The UK electricity supply market is an oligopoly. Over 95% of the market is supplied by the ‘big six’: British Gas (Centrica), EDF Energy, E.ON, npower (RWE), Scottish Power (Iberdrola) and SSE. The big six also generate much of the electricity they supply; they are vertically integrated companies. Between them they generate nearly 80% of the country’s electricity. There are a further two large generators, Drax Power Limited and GDF Suez Energy UK, making the generation industry an oligopoly of eight key players.
Ofgem, the energy market regulator, has just published a report on the wholesale electricity market, arguing that it is insufficiently liquid. This, argues the report, acts as a barrier to entry to competitor suppliers. It thus proposes measures to increase liquidity and thereby increase effective competition. Liquidity, according to the report, is:
… the ability to quickly buy or sell a commodity without causing a significant change in its price and without incurring significant transaction costs. It is a key feature of a well-functioning market. A liquid market can also be thought of as a ‘deep’ market where there are a number of prices quoted at which firms are prepared to trade a product. This gives firms confidence that they can trade when needed and will not move the price substantially when they do so.
A liquid wholesale electricity market ensures that electricity products are available to trade, and that their prices are robust. These products and price signals are important for electricity generators and suppliers, who need to trade to manage their risks. Liquidity in the wholesale electricity mark et therefore supports competition in generation and supply, which has benefits for consumers in terms of downward pressure on bills, better service and greater choice.
So how can liquidity be increased? Ofgem is proposing that the big six publish prices for two years ahead at which they are contracting to purchase electricity from generators in long-term contracts. These bilateral deals with generators are often with their own company’s generating arm. Publishing prices in this way will allow smaller suppliers to be able to seek out market opportunities. The generating companies will not be allowed to refuse to contract to supply smaller companies at the prices they are being forced to publish.
In addition, Ofgem is proposing that generators would have to sell 20% of output in the open market instead of through bilateral deals. As it is, however, some 30% of output is currently auctioned on the wholesale spot market (i.e. the market for immediate use).
But it is pricing transparency plus small suppliers being able to gain access to longer-term contracts that are the two key elements of the proposed reform.
Articles
UK utilities face having to disclose long-term deals Reuters, Karolin Schaps and Rosalba O’Brien (12/6/13)
Ofgem set to ‘break stranglehold’ in the energy market BBC News, John Moylan (12/6/13)
Ofgem plan ‘to end energy stranglehold’ BBC Today Programme, John Moylan and Ian Marlee (12/6/13)
Ofgem outlines proposals to ‘break stranglehold’ of big six energy suppliers on electricity market The Telegraph (12/6/13)
Ofgem widens investigation into alleged rigging of gas and power markets The Guardian, Terry Macalister (6/6/13)
Ofgem moves to break stranglehold of ‘big six’ energy suppliers Financial Times, Guy Chazan (12/6/13)
Ofgem to crackdown on Big Six energy suppliers in bid to cut electricity prices Independent, Simon Read (12/6/13)
Reports and data
Opening up Electricity Market to Effective Competition Ofgem Press Release (12/6/13)
Wholesale power market liquidity: final proposals for a ‘Secure and Promote’ licence condition – Draft Impact Assessment Ofgem (12/6/13)
Electricity statistics Department of Energy & Climate Change
The Dirty Half Dozen Friends of the Earth (Oct 2011)
Questions
- What barriers to entry exist in (a) the wholesale and (b) the retail market for electricity?
- Distinguish between spot and forward markets. Why is competition in forward markets particularly important for small suppliers of electricity?
- How will ‘liquidity’ be increased by the measures Ofgem is proposing?
- To what extent does vertical integration in the energy industry benefit consumers of electricity?
- What is a price reporting agency (PRA)? What anti-competitive activities have been taking place in the short-term energy market and why may PRAs not be ‘fit for purpose’?
- Do you think that the measures Ofgem is proposing will ensure that the big generators trade fairly with small suppliers? Explain.
- What are the dangers in the proposals for the large generators?
The Competition Commission (CC) recently completed their provisional investigation into the cement and concrete market in Great Britain (press release). They concluded that coordination between the main cement producers is resulting in high prices.
In contrast, to illegal cartels (see for example the recent post on this site), the firms in this market are not accused of doing anything illegal. Instead, the CC’s concern is with tacit collusion. Here, no illegal communication between firms takes place, firms simply do not compete intensely due to a mutual understanding that high prices are collectively beneficial.
