days of the publication of the Competition Commission's
report.
THE COMPETITION
COMMISSION HAS
AN EXPERT
ENERGY PANEL
ON-HAND
The Competition Commission also has a special
utilities panel, made up of CC members expert in the energy and
related sectors. Most usually the panel deals with water, electricity,
gas and energy code modification appeals but these members would
clearly be involved in any market investigation into the energy
sector, thus ensuring an expert and thorough review.
THE COMPETITION
COMMISSION EXISTS
TO FILL
THE EXISTING
GAP BETWEEN
REGULATION (OFGEM) AND
COMPETITION LAW
ENFORCEMENT (OFT)
In the words of the Chairman of the Competition
Commission, Peter Freeman:
"Not only are market investigations a very
useful way of investigating industry-wide issues but, in terms
of fairness of process, thoroughness of investigation and practicality
of remedies, they can have important advantages over the so-called
`prohibition' system. And with a maximum of two years they are
comparatively quick for what they can deliver. So, in conclusion,
I do not know what chemical is concocted from mixing regulatory
"chalk" with competition "cheese"; but .
. . the distinction between them is not as clear cut as some would
argue and that, in particular, market investigations can act as
a bridge over whatever gap divides the two".[224]
So what is needed?
Even before a market investigation is called,
it is obvious what is needed to address the problems identified
by the European Commission alone:
The most obvious candidate is improved transparency.
The recent price spikes in the UK gas market and the difficulties
in determining why more gas was not flowing from the Continent
to the UK are a clear indication of this. If the authorities have
difficulties getting the information that they need, competitors
of the vertically integrated incumbents must be operating completely
in the dark. So regulation here may well be needed. The Competition
Commission is ideally suited to identify further informational
remedies to promote transparency in this sector.
However, transparency alone will not suffice.
The greatest problems with the sector stem purely from oligopoly,
and indeed collective dominance. In such cases, as the European
Commission has identified in this and other sectors,[225]
the primary problem is one of a forcing out, or keeping out, of
rival providers, and thereby allowing incumbents to charge consumers
what they wish. Other problems may arise as well, simply out of
coordinated effects and tacit collusion that can stem from oligopoly.
One of the most common problems in such a closely held market,
however, is the fact that two to three players can effectively
sew up the market through long-term agreements with downstream
distributors. This is precisely the problem identified by the
European Commission in the energy sector. In its final report
on its sector inquiry, the EC reported that "the prevalence
of long-term supply contracts between gas producers and incumbent
importers makes it very difficult for new entrants to access gas
on the upstream markets. Similarly, electricity generation assets
are in the hand of a few incumbent suppliers or are indirectly
controlled by them on the basis of long-term power purchase agreements
. . . giving the incumbents control over the essential inputs
into the wholesale markets".[226]
"The Sector Inquiry has also confirmed the vertical tying
of markets by long-term downstream contracts as a priority for
review of case situations under competition law and of providing
guidance where required".[227]
These problems of vertical foreclosure and long-term
contracts, and the linking through de facto integration between
the wholesale and retail levels, is precisely the problem that
energywatch has identified as prevailing in the UK energy sector.[228]
It needs to be addressed as a matter of high priority by Her Majesty's
Government, and it is submitted that the Competition Commission
has the analytical tools, the remedial powers and the expertise
to do the job.
1 April 2008
199 Senior Research Fellow and Director, Competition
Law Forum-http://www.biicl.org/philipmarsden/ Back
200
European Commission, Energy Sector Inquiry, Final Report, January
2007. Back
201
R Owen-Howes and C Thomas, "Freeing Energy" finding
that stricter merger control is a major policy tool of the European
Commission, when its usual competition law enforcement powers
under Article 81 and 82 are found wanting: reviewing the E.On/MOL,
GDP/EDP/ENI, Endesa/Gas Natural and Endesa/E.On transactions.
