Comparing banking and energy; should utilities ring-fence their retail arms?

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19 September 2011, Gas, Electricity

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The energy and banking sectors provide essential utility services for macroeconomic development. As such, the UK's citizens depend on the security, affordability, and economic, environmental, and social sustainability of both money and energy supply. Thanks to privatization and liberalization, both sectors have enjoyed years of strong growth and healthy shareholder returns. In recent years, however, the government has had to realize that despite privatization, huge losses have to be socialized and financial burdens have to be shouldered by the tax and tariff payers.

The Independent Commission on Banking has now recommended that banks' retail divisions should be ring-fenced from their riskier investment banking arms to curb excessive risk-taking, to make banks better able to absorb losses, and to make it easier and less costly to sort out banks that still get into trouble. Some similarities with the UK's energy market are striking.

On the supply side, the largest four banks account for 77% of personal current accounts and 85% of small and medium-sized enterprise current accounts. On the demand side, competition between banks for current accounts is muted by the difficulties of switching between providers and by a lack of transparency about the banking services on offer. In the energy sector, the "big six" suppliers account for about 95% of all retail customer accounts, and switching rates, although among the highest in Europe, are nowhere near as high as the regulator would like them to be. More importantly, customers are getting increasingly frustrated about repeated and opaque energy price rises.

This begs the question of whether a structural reform similar to that in the banking sector might achieve some of the government's aims. For example, if vertically integrated utilities had to ring-fence their retail arms so as to operate in a more strongly regulated business environment, would this increase price transparency? This might be achieved by the retail subsidiary having to make disclosures and produce reports as if it were an independently listed company.

Further upstream, as part of its retail market review Ofgem is currently considering the proposal that some 10-20% of generation output should be made available to the market via monthly auctions in an attempt to make the market more competitive. By economically and organizationally separating retail from the generation division, this might improve liquidity on the wholesale market and allow new and smaller entrants to compete more fairly in both the retail and generation markets.

However, given that the UK economy is highly dependent on both the upstream and downstream sections of the energy value chain, the government cannot afford to gamble. Ofgem's latest decision to hire forensic accountants BDO suggests that it is taking a greater interest in the financial dealings within vertically integrated utilities. While it is doubtful that the regulator is going to recommend similar arrangements to the banking sector, utilities should still consider how they can improve transparency and accountability across their divisions in order to retain their licenses to operate.

Source: Datamonitor

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