4.2 Focus on Processes of Regulation not Just Outcomes
Currently independent regulators and those who review their performance
are very focused on measures related to the outcomes of regulation. Historically,Ofgem has been much concerned about the degree of competition in the generation market as measured by the market shares of the leading generating companies, the degree of competition in the residential market as measured by the retail switching rate and loss of incumbent market share. In relation to regulation of networks Ofgem has been very concerned about the size of X, within the RPI-X formula, in its price control reviews, with higher values of X (subject to the condition
that there are also high levels of investment) being associated with better
outcomes for consumers, i.e. that lower regulated charges are better.
Most of these measures have no real meaning for an economic regulator,
when looked at across time. Generation market shares can fluctuate but it is
possible to have a very competitive market with higher concentration ratios than
currently exhibited (in particular via integration of the UK national market within
a bigger regional European market). It is not clear where Ofgem can go with this
measure in the future. This is also true of its measures of retail market competition.
Lower rates of switching may reflect more competitive offers by incumbents
and less exploitation of incumbent customers. A clear parallel with telecoms exists
here, where the incumbent in the UK, BT, the former incumbent monopolist,
still has a significant share (of its traditional fixed line market) but is faced with an
increasingly competitive market (see Ofcom, 2007). I am not saying that energy
regulators are not aware of the measurement issues here, but that they have an issue
in how they present useful metrics of performance.
Ofgem has successfully achieved a competitive market in wholesale and
retail power (though it is currently investigating the latter). This suggests that higher
level monitoring and investigation can increasingly be left to the general competition
authorities, who are able to apply sophisticated and proportionate regulation
of competition, reflecting best practice across competition cases. There are two
major advantages of general competition regulators over sector specific regulators.
First, they are able to take a view on competition relative to other markets, particularly
those that are not regulated. This ensures a degree of consistency in the approach
to promoting competition, which trades off the costs and benefits of regulatory
action. Second, where the problems are severe they can propose much tougher
remedies including fines and structural reforms. Indeed arguably the GB electricity
generation market and the GB gas supply industry only made significant progress
following competition authority interventions, in spite of years of prior pressure
from their sectoral regulators. Earlier referral to the competition authorities in both
cases would have yielded benefits for consumers. Indeed an encouraging sign, in
this vein, is that competition within the central European electricity market may
be significantly facilitated by the activity of the European competition inquiry into
the competitiveness of the energy sector (European Commission, 2007), initiated
on the basis of EU competition law. General competition authorities do suffer from
delays in decision making, but when combined with ongoing market monitoring
(as undertaken by the Independent System Operator), this does necessarily not
require constant oversight by the economic regulatory agency, which may anyway
have weak powers to actually enforce effective longer term remedies.
Instead climate change policies will pose new competitive challenges.
Driven by rising prices for energy from gas and coal based technologies, incumbent
network operators may face entry from private networks (which may want
to connect up a few electricity and/or heat customers in a locality to a low carbon
energy source) and requests to connect distributed generation. Thus ensuring that
free entry and exit of new players and individuals, who wish to self-generate,
should become an increasing focus of sector specific regulation (as this involves
ongoing detailed assessment of connection rules and individual requests to connect/
disconnect). These new entrants may wish to sign customers up to long term
contracts for electricity, energy services and /or heat. Such contracts will need
monitoring, at least initially, for unfair terms clauses and for mis-selling.
In the incentive regulation of networks, X will be driven by new investments.
This means that independent regulators, like Ofgem, need to focus on the
process by which it is decided that new investments are necessary. Reliance on an
investment plan submitted by an incumbent network, audited by consultants, to
determine both whether the investments are necessary and are least cost no longer
seems appropriate, especially given the likely scale of the new investment. Indeed
it may never have been appropriate, but may have been a reasonable shortcut
when the investments being considered were less debatable and less significant.
We look at this in more detail in section 5.1.
Underlying all of the above, is the context that prices will be rising and
hence judging a regulator’s success on the basis of price will be increasingly difficult.
Higher prices might well be justified if they deliver more CO2 reduction,
more quickly. Thus a focus on both more sophisticated measures of the impact of
regulation on social welfare – reflecting environmental externalities - and on the
process by which regulatory decisions are arrived at seems appropriate. Indeed, as
some of the original studies of the impact of UK electricity market and regulatory
reforms make clear, the social welfare impact is not merely about price per se (see
Newbery and Pollitt, 1997, and Domah and Pollitt, 2001).
Beyond price, regulators will also need to decide on the quality of energy
supply and local environmental impact that consumers are willing to pay for. This
cannot be decided as the outcome of a submission from the regulated companies. It
will require an informed discussion between buyers and suppliers of network services
and also be informed by the opinions of customers (expressed via willingness
to pay surveys). One key element of this better informed process will be the system
of penalties for over or under performance in the area of quality of service.