Economic theory suggests that one key factor that facilitates tacit coordination is a low number of firms in the market. The UK cement market certainly meets this criteria as it is an oligopoly with just three main players plus a new entrant. The CC concluded that:
In a highly concentrated market where the product doesn’t vary, the established producers know too much about each other’s businesses and have concentrated on retaining their respective market shares rather than competing to the full.
They estimate that this cost consumers over £180m in a 3 year period.
Whilst tacit collusion is not illegal, competition authorities can try to prevent it from arising by intervening in mergers that they believe will make it more likely. In fact, the new entrant to the cement market came about due to sales required by the CC before they would allow a joint-venture between two of the main players to go ahead. Clearly the CC’s recent findings suggest that this intervention was not sufficient to ensure intense competition in the market. However, an additional tool available to the authorities in the UK is to be able to remedy harm to competition undercovered as a result of an investigation into the market. In some cases this may even involve breaking-up firms in the market (see for example the decision to force BAA to sell several airports).
When deciding on how to remedy the problem in the cement market, the CC will be keen to avoid the past mistakes of their Danish counterparts. In a famous case, in 1993 the Danish authorities attempted to increase competition in the concrete market by publishing individual sellers’ prices. The idea was that this would stimulate competition by encouraging buyers to shop around. However, evidence published here suggests that this in fact increased prices by around 15%! Why? The paper examines possible explanations and concludes that the information published by the competition authorities helped firms to monitor each others behaviour and therefore facilitated tacit coordination in the market. This is entirely consistent with economic theory which shows that another key factor which facilitates tacit coordination is market transparency.
The CC suggest that such monitoring is also possible in the GB market:
Established information channels such as price announcement letters can signal their plans, and tit-for-tat behaviour and cross-sales can be used to prevent or retaliate against any moves to disturb the overall balance between the different players in this market.
According to the above press release, the remedies the CC are considering include: the sale of capacity or plants by the leading players in the market, creation of buying groups, prohibition on price announcements and restrictions on the publication of industry level data. This suggests that the CC are well aware that reducing market transparency can play a key role in preventing coordination. It will be fascinating to, first, see what the CC opt for, then, what impact this has on competition in the industry.
Articles
Same product, same price? Competition in the UK Global Cement (22/05/13)
Competition Commission uncovers `serious problems’ in cement market Graham Huband, The Courier (22/05/13)
Competition Commission call for cement sell-off Mark Leftley, London Evening Standard (21/05/13)
Competition Commission documents
CC looks to break open cement market Competition Commission Press Release (21/5/13)
Aggregates, cement and ready-mix concrete market investigation Competition Commission core documents (various dates)
Questions
- Explain tacit collusion using a Prisoner’s dilemma game.
- Is cement the type of product where we might expect coordination to be most likely?
- Why is cement an important market in the UK economy?
- The first article above suggests that most of the management team at the new entrant came from the other main players in the market. Do you think this may significantly affect the likelihood of tacit collusion?
- Evaluate the pros and cons of the alternative remedies the CC are considering.
Since the late 1990s the European Commission (EC) has been concerned with trying to prevent Microsoft from abusing its dominant position. As described previously on this site, in the latest instalment last week Microsoft was fined for accidentally failing to adhere to an earlier commitment automatically to allow Windows users a choice of web browser.
This is the first case of fines being imposed for failure to comply with commitments required by the EC. In part because of Microsoft’s compliance, the fine imposed was well below the maximum level it could have been. However, it still means that Microsoft has now in total contributed enough to the EC’s coffers to cover the competition department’s budget for over 20 years.
Commitments appear to be increasingly the EC’s preferred solution for resolving competition disputes, especially in the rapidly changing IT sector (see for example Google and e-books). In contrast to a lengthy litigation process, in theory such commitments can quickly fix the problem and increase competition. The EC hopes that the fine imposed on Microsoft will send clear signals to firms that agreed upon commitments must be adhered to. However, this case also highlights that behavioural commitments require close monitoring by the competition authorities. As one industry consultant argues:
While it’s highly likely that it was a technical mistake that broke the browser choice facility the fact that it remained broken for 14 months raises significant questions about Microsoft’s ability and willingness to comply with the voluntary agreement with the EU.
At the same time the situation also raises concerns over the EU’s ability to actually monitor the outcomes of antitrust agreements.
Microsoft offers web browser choice to IE users BBC News (19/02/10)
Microsoft faces hefty EU fine The Guardian (06/03/13)
Microsoft fined €561m for ‘browser choice’ error The Guardian, Charles Arthur (06/03/13)
Questions
- Why is it essential that competition disputes in the IT sector are quickly resolved?
- What are the problems with monitoring company behaviour in this sector?
