THE NEW POWER INTERVIEW: STEPHEN LITTLECHILD

As head of then-energy regulator Offer, Stephen Littlechild was instrumental in setting up our energy market, and he says it would still work – provided political pressure does not put a spoke in the wheel. But that’s exactly what has been happening.

He says:  “Until 2008 it was probably the most competitive retail market in the world. Since then, the actions that Ofgem has taken have limited the ability of companies to compete with each other so it is no longer as competitive as it used to be. I think that is reflected in the higher profit margins that are being earned on retail. But broadly speaking I think it still is pretty competitive, so I don’t think that there is any question that it didn’t work or wouldn’t work unless it is prevented by regulation and government from doing so.

He said competition started to erode in 2008, “when Ofgem decided that it wanted to prevent what it called unfair pricing … people charging lower prices outside their traditional areas than inside. The simple tariff is just the latest stage of this limiting of competition and I am inclined to think it is no accident that the prices have gone up quite considerably for the last few months.”

If competition is decreasing, as Littlechild says, how can that be assessed? Is switching the right measure?  He says it can’t be the only one. He adds innovation, new companies entering the market, new tariffs being offered and customers’ awareness of alternatives and price reductions as other measures. He has praise for switching sites, which he says are a “very positive force in the retail market. We have much better switching sites, much more variety, much more competition in Britain than there is anywhere else in the world. Sometimes you have just the regulator providing detail on what offers there are and that’s it. Not very exciting.”

In Littlechild’s view, the last few years have seen companies find new ways to compete in the face of Ofgem actions to limit their action. “When Ofgem limited the ability to compete out of area, that is when the companies started looking for different ways of competing and made online offerings.

“That is when Ofgem then started complaining that there were too many tariffs. That was an indication that companies were looking for more and more ways of competing because they had been prevented from competing in the way that was the most effective.

“Similarly, when they were encouraged to stop doorstep selling. Then they started looking for other ways to compete such as online tariffs … now we are getting fixed price tariffs, which I think has been overdue.”

He says Ofgem had not previously encouraged fixed price deals and nor had switching sites: “they could see that if a customer was signed up for two years that was not a customer that would be coming back to them in six months.”

 

Retail competition does work, Littlechild says, but you have to be realistic about what it can achieve. “It can drive the companies to buy electricity as cheaply as they can … As far as I can see it’s doing that.”

If that’s the case, why has Ofgem been compelled to act? He says, “In 2008 they felt under pressure to do something because prices had been going up for a few years, the select committee was investigating, government I am sure was feeing uncomfortable and thinking something had to be done. But instead of the government really explaining that the market was working alright, but there were these reasons why prices were going up, the government too found it more convenient to suggest there was something the matter with competition.”

He says the regulator made two mistakes: “First Ofgem felt inclined to do something, and second what it chose to do showed a misunderstanding of competitive markets and how they operate.

“The simple answer would have been to do nothing. It’s not always a comfortable message for regulators to give but that would have been the right answer at the time.”

Now, he says, Ofgem “are making things worse,” and should unwind all the retail market reform measures. “They are going to limit the attractive offers available, but I am not convinced that the market is going to seem any simpler to customers.

“It is going to be more difficult for companies to compete and frankly they are going to be less interested in competing.”

He acknowledges the recent increase in switching, but says the uncertainty has driven people to fixed price deals, and  “it’s despite the simple tariffs agenda” – not because of it.

He adds, “The government is now at the point where I wish it had been five years ago, of saying that a lot of these costs are substantially outside our control and using the market in a sensible way is the best thing customers can do.

“That’s the kind of message Ofgem or switching sites could convey without limiting the tariffs on offer. If Ofgem or switching sites had said a few years ago, ‘I’m afraid prices are going to keep going up  and there are reasons for that, we can’t do anything about it why don’t you consider taking fixed price offers if you want to reduce uncertainty’, then things would have been different.”

How does he think the market will look, once RMR has been fully rolled out? Littlechild says it will be comfortable for the big suppliers, who will aim to hold on to existing customers rather than attract new ones. “They would make sure their tariffs were comparable with others in the market but they wouldn’t be particularly aggressive…

“If you have only got four tariffs, then if you change one you have to sacrifice a quarter of your customers. That is a big hurdle to jump: is it really going to be worth innovating? “

He points out that the four-tariff limit also locks utilities out of the kind of experimentation, perhaps through third parties or new subsidiaries, that has happened in insurance: “Ofgem has given enormous thought to how people might get round the regulations and specifying them in such a way that they can’t.”

How far back would he undo the market reform – right back to banning out-of areas tariffs? He says yes: “I am inclined to think we should sweep away all the restrictions and consider afresh whether any of them serve any useful function or not”.

Does that mean we should sweep away regulator Ofgem with them? “Only part of it,” he says.