Currently independent regulators and those who review their performance
are very focused on measures related to the outcomes of regulation. Historically,Ofgem has been much concerned about the degree of competition in the generation market as measured by the market shares of the leading generating companies, the degree of competition in the residential market as measured by the retail switching rate and loss of incumbent market share. In relation to regulation of networks Ofgem has been very concerned about the size of X, within the RPI-X formula, in its price control reviews, with higher values of X (subject to the conditionthat there are also high levels of investment) being associated with better
outcomes for consumers, i.e. that lower regulated charges are better.
Most of these measures have no real meaning for an economic regulator,
when looked at across time. Generation market shares can fluctuate but it is
possible to have a very competitive market with higher concentration ratios than
currently exhibited (in particular via integration of the UK national market within
a bigger regional European market). It is not clear where Ofgem can go with this
measure in the future. This is also true of its measures of retail market competition.
Lower rates of switching may reflect more competitive offers by incumbents
and less exploitation of incumbent customers. A clear parallel with telecoms exists
here, where the incumbent in the UK, BT, the former incumbent monopolist,
still has a significant share (of its traditional fixed line market) but is faced with an
increasingly competitive market (see Ofcom, 2007). I am not saying that energy
regulators are not aware of the measurement issues here, but that they have an issue
in how they present useful metrics of performance.
Ofgem has successfully achieved a competitive market in wholesale and
retail power (though it is currently investigating the latter). This suggests that higher
level monitoring and investigation can increasingly be left to the general competition
authorities, who are able to apply sophisticated and proportionate regulation
of competition, reflecting best practice across competition cases. There are two
major advantages of general competition regulators over sector specific regulators.
First, they are able to take a view on competition relative to other markets, particularly
those that are not regulated. This ensures a degree of consistency in the approach
to promoting competition, which trades off the costs and benefits of regulatory
action. Second, where the problems are severe they can propose much tougher
remedies including fines and structural reforms. Indeed arguably the GB electricity
generation market and the GB gas supply industry only made significant progress
following competition authority interventions, in spite of years of prior pressure
from their sectoral regulators. Earlier referral to the competition authorities in both
cases would have yielded benefits for consumers. Indeed an encouraging sign, in
this vein, is that competition within the central European electricity market may
be significantly facilitated by the activity of the European competition inquiry into
the competitiveness of the energy sector (European Commission, 2007), initiated
on the basis of EU competition law. General competition authorities do suffer from
delays in decision making, but when combined with ongoing market monitoring
(as undertaken by the Independent System Operator), this does necessarily not
require constant oversight by the economic regulatory agency, which may anyway
have weak powers to actually enforce effective longer term remedies.
Instead climate change policies will pose new competitive challenges.
Driven by rising prices for energy from gas and coal based technologies, incumbent
network operators may face entry from private networks (which may want
to connect up a few electricity and/or heat customers in a locality to a low carbon
energy source) and requests to connect distributed generation. Thus ensuring that
free entry and exit of new players and individuals, who wish to self-generate,
should become an increasing focus of sector specific regulation (as this involves
ongoing detailed assessment of connection rules and individual requests to connect/
disconnect). These new entrants may wish to sign customers up to long term
contracts for electricity, energy services and /or heat. Such contracts will need
monitoring, at least initially, for unfair terms clauses and for mis-selling.
In the incentive regulation of networks, X will be driven by new investments.
This means that independent regulators, like Ofgem, need to focus on the
process by which it is decided that new investments are necessary. Reliance on an
investment plan submitted by an incumbent network, audited by consultants, to
determine both whether the investments are necessary and are least cost no longer
seems appropriate, especially given the likely scale of the new investment. Indeed
it may never have been appropriate, but may have been a reasonable shortcut
when the investments being considered were less debatable and less significant.
We look at this in more detail in section 5.1.
Underlying all of the above, is the context that prices will be rising and
hence judging a regulator’s success on the basis of price will be increasingly difficult.
Higher prices might well be justified if they deliver more CO2 reduction,
more quickly. Thus a focus on both more sophisticated measures of the impact of
regulation on social welfare – reflecting environmental externalities - and on the
process by which regulatory decisions are arrived at seems appropriate. Indeed, as
some of the original studies of the impact of UK electricity market and regulatory
reforms make clear, the social welfare impact is not merely about price per se (see
Newbery and Pollitt, 1997, and Domah and Pollitt, 2001).
Beyond price, regulators will also need to decide on the quality of energy
supply and local environmental impact that consumers are willing to pay for. This
cannot be decided as the outcome of a submission from the regulated companies. It
will require an informed discussion between buyers and suppliers of network services
and also be informed by the opinions of customers (expressed via willingness
to pay surveys). One key element of this better informed process will be the system
of penalties for over or under performance in the area of quality of service.
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