- What are the pros and cons of agreeing commitments rather than litigation for competition law infringements?
- How might Microsoft respond to this latest fine from the EC?
In 2009, the European Commission investigated Microsoft’s practice of bundling its own browser, Internet Explorer, with new copies of Windows. It found that this was an abuse of market power and created an unfair barrier to entry of other browsers, such as Firefox.
An agreement was reached that Microsoft would include a ‘choice screen’ in which users in the EU would be given a full list of alternative browsers and asked which they would like to install. On making their selection, a link would take them to the browser site to download the installation program. This screen would be available until 2014. Between March 2010, when the choice screen was first provided and November of the same year, 84 million browsers were downloaded through it.
In May 2011, however, the screen was no longer present on new Windows 7 purchases. The Commission took some time to realise this: indeed it was Microsoft’s rivals that pointed it out. The screen reappeared some 13 months later, after some 15m copies of Windows software had been sold.
For this lapse, the Commission has just fined Microsoft €561m. Commission Vice President in charge of competition policy, Joaquín Almunia, said:
In 2009, we closed our investigation about a suspected abuse of dominant position by Microsoft due to the tying of Internet Explorer to Windows by accepting commitments offered by the company. Legally binding commitments reached in antitrust decisions play a very important role in our enforcement policy because they allow for rapid solutions to competition problems. Of course, such decisions require strict compliance. A failure to comply is a very serious infringement that must be sanctioned accordingly.
This may seem unduly harsh, given that Internet Explorer’s share of the browser market has fallen dramatically. In 2009, it had around 50% of the European market, with its main rival at the time, Mozilla’s Firefox, having just under 40%. By 2013, Internet Explorer’s share has fallen to around 24% and Firefox’s to around 29%. Google’s Chrome, which was just starting up in 2009, has seen its share of the European market rise to around 35% and is now the market leader. Partly this is due to the rise in tablets and smartphones, a large proportion of which use Google’s Android operating system and the Chrome browser.
Not surprisingly, the European Commission is investigating Google to see whether it is abusing a dominant position. Is Google’s case, it’s not just about its share of the browser market, it’s more about its share of the search market, which in the EU is around 90% (compared with around 65% in the USA). As The Economist article below states:
The Commissioner believes that Google may be favouring its own specialised services (eg, for flights or hotels) at rivals’ expense; that its deals with publishers may unfairly exclude competitors; and that it prevents advertisers from taking their data elsewhere.
Joaquín Almunia asked Google to respond to these concerns by January 31. Google delivered its suggestions on the deadline, but we await to hear precisely what it said and how the Commission will respond. It is understood that Google’s proposal is for clearly labelling its own products on its search engine.
Articles
Microsoft Fined $732 Million By EU Over Browser eWeek, Michelle Maisto (6/3/13)
Microsoft faces hefty EU fine The Guardian (6/3/13)
Sin of omission The Economist (9/3/13)
Microsoft fined by European Commission over web browser BBC News (6/3/13)
EU commissioner Joaquin Almunia announces Microsoft fine BBC News (6/3/13)
Microsoft’s European Fine Comes in an Era of Browser Diversity Forbes, J.P. Gownder (6/3/13)
Life after Firefox: Can Mozilla regain its mojo? BBC News, Dave Lee (11/4/12)
Google responds to European commission’s antitrust chief The Guardian, Charles Arthur (31/1/13)
Google May Clinch EU Settlement After ‘Summer,’ Almunia Says Bloomberg Businessweek, Stephanie Bodoni and Aoife White (22/2/13)
European Commission Press Release
Antitrust: Commission fines Microsoft for non-compliance with browser choice commitments Europa (6/3/13)
Questions
- Why did Microsoft’s share of the browser market continue to decline between May 2011 and June 2012?
- Why would it matter if Microsoft had market power in the browser market, given that it’s free for anyone to download a browser?
- In what ways might Google be abusing a dominant position in the market?
- Can Mozilla regain its mojo?
- According to the second Guardian article, the Microsoft-backed lobby group Icomp said “To be seen as a success, any settlement must … include specific measures to restore competition and allow other parties to compete effectively on a level playing field with Google in the key markets of search and search advertising.” Give examples of such measures and assess how successful they might be.
- Would “clearly labelling its own products on its search engine” be enough to ensure adequate competition?
As part of the Basel III round of banking regulations, representatives of the EU Parliament and member governments have agreed with the European Commission that bankers’ bonuses should be capped. The proposal is to cap them at 100% of annual salary, or 200% with the agreement of shareholders. The full Parliament will vote in May and then it will go to officials from the 27 Member States. Under a system of qualified majority voting, it is expected to be accepted, despite UK resistance.