“I am not criticising Ofgem for everything,. They do a good job on network regulation, broadly speaking …. It’s only on the retail side and what’s happened since 2008 where I have been critical.

“What I am increasingly coming to realise is that trying to regulate a competitive market is difficult, particularly when you are in an era of rising prices. It’s also an era of rising profits but I think at the moment it’s rising prices that are the issue. There is pressure on a regulator to intervene and the regulator is in a difficult position because he is being asked to evaluate whether he has made a good job of it over the past five or ten years,

“Ofgem has undertaken a review of the state of competition, but really it’s going to be reviewing whether its measures have worked or not.  I don’t think it’s reasonable to expect any organisation to carry out a dispassionate analysis of its own policy.”

Hi suggestion is “In the first instance for the Competition Commission to look at this market to see how competition is working, and also to look at what impact regulation has had. That seems to me the critical thing that has gone wrong, so we need someone other than the regulatory body to examine it.”

Should the Competition Commission have been involved sooner? A pan-industry investigation has been suggested, but the CC has also complained that there had been no referrals on aspects of the market.

“This has been a grumble of the CC for some years and it’s not just Ofgem – they think all the regulators have been reluctant to make references”, Littlechild says.  “I can quite understand why regulators would think ‘why not sort it out ourselves’. It’s not the ideal solution but it’s quick, it doesn’t involved being tied up for two years, its less costly.  But from time to time, especially when regulatory policy itself is at issue, I think you do need an investigation by an outside body. If the CC had been invited to look at the industry back in 2008 that would have been a perfectly reasonable response by Ofgem.

“Ofgem had carried out a whole series of almost annual competition reviews and found that competition was working well. Then it was put in the position where, basically, people didn’t believe it  … that’s when they started finding out that there were things wrong and that was when they started to do things.

“I think the sooner the CC gets involved the sooner we can stop the mistaken polities that have been adopted over the past five years.”

 

As for whether Ofgem should be abolished, he says, “Every time there is a price increase the regulator gets pushed to do something about it and I think it is very difficult for a regulatory body to resist.

“I am coming to the view that in the competitive market like the retail sector there would be an advantage if it weren’t regulated by Ofgem, but it was the responsibility of the Office of Fair Trading, which if it seemed to be a problem could make a reference to the CC. It would happen … every few years and it would be quite open for the OFT to say ‘you may think there is a problem here but the CC looked at it a couple of years ago, they didn’t see a problem, we don’t see a case for intervening’.”

He is struck by an apparent industry acceptance that competition is fading. “It’s striking – companies say x% is a reasonable amount of profit, we will content ourselves with that, and by implication could have a little bit more if we wanted. That doesn’t sound like a very competitive market – in other markets people are desperate to make as much profit as they can and are grateful for the opportunity.

“One has the sense of it being a more comfortable market now – not for customers of course, because prices are going up. But for companies.“

If retail competition is fading, does Littlechild think criticisms of the wholesale market are justified? He says, “It’s a market that has operated remarkably well.

“It has been shaken now with the great fears of what the government might do and the uncertainty that exists regardless of what the government does now, and I can imagine investors are much more cautious.

“Whether it has been working as well in the last year or two as it had been until then I don’t know.  Some people criticised the New Electricity Trading Arrangements (Neta) that I helped to bring in. But one consequence of Neta is that there has been almost no allegation that the wholesale market isn’t working effectively. There has been no allegation from the regulator, not even hints and murmers and coded sentences, warnings to companies, it just hasn’t happened.

“That is in contrast to markets in the USA and elsewhere where you frequently get allegations of the market being rigged. I reckon that a factor in this is that 95% of the trades in the market are bilateral, in contrast to many other states where there is a pool – a mechanism, a formula that sets the price based on what the bids have been.

“I think it’s easier for companies to game a pool as a market mechanism, whereas if they are selling to sharp buyers who want to minimise their energy costs then you can’t get away with that. You have more than six entities purchasing the vast bulk of power in this country and they know that they stand to lose if they don’t purchase it well. I think that has led to a market that operates very well.”

Even if the market was failing, he doesn’t see a pool as a solution.  “All round the world where you get pools you get investigations and you get recriminations and people are found guilty and fined. That seems to me a universal characteristic of energy pools. We have a market here and I haven’t seen that kind of activity carried on or alleged to be carried on, at least for the last 15years.

“It sounds like another example of feeling you have to do something.”

He also has little time for Labour’s concerns that vertically integrated companies game through self supply. He says companies are frequently in the market, as for none of them supply matches demand, and because they need to hedge. They will buy and sell the power a number of times as they see a market opportunity: “It is not as if they just supply themselves and have a little bit to play with, they are constantly trading in the market and it looks pretty competitive to me.