Competition Law Insight, 6 June 2006. Back
202
Spiegel Online reported as late as November 2007 that the German
BundesKartellamt and European Commission have found evidence of
price-fixing after raids in Germany yielded thousands of documents
in dawn raids. "German Energy Giants Accused of Collusion",
Spiegel Online, 5 November 2007. The European Commission is also
investigating Distrigas, the dominant gas supplier in Belgium-for
suspected violations of Article 82 from its long term gas supply
contracts with many of its industrial customers. Back
203
http://www.ofgem.gov.uk/Media/PressRel/Documents1/ProbeFINAL.pdf Back
204
Allan Asher, Chief Executive of energywatch, "Consumer welfare-a
casualty of `light touch' regulation-The End of Regulation as
we know it? . . . so where next?" SBGI 2008 Seminar London,
6 March 2008, Back
205
See Part IV of the Enterprise Act 2002. Back
206
Ibid at Section 134(5). It should be obvious that these
two "effects" are the opposite of those defined as benefits
under Section 1(a) of the same act; see supra. Section 134(8)
also defines customer benefit as (i) lower prices, higher quality
or greater choice of goods or services in any market in the United
Kingdom; or (ii) greater innovation in relation to such goods
or services. Back
207
http://www.competition-commission.org.uk/rep-pub/reports/2003/480centrica.htmfull Back
208
http://www.competition-commission.org.uk/rep_pub/reports/1993/335britishgas.htmsummary Back
209
Store Cards, OFT Reference to the Competition Commission,
18 March 2004. Back
210
Emphasis added. Back
211
United Brands Co. v Commission [1978] 1 CMLR 429, at paragraph
235. Back
212
At paragraph 6.1 of the reference, the OFT underlined its suspicions
that excess prices were being paid by some consumers for certain
store cards: "the provision of store card credit may not
be working well for consumers. It is possible . . . that the difference
between the interest charged on store cards and other credit cards
is not fully explained by the offsetting benefits and the differences
in the cost of providing these services". Back
213
See Paragraph 1 of Annex 9.1 of the Competition Commission Report,
available at: http://www.competition-commission.org.uk/rep_pub/reports/2006/509storecards.htm. Back
214
Supply of Liquefied Petroleum Gas, Market Investigation
Reference, 5 July 2004. Back
215
Northern Ireland Banking, Market Investigation Reference,
26 May 2005. See also: Home Collected Credit, Market Investigation
Reference, 20 December 2004. Back
216
At paragraph 3 of the OFT Reference (emphasis added). Back
217
See paragraph 75 of the OFT Report. Back
218
Home Collected Credit, Market Investigation Reference,
20 December 2004. Back
219
Ibid, Competition Commission News Release, 27 April 2006,
available at: http://www.competition-commission.org.uk/inquiries/current/homecredit/index.htm,
at p 1. It should be noted that these findings are only provisional
and that the Competition Commission intends to discuss them further
with home credit companies before making its final conclusions
on the matter: ibid. Back
220
Ibid, at p 2. Back
221
Classified Directory Advertising Services, Market Investigation
Reference, 5 April 2005, Competition Commission, Issues Statement,
Paragraph 17 (emphasis added). Back
222
Northern Ireland Banking, Market Investigation Reference,
26 May 2005, at paragraph 83 of the OFT Report (emphasis added).
See also Section 138 of the Enterprise Act 2002. Back
223
Competition Commission, Provisional Decision on Remedies. http://www.competition-commission.org.uk/inquiries/ref2006/grocery/provisional_decision_remedies.htm Back
224
P Freeman, "Regulation and Competition-Chalk and Cheese?
The Role of the Competition Commission", CRI Frontiers
of Regulation Conference, Keynote Speech University of Bath 7
September 2006. Back
225
Case T-342/99 Airtours/First Choice [2002] ECR II-2585;
Case T-464/04, IMPALA vs Commission of the European Communities,
13 July 2006. Back
226
European Commission, Energy Sector Inquiry, Final Report, January
2007 at 8. Back
227
European Commission, Energy Sector Inquiry, Final Report, January
2007 at 13. Back
228
energywatch, Efficiency Review of the GB Wholesale Gas and Electricity
Markets; Business and Enterprise Committee: Inquiry into possible
anti-competitive behaviour in the energy markets. Back
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