CUAC discusses problems re vertical integration and lack of price difference
The Consumer Utilities Advocacy Centre has just launched a Policy Issues Paper examining the issue of market concentration in the Victorian retail energy market. The analysis shows how difficult it is to erode the market share of Victoria’s largest energy retailers.
‘Market concentration’ is the number of firms that control output in a particular market. A highly concentrated market is characterised by a small number of firms controlling a vast majority of market share. Market concentration is of interest because its presence can indicate that the conditions exist for a firm or groups of firms to exercise market power and set prices above efficient levels.
Our research applied two widely used measures of market concentration, the Herfindahl–Hirschman Index (HHI) and the four firm concentration ratio, to Essential Services Commission electricity and gas retail market share data.
Contrary to our expectations, the research showed that, across both electricity and gas markets, concentration had either increased or remained stable since price deregulation. Furthermore, concentration was at high levels. This is noteworthy because price deregulation was intended to foster greater competition and allow smaller retailers to succeed in the market through the use of innovative products and business models.
The presence of market concentration does not necessarily mean a market is uncompetitive or that companies are exercising power. However, when considered alongside other features of a market, it can highlight issues worthy of further consideration.
One such issue considered in CUAC’s paper is the lack of major price differences between large and small retailers. Lower prices are consistently identified as the main driver of consumer switching. If small retailers cannot compete with large retailers on price, then this may suggest the presence of barriers to entry.
One barrier to entry that may be contributing to ongoing high levels of concentration is vertical integration. Increasingly, energy retailers, particularly the largest energy retailers, are seeking to manage wholesale market volatility through investment in electricity generation and upstream gas assets. This can allow these vertically integrated retailers to manage risks at lower costs than retailers that are not vertically integrated and have to rely on hedge markets.
Large retailers have invested heavily in wholesale market assets in recent years. The AER has flagged its concerns with this, noting that it ‘can reduce liquidity in contract markets, posing a potential barrier to entry and expansion for generators and retailers that are not vertically integrated.’
CUAC’s research suggests that there remains a need to monitor the effectiveness of retail competition in Victoria to ensure that consumers are accessing benefits. As part of this, further analysis and policy development is required from government on the issue of vertical integration. Moreover, the ACCC should carefully scrutinise future takeovers by energy retailers to ensure they does not have anticompetitive impacts.
Download the full paper at www.cuac.org.au/research