The retail energy market, and the role of Ofgem in regulating that market, has emerged as one of the major issues in this year’s general election campaign.
The Labour Party (which ultimately calls for Ofgem’s abolition) has proposed that, if it forms the next government, it will impose a duty on the energy regulator to ensure that prices charged by energy suppliers are “fair”. At the same time, the energy market investigation being conducted by the Competition and Markets Authority (CMA), which is scheduled to conclude some months after polling day, may also result in recommendations for changes to Ofgem’s role and approach in regulating the retail energy market.
In this context, a question that often arises is whether the UK government’s ability to expand or shrink Ofgem’s role or functions is restricted by European Union law. Would EU law prevent, for instance, the “rolling back” of Ofgem’s current approach to regulating the retail market, as some are calling on the CMA to support? On the other hand, would the imposition of a duty on Ofgem to ensure “fair” retail prices fall foul of EU law?
The EU’s interest in Ofgem derives primarily from the internal market in energy directives, which broadly speaking require member states to ensure that the electricity and gas sectors are operated according to free market principles.
Proposals to add to Ofgem’s duties, in particular any blanket requirement that Ofgem impose fair prices, may not be consistent with this fundamental principle. Indeed, there is precedent for the European Court of Justice applying this principle to rule against member states’ attempts to constrain the operation of market forces in energy pricing.
In its celebrated Federutility ruling of April 2010, the Grand Chamber of the European Court declared that it followed from the very purpose and general scheme of the Gas Directive (and by implication its sister Electricity Directive) that the price for the supply of natural gas (and electricity) must be determined solely by the operation of supply and demand. While member states have the ability to derogate from that basic principle, for example in the name of consumer protection, the upshot of Federutility is that the member state will have the difficult task of justifying the derogation on proportionality grounds by demonstrating that:
• the intervention is limited in duration to what was strictly necessary in order to achieve its objective (which means more than simply labelling the measure as temporary and would, for instance, require periodic re-examination of the necessity of the intervention);
• it goes further than required in order to achieve the objective being pursued, that is, by ensuring that it is tailored to address only the effects of the particular market failure that the member state might be able to identify;
• it takes proper account of the categories of beneficiary supported by the intervention and any objective differences between them that might call for difference in treatment.
One might reasonably speculate that an early attempt by an incoming administration to introduce a “fair prices regime” after the general election, thus potentially pre-empting the outcome of the CMA’s energy market investigation, might not easily pass muster under this proportionality test.
Turning to the question of rolling back Ofgem’s current regulatory scope, it is true that the directives do require member states to ensure that the interests of retail, particularly domestic, customers are properly protected. In addition, the directives mandate the establishment of national regulatory authorities, independent of both political and industry influence, with a specified set of objectives and powers.
Given that a key objective of the directives is the provision of transparent, cost-reflective and non-discriminatory access to electricity and gas networks, many of these functions relate to the operation of those networks and the conduct of network owners and operators. Nonetheless, the directives do contemplate that the national regulatory authorities will have a role to play in the wholesale and retail markets. It is also fair to say, however, that the role which the directives require national regulatory authorities to play in relation to retail consumers and markets is actually quite limited. It consists broadly in the following:
• monitoring the level and effectiveness of market opening and competition at wholesale and retail levels;
• helping to ensure that the specific consumer protection measures envisaged in the directives (that is, on providing advance notice of price rises) are effective and enforced;
• publishing recommendations as to whether national retail prices are reasonable, easily and clearly comparable, transparent and non-discriminatory;
• ensuring access to customer consumption data (including by customers themselves).
The scope of Ofgem’s current role in regulating the energy supply market is clearly much broader than this (for example, in terms of the various pricing and marketing requirements it has imposed on energy suppliers in the wake of its Retail Market Review) and so it would seem that any measures to roll back the extent of current retail market regulation would be relatively uncontroversial from an EU standpoint, provided they left intact Ofgem’s ability (as the GB national regulatory authority) to discharge the limited set of functions specified in the directives.
Gordon Downie, partner, Shepherd and Wedderburn LLP