3.1 The Maturity of the Existing Model
Ofgem’s mandate is to achieve its principal objective by promoting effective
competition. It is legitimate to ask how we would know if we had established
‘effective competition?’ And if we have achieved it, what are the implications
for the existing model of regulation?
Independent sectoral regulatory agencies exist for a purpose. Usually that
purpose is related to the idea that the markets they are regulating need special attention
that cannot be provided by the general competition authorities, such as the
Office of Fair Trading or the Competition Commission in the UK. This special attention
can be due to the immaturity of the markets being regulated and hence their
need for considerable ongoing monitoring and/or the complexity of the assessment
of whether the market is competitive and hence the need for specialist staff best
organized into a separate regulatory agency (or indeed the specialist market monitoring
function of the Independent System Operator, as in the United States).
Independent sectoral regulatory agencies in some countries may substitute
for a weak competition authority, however it is interesting to note the very
active role of the EU competition authorities in highlighting the nature of problems
with the operation of central European electricity and gas markets (European
Commission, 2007). The European Commission has been able to have a powerful
forcing effect in bringing about structural change where national regulators and
competition authorities failed to do so (e.g. in Germany where electricity and gas
companies have announced their intention to voluntarily unbundle their transmission
assets).
In terms of its principal objective Ofgem (and its predecessor Offer) has
witnessed notable success. The wholesale market was substantially competitive by
2001 when the market shares of the leading companies had been reduced by divestiture
(Newbery, 2006). Incentive regulation and tough reallocation of costs between
distribution and retail had ensured that there was a level playing field in retail
competition between incumbent retailers and new entrants, such that the residential
switching rates in GB are among the highest in the world (see Littlechild, 2006).
In terms of promoting the efficiency of network companies, real prices
fell in all the price review periods up to 2005. There was also significant conver-
gence in costs observed between electricity distribution companies (Jamasb and
Pollitt, 2007).
We suggest that scope for Ofgem’s efforts to impact prices by promoting
competition and incentivizing efficiency in electricity (and gas) supply further is
now limited by the achievement of de-concentration in generation asset ownership
and significant price convergence between suppliers and by the elimination of
initially high levels of inefficiency in network companies. This is not to say that incumbents
have not got considerable scope to lose more market share in the household
sector but that this trend is now well established (3% per year since 2002).
There may also be specific issues associated with gas distribution in the
UK, where the recent breakup and sale of National Grid’s former monopoly seems
to be resulting in significant efficiency improvements.7 This suggests that gas distribution’s
former structure was inefficient and that introducing comparative competition
between regional monopolies, as was already the case in electricity, will
yield significant improvements. It remains to be seen how long these efficiency
gains will take to be realized, especially within National Grid’s remaining four
gas distribution areas, now that the scope for efficiency savings has been revealed
by the new operators of the divested regions.
Ofgem’s mandate is to achieve its principal objective by promoting effective
competition. It is legitimate to ask how we would know if we had established‘effective competition?’ And if we have achieved it, what are the implications
for the existing model of regulation?
Independent sectoral regulatory agencies exist for a purpose. Usually that
purpose is related to the idea that the markets they are regulating need special attention
that cannot be provided by the general competition authorities, such as the
Office of Fair Trading or the Competition Commission in the UK. This special attention
can be due to the immaturity of the markets being regulated and hence their
need for considerable ongoing monitoring and/or the complexity of the assessment
of whether the market is competitive and hence the need for specialist staff best
organized into a separate regulatory agency (or indeed the specialist market monitoring
function of the Independent System Operator, as in the United States).
Independent sectoral regulatory agencies in some countries may substitute
for a weak competition authority, however it is interesting to note the very
active role of the EU competition authorities in highlighting the nature of problems
with the operation of central European electricity and gas markets (European
Commission, 2007). The European Commission has been able to have a powerful
forcing effect in bringing about structural change where national regulators and
competition authorities failed to do so (e.g. in Germany where electricity and gas
companies have announced their intention to voluntarily unbundle their transmission
assets).
In terms of its principal objective Ofgem (and its predecessor Offer) has
witnessed notable success. The wholesale market was substantially competitive by
2001 when the market shares of the leading companies had been reduced by divestiture
(Newbery, 2006). Incentive regulation and tough reallocation of costs between
distribution and retail had ensured that there was a level playing field in retail
competition between incumbent retailers and new entrants, such that the residential
switching rates in GB are among the highest in the world (see Littlechild, 2006).
In terms of promoting the efficiency of network companies, real prices
fell in all the price review periods up to 2005. There was also significant conver-
gence in costs observed between electricity distribution companies (Jamasb and
Pollitt, 2007).
We suggest that scope for Ofgem’s efforts to impact prices by promoting
competition and incentivizing efficiency in electricity (and gas) supply further is
now limited by the achievement of de-concentration in generation asset ownership
and significant price convergence between suppliers and by the elimination of
initially high levels of inefficiency in network companies. This is not to say that incumbents
have not got considerable scope to lose more market share in the household
sector but that this trend is now well established (3% per year since 2002).
There may also be specific issues associated with gas distribution in the
UK, where the recent breakup and sale of National Grid’s former monopoly seems
to be resulting in significant efficiency improvements.7 This suggests that gas distribution’s
former structure was inefficient and that introducing comparative competition
between regional monopolies, as was already the case in electricity, will
yield significant improvements. It remains to be seen how long these efficiency
gains will take to be realized, especially within National Grid’s remaining four
gas distribution areas, now that the scope for efficiency savings has been revealed
by the new operators of the divested regions.
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