The main arguments in favour of a cap are that it will reduce the focus of bankers on short-term gains and reduce the incentive to take excessive risks. It will also appease the anger of electorates throughout the EU over bankers getting huge bonuses, especially in the light of the recession, caused in major part by the excesses of bankers.
The main argument against is that it will drive talented top bankers to countries outside the EU. This is a particular worry of the UK government, fearful of the effect on the City of London. There is also the criticism that it will simply drive banks into increasing basic salaries of senior executives to compensate for lower bonuses.
But it is not just the EU considering curbing bankers’ pay. The Swiss have just voted in a referendum to give shareholders the right to veto salaries and bonuses of executives of major companies. Many of these companies are banks or other financial sector organisations.
So just what will be the effect on incentives, banks’ performance and the movement of top bankers to countries without such caps? The following videos and articles explore these issues. As you will see, the topic is highly controversial and politically charged.
Meanwhile, HSBC has revealed its 2012 results. It paid out $1.9bn in fines for money laundering and set aside a further $2.3bn for mis-selling financial products in the UK. But its underlying profits were up 18%. Bonuses were up too. The 16 top executives received an average of $4.9m each. The Chief Executive, Stuart Gulliver, received $14.1m in 2012, 33% up on 2011 (see final article below).
Webcasts and podcasts
EU moves to cap bankers bonuses Euronews on Yahoo News (1/3/13)
EU to Curb Bank Bonuses WSJ Live (28/2/13)
Inside Story – Curbing Europe’s bank bonuses AlJazeera on YouTube (1/3/13)
Will EU bonus cap ‘damage economy’? BBC Radio 4 Today Programme (28/2/13)
Swiss back curbs on executive pay in referendum BBC News (3/3/13)
Has the HSBC scandal impacted on business? BBC News, Jeremy Howell (4/3/13)
Articles
Bonuses: the essential guide The Guardian, Simon Bowers, Jill Treanor, Fiona Walsh, Julia Finch, Patrick Collinson and Ian Traynor (28/2/13)
Q&A: EU banker bonus cap plan BBC News (28/2/13)
Outcry, and a Little Cunning, From Euro Bankers The New York Times, Landon Thomas Jr. (28/2/13)
Bank bonuses may shrink – but watch as the salaries rise The Observer, Rob Taylor (3/3/13)
Don’t cap bank bonuses, scrap them The Guardian, Deborah Hargreaves (28/2/13)
Capping banker bonuses simply avoids facing real bank problems The Telegraph, Mats Persson (2/3/13)
Pro bonus The Economist, Schumpeter column (28/2/13)
‘The most deluded measure to come from Europe since fixing the price of groceries in the Roman Empire’: Boris Johnson attacks EU banker bonus cap Independent, Gavin Cordon , Geoff Meade (28/2/13)
EU agrees to cap bankers’ bonuses BBC News (28/2/13)
Viewpoints: EU banker bonus cap BBC News (28/2/13)
Voters crack down on corporate pay packages swissinfo.ch , Urs Geiser (3/3/13)
Swiss voters seen backing executive pay curbs Reuters, Emma Thomasson (3/3/13)
Swiss referendum backs executive pay curbs BBC News (3/3/13)
Voters in Swiss referendum back curbs on executives’ pay and bonuses The Guardian, Kim Willsher and Phillip Inman (3/3/13)
Swiss vote for corporate pay curbs Financial Times, James Shotter and Alex Barker (3/3/13)
HSBC pays $4.2bn for fines and mis-selling in 2012 BBC News (4/3/13)
Questions
- How does competition, or a lack of it, in the banking industry affect senior bankers’ remuneration?
- What incentives are created by the bonus structure as it is now? Do these incentives result in desirable outcomes?
- How would you redesign the bonus system so that the incentives resulted in beneficial outcomes?
- If bonuses are capped as proposed by the EU, how would you assess the balance of advantages and disadvantages? What additional information would you need to know to make such an assessment?
- How has the relationship between banks and central banks over the past few years created a moral hazard? How could such a moral hazard be eliminated?
The UK electricity supply market is an oligopoly. Over 95% of the market is supplied by the ‘big six’: British Gas (Centrica), EDF Energy, E.ON, npower (RWE), Scottish Power (Iberdrola) and SSE. The big six also generate much of the electricity they supply; they are vertically integrated companies. Between them they generate nearly 80% of the country’s electricity. There are a further two large generators, Drax Power Limited and GDF Suez Energy UK, making the generation industry an oligopoly of eight key players.
