A competition inquiry is right for UK energy

The full-scale competition review of the UK’s energy market which will be announced later this week is a challenge the industry should welcome. The inquiry will absorb a huge amount of time and effort over the next year but it offers the chance both for the industry to clear its name by removing the cloud of public suspicion over pricing policies and simultaneously for individual companies to examine their own strategic positioning in a market which is changing rapidly.

Of course, the competition review will add to uncertainty and will reinforce the reluctance to invest in new generating capacity, which is already evident, but the sense of doubt will exist in any case, and the review may help to produce some longer-term clarity. In the short term the government will have to find a new mechanism to ensure that supply is adequate to meet demand – and doing so with an expensive plan for emergency electricity supplies. But that is a separate issue from this fundamental analysis

The review should be comprehensive – going back down the supply chain to look at the pricing of inputs from third parties as well at the operations of the big six energy companies themselves. Its analysis should show us:

  • the price chain from production to the end consumer;
  • the impact of vertical integration;
  • the influence of green policies on final prices;
  • the extent, if any, of inappropriate behaviour by any of the companies involved.

Clearly, the detailed terms of reference will matter but on the basic issue of whether the sector is competitive three basic conclusions are possible:

  1. That there has been unacceptable behaviour by one or more companies which requires a punitive response as well as remedies for the future.
  2. That there is a structural problem within the industry which requires the break-up of some or all of the existing integrated companies so that retail operations are quite separate from production.
  3. That there is no basic problem and that the challenges of the past 12 months which have left the industry vilified are misplaced and are the product of a lack of knowledge or deliberate political gamesmanship.

Most companies would like to expect the third outcome but complacency would be quite inappropriate. The review probably makes redundant the threat of a price freeze, and to an extent neutralises the issue during the election campaign. But on that too companies cannot be sure what will happen, given the obvious popularity of the idea of a freeze.

The priority for companies will be assembling their evidence (a valuable exercise in itself in a sector where there seems to be a surprising degree of vagueness within management reporting systems and a worrying lack of precision in analyst presentations to investors on the actual sources of cash and profits). But the exercise, and the lack of certainty about the outcome, will also force companies to review and reconsider their strategies. This process should start now, even if the resulting decisions have to wait for the review’s conclusions and the response of the government.

These internal strategic reviews should address four key questions (each company will have different answers reflecting their history, strengths and corporate aspirations):

  • In addition to presenting evidence on the history and record of the business, should we be arguing for change, and if so in what directions?
  • Where does value lie in the chain of activity from the point of production to the point of sale? Are we happy with our current position against that value map?
  • Is this becoming a sector in which returns, however much they are justified by the risks being taken, are going to be squeezed and squeezed again by political decisions driven by a wider agenda? Is it going to be possible to make a reasonable return in the foreseeable future? Or is electricity, 25 years after privatisation, now effectively back under state control?
  • How will the conclusions of this review mesh with the other patterns of change in the sector – shifting demand as the balance of the economy moves even further in favour of services, public subsidies to various sources of supply, the coming development of new supplies of indigenous shale gas, the emergence of insurgent players and the impact of technology such as smart meters?

The fact that different companies will answer these questions in different ways suggests that the shape of the industry to which we have grown accustomed will be rather different in two to three years. For the energy business this is the biggest moment of change since the process of privatisation in the 1980s.