“I think there is a question of what tax companies pay and where do they pay it and can you adjust your transfer prices in such a way as to make your profits here or there to reduce tax bills. That may be possible. What I am saying is that I don’t think any of these things are putting up prices for customers in the market.“

On the question of whether those vertically integrated companies should be split, he says “It looks as though you can generate without supply.  But supply without a generation business just hasn’t survived in the Darwninian struggled.  So I am very reluctant to force that split when the market hasn’t indicated that it is an efficient way of operating.”

He suggests the logic is faulty. “So we are saying it’s an advantage to be vertically integrated and you can compete more effectively if you are, and so for that reason we are going to ban everyone that is? That sounds like cutting off your nose to spite your face.”

What about Labour’s proposal to freeze prices? “I think it is a bad idea.” He  understands the arguments in favour and in fact he has imposed price caps in the past, but prices had been controlled beforehand. In the present situation, the Labout party is planning a price control in 2017. Littlechild laughs out loud at the idea: “You do what any sensible person would do and double your prices before then and you will be alright.  It seems to me a bizarre thing to say whatever the prices are, when we get to them, we’ll freeze them. That’s no protection for anyone.”

I say that Labour has said it will choose the price level of the freeze.  Littlechild says, “That’s quite different. You are not into price freezing, you are in a situation where you choose a price control and you arbitrarily choose a price cap. It’s not a question of holding the fort, which was a phrase I once used, you are saying you will decide what everyone’s price will be.

“No doubt if you have a majority in parliament you can take the power to do that, but the consequence would be that investment would move out of the power sector.  Either this price is going to be set at a level where it’s not going to cause any problems for the companies, in which case why is it being done? Or it’s at a level where it will cut into their revenues to the extent of getting below their costs. We just don’t know how this thing would be set if it’s not going to be freezing.

“It’s going to distort the market, it’s going to discourage investment, it’s going to impact not just on the retail side. These big companies are also considering building generation and some of the decisions they have to take – whether to close plant – are going to be influenced by the climate of political opinion.  All the arguments are against it.”

But Littlechild sees that market distortion arising already: “The market is steadily being undermined by all the aspects of the government’s energy policy. Whether there will be a market in a few years time and what it will look like is uncertain.  All the intervention is just so great that it must seriously affect the way this market works – and whether it could seriously be called a market any more. “

I ask him if that process is already far advanced. If we really had a market would we have new nuclear, for example?

“I would guess not at the present stage. If the carbon taxes or obligations were set tight enough it’s conceivable that new nuclear could become economic.  Energy prices would have to double to make nuclear worth building in a competitive market.  Would any government be willing to enforce carbon prices or restrictions that would lead to prices high enough to bring nuclear forward? My guess is the answer is no they wouldn’t”, and, he suggests, investors wouldn’t believe it could endure if they did. “So the market for the next few years would focus on gas, onshore wind.  We are being led into a much higher priced generation mix than the market would deliver.”

He attributes that to the decarbonisation agenda and says, “We have hurtled into this without looking at the implications and now people are beginning to see those implications in terms of higher prices they are beginning to wonder whether  it was a sensible rate at which to make these changes.”

“Thee years ago I would have said we were much more competitive than most other markets, but what’s happening now with government has introduced so many interventions and so much uncertainty that who knows what will happen.  It’s possible to say that costs will go up because there is more uncertainty and more risk and because technologies will be chosen that wouldn’t have been chosen by the market.  So things are going to get worse, we can say that with confidence.”

 

Magic numbers

 

Is there a magic number for how many companies are enough for a functioning market?

Littlechild says: “If you had asked me 20 years ago I would have thought three was good and six was pretty attractive.  It is not just the number, but the demonstrable ability of companies to get in and out. And that has happened in the UK – not on a large scale, but people are building generation. They have tended to build CCGTs but that’s the most effective.”

On the retail side, “there hasn’t been much entry over the years and if so they haven’t gone above 1% of domestic market. That used to indicate that the profits weren’t that good and it wasn’t worth moving in. There is more margin now.  I am very pleased to see new entrants, they have new ideas.  But they have a very significant advantage, worth £60-100 per customer per year and the latest figures are near the top of that.  It’s a big subsidy for new entrants and it remains to be seem whether they can beat the 250k barrier [at which they incur Eco and other obligations] or not. At  250,000 accounts they don’t just pay that obligation on the next customer but on all 250,000.

“You have to run like mad to get 500,000 and when you get beyond that you can cope – but that’s a pretty desperate period.  I think three of those new entrants are going through the barrier.

“I wouldn’t be surprised to see companies reach the 250,000 mark and then sell their customers or companies to another.”

This interview appeared in the November 2013 issue of New Power.  For more details and a sample issue email subscriptions@newpower.info

 

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