Price discrimination in the British retail market for gas and electricity

Transcription

1 Prie disrimination in the British retail market for gas and eletriity Claude Crampes and Mathias Laffont

2 Overview of the industry Competition authority (CMA, ) Wholesale market Retail market Prodution Transmission Distribution Supply Consumers Regulatory ageny (Ofgem, )

3 Two deviations (among many) 1. The retail market is not ative enough. Many onsumers do not distinguish between supplier and distributor. Prodution Transmission Distribution Supply Consumers 3

4 Two deviations (among many). The regulatory ageny extends its ompeteny to ompetitive segments Prodution Transmission Distribution Supply Consumers 4

5 Eletriity market shares in the UK HHI At first sight, ompetition is satisfatory, but Big6 Centria, SSE E.ON EDF Energy Npower Sottish Power small suppliers 5

6 SA/CC/TOL/Wagram 6

7 Regional suppliers With inherited regional markets, one an expet suppliers to prie differently their home onsumers and others. 7

8 Ofgem attaks. Why? In "Energy Supply Probe - Initial Findings Report" (6 Otober 008), pp. 8-9, Ofgem expressed onern as regards differential priing. the former inumbent eletriity suppliers harged eletriity ustomers in their former monopoly areas an average of over 10 per ent higher pries than omparable "out-of-area" ustomers. ompanies harged more to existing ustomers whilst maintaining ompetitiveness in more prie sensitive segments of the market. it means that pressure on pries in the most ompetitive segments of the market does not always onstrain pries for all other onsumers. 8

9 Ofgem attaks. How? To address "undue disrimination", Ofgem eventually deided to impose energy suppliers a liene ondition that would limit the differenes in the tariffs that they an harge to their `in-area' ustomers ompared with their `out-ofarea' ustomers (SLC 5A). The ondition inluded a three-year sunset lause, to allow it to lapse three years after its implementation. 9

10 The eonomists' ritiism SLC 5A strongly ritiized, partiulary by Stephen Littlehild, John Vikers, Catherine Waddams, and George Yarrow. The three aademis that responded to our onsultation were strongly opposed to the proposed liene onditions on the basis that they believe that the rules are likely to stifle ompetition and, as suh, ould have harmful onsequenes for onsumers. (Ogem, Addressing undue disrimination, 6 June 009) 10

11 Ofgem surrenders This no-disrimination provision expired on 31 July 01. In advane of the expiry of SLC 5A, Ofgem issued a onsultation on whether it was appropriate to retain the ondition for a further two year period. " The nature of ompetition in the industry has hanged, with less effetive rivalry between the regional inumbents and large regional ompetitors following the intervention; ompanies seem to have `retreated' to their home regions, leaving a market where priing behaviour resembles more losely a duopoly between British Gas and the regional inumbent. (Waddams and Zhu, The Energy Journal, 013; Hviid and Waddams, The Eonomi Journal, 01) Following the onsideration of responses, Ofgem gave up. 11

12 Is prie disrimination good or bad? Shmalensee (1981), Varian (1985), Thisse and Vives (1988), Stole (006) Mark Armstrong (006): "Prie disrimination an lead to more intense ompetition whih benefits onsumers. When firms have diffiulty ommitting to pries, they often are fored to harge low pries. In suh situations, a poliy whih forbids disrimination endows a firm with ommitment power and prevents the firm ompeting with itself, to the detriment of onsumers and welfare. Geradin and Petit (005): Prie Disrimination under EC Competition Law. The need for a ase-by-ase approah 1

13 Prie ompetition with produt differentiation Question: was it obvious from srath that SLC 5A was anti-ompetitive, as Littlehild and others said, or was it neessary to go through the threeyear experiment? IO analysis: a model of prie ompetition with both spatial and behavioral differentiation to highlight the pro-ompetitive and anti-ompetitive onsequenes of a prohibition of prie disrimination; three markets and two firms: eah firm is a loal monopolist (British Gas is supposed to have a neutral poliy) and it ompetes against the other one on the third market. we determine prie equilibrium in the ase where priing is not regulated and in the ase where eah firm must harge the same prie in its loal market and in the ompetitive segment. we ompare the two ases in terms of onsumer s surplus average prie 13

14 Hypotheses and notations Two firms and three markets: market a is the historial ground of firm a. Demand is p q a a a. pb qb b where ba. market b is the historial ground of firm b. Demand is beause of swithing osts, it is too ostly for a (resp. b) to enter the loal market served by b (resp. a). firms a and b ompete in market. All onsumers have the same willingness to pay (<b). They are uniformly distributed along a segment of length 1. Firm a (resp. b) is installed at the left (resp. right) end of the segment. They fix FOB pries and onsumers have to pay the extra ost for 'travelling' towards their preferred supplier at ost t per unit of distane. In what follows,. Firms have zero prodution and selling osts. t 0 14

15 Two levels of demand differentiation Set of buyers 15

16 Two levels of demand differentiation ative ability to searh and swith inative 16

17 Two levels of demand differentiation ative market stuk with firm a hysteresis stuk with firm b 17

18 Three markets and two retailers p a p a No ost p b p b a a q a a p a b p qb b b b a 0 q a q b 1 b market a q a market market b q b 18

19 Before SLC 5A pi Firm i maximizes pq i i pii in its home market Then i i i p m, m, m, m i i qi i CSi ia, b 4 On market, Bertrand ompetition results in 1 p N 0, N, 0,, N m i qi i CS i a b 19

20 Prie disrimination is permitted p a a market a p a m a b CSa 4 m b m CS CSb 4 m pa a m pb b m a m b a b N N 0 pa pb 0 1 a / q a 1/ q b / b market p b p b market b 0

21 Under SLC 5A Question: will the two firms remain ative in market? If retailer i stays in market, it must fix the same prie in markets i and, whih is 0 if j also stays in market (extended Bertrand ompetition) if j retreats from market : i s profit is i- 1 If retailer i retreats from market, it keeps its monopolist s profit on market i, that is i²/ ; To avoid equilibrium in mixed strategies, assume that a² b² a 1- b Then, firm a gives market to firm b. 1

22 Prie disrimination is not permitted p a a market a p a m a b CSa ND 4 CS b b ND CS 0 m pa a ND p m a ND a b b ND N N 0 pa pb 0 1 / q a 1/ b / q b a market p b p b market b

23 Consequenes of SLC 5A Disrimination vs. Regulation 1 Total surplus W D ND b² ² W 4 0 The no-disrimination lause inreases welfare. 3

24 Consequenes of SLC 5A Disrimination vs. Regulation Consumer s surplus D ND b² b² ² CS CS [ 1 ] b 0 4 Example: CS D ND 3 CS 0 16 ND 1 CS 0 9 if b=1,=1/, then SLC 5A is bad CS D if b=1,=1/3, then SLC 5A is good 4

25 Average prie Consequenes of SLC 5A Disrimination vs. Regulation 3 pq q Both quantities and expenditures are larger under the ND lause. Example: p D if a=, b=1,=1/, then SLC 5A is bad p D if a=, b=1,=1/3, then SLC 5A is good p p ND ND 5

26 Consequenes of SLC 5A Disrimination vs. Regulation 4 Alternative definition of average prie: market a should not D ND D be inluded, like in the omputation of W W and CS CS ND Problem: divergent indexes 1 Example: if b=1, for.4 3 D ND p p 0 SLC 5A is bad CS D ND CS 0 SLC 5A is good 6

27 Conlusions Even in a simplisti framework of spatial and behavioral differentiation, one annot asertain whether a nodisrimination lause is good or bad for onsumers. Therefore, even though SLC 5A showed ex post to be a mistake, Ofgem was right ex ante in proposing a priing onstraint aompanied by a sunset lause. Good news for the eonometriian: the English ase annot be generalized. Reminder: Geradin and Petit (005): Prie Disrimination under EC Competition Law. The need for a ase-by-ase approah. 7