OREANDA-NEWS. The measures proposed by the Competition & Markets Authority (CMA) to increase competition in the British energy market may reinforce pressure on supply margins in the medium term, Fitch Ratings says. However, the authority's conclusion that vertical integration does not adversely affect competition significantly reduces the chances of suppliers being forced to break up.

The CMA's range of remedies includes possible price caps on the highest tariffs. Centrica (A-/Stable) and SSE (A-/Negative) are the most exposed of the big-six energy companies to any regulatory changes as market leaders and as they are predominantly UK-focused. Both companies have indicated that EBIT supply margins of 6.4% (5% after tax) are achievable, but we believe hitting this target may become more challenging.

Average EBIT margins on sales to residential customers for the Big Six were 3.3% between 2009 and 2013, ranging from 2.1% in electricity to 4.4% in gas. However, there are a range of other factors driving supply margins, such as volumes for gas and the growth of independents, which had 12.6% market share in April 2015.

The potential price-cap remedy follows the CMA's calculation that industry profits in excess of the cost of capital amounted to about GBP900m a year. This calculation is based on the difference between return on capital and cost of capital. This is a standard approach for capital-intensive businesses, but its value in assessing a customer service business is questionable, given that supply is not capital-intensive. Energy companies may therefore challenge this finding, particularly if it signals a broader change in approach to assessing their profitability.

The proposed remedies do not include any suggestion that operators' generation and supply arms should be forcibly separated. This would have been credit negative for both companies as it would have reduced diversification, although it would have a much bigger impact on Centrica because its upstream gas operations represent around 50% of the business.

The decision gives both companies greater strategic flexibility, particularly Centrica ahead of its strategic review later this month. However the risk of more significant reform has not been eliminated, as the findings are provisional and the authority will consult with all interested parties before issuing a final report by the end of the year.

The impact of other potential remedies is less clear as the CMA's proposal of greater tariff choice seems to contradict the simplification of tariffs from the Retail Market Review in 2014. The CMA's survey finding that 34% of respondents have never considered switching supplier suggests that some may simply not have the time, but that others may still see energy as a monopoly product from pre-privatisation. The investigation may be a success if it restores customer trust in suppliers.

The proposals for a further assessment of the contract for difference (CfD) auction mechanism and of the eligible technologies suggest the CMA wants to achieve even better value for money for customers from renewable energy built under the CfD remuneration mechanism. Given that