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CMA Submission – British Gas (Centrica)

British GasIn the latest in our series analysing the responses of key players to the CMA investigation into the UK energy market we focus on Centrica, owner of British Gas, the largest energy supplier in the UK.

Centrica’s initial submission to the CMA, as expected, built upon the hyperbole of risk peddled vociferously by Sam Laidlaw the soon to be departed and recently neutered Chairman of the business.

Centrica’s position is very much one of cautioning the investigation to ‘be careful what you wish for’ and that any interruption to the status quo could place future investment in the UK energy market at risk.

Commentators and rivals have already lambasted this position however it is of interest to see Centrica once again turning to familiar ground with the business cautioning:

“Little consideration [has been made that supplying retail energy] requires the management of large and complex financial risks”

In a troubling statement that appeared to simply confirm the dysfunctional nature of the wholesale energy market Centrica also said:

“A strong credit rating is also important for the efficient management of collateral costs, which arise from providing customers an on-demand supply at a price, set in advance, that varies infrequently.

“These collateral requirements can be significant, however we believe they are a necessary cost of serving customers in the face of often volatile commodity markets”.

It can only be assumed that Centrica hadn’t thought through the inference of this statement however for the rest of us their point underlines the “value” and “security” (or benefit) that their ‘Vertically Integrated’ business model brings to the market.

Whilst it is difficult, indeed nigh impossible, to disagree that vertical integration enables the Big 6 to insulate themselves from the worst effects of a volatile market, Centrica have openly highlighted that smaller, non vertically integrated suppliers cannot find the same level of credit support and willing counterparties to provide energy at a stable rate and reasonable cost.

This in our opinion therefore is a very strange point for Centrica to use to defend their position.

If the market doesn’t work unless such Vertically Integrated players dominate it then the CMA is likely to be extremely busy over the coming months.

To be fair to Centrica, one of the outcomes of the CMA’s investigation could be the breakup of the Big 6 energy suppliers into supply and generation arms, and so they would be expected to defend their structure, quite so openly illustrating the core problems of this construct however was presumably not part of the plan.

On far safer ground Centrica have highlighted the very real influence of external costs to the retail price that has ultimately led to the CMA investigation by saying:

“[Since 2009] underlying commodity costs have risen by four per cent a year, transportation and distribution costs have risen by seven per cent a year and the costs of environmental and social schemes have increased by 17 per cent a year”.

We have some sympathy with this argument. From our own analysis we have found that in the electricity market the commodity element contributes 35% of the retail price and supplier margins 12% whilst the remaining 53% flows to various government levies and network costs. For the gas market the ratio is 46% / 12% and 42%.

In the final highlight from their response, Centrica squarely laid responsibility for some of the ills in the market at the door of Ofgem by saying:

“We welcome the CMA’s intention to assess the impact of regulation on competition.

“We firmly believe that competitive activity in, and consumer engagement with, the retail market … has been shaped by the ever changing regulatory framework”

On balance then Centrica have made some sensible points in their response to the CMAs Statement of Issues. Indeed the issues of confused regulation and the significant impact of non-supply and generation costs on the retail price are often overlooked, willfully or otherwise by populist politicians and commentators. However perhaps the most notable comment has been Centrica’s achilles heel, the great success achieved within the vertically integrated model.

This defence simply underlines the problem of the energy market, too much power and influence in too narrow a band creating significant barriers to entry and minimal competitive opportunity outside of the cosy status quo of the Big 6 and the current wholesale market arrangements.

However perhaps another slant can be placed on Centrica’s self promotion of the vertically integrated model following Nick Luff, Centrica finance director, confidently predicting that even in the more apocalyptic scenarios of a vertically integrated break up Centrica would fare just fine.

Could it be that Centrica are goading the CMA to act and indeed forcefully separate the business units so that Centrica can gain short and long term competitive advantage?

Luff said:

“We are [already] moving into a different era, which changes the vertical integration dynamics. If there was a break-up of vertical integration around power generation, it would not have a big impact on Centrica.”

Interesting words as ever from Centrica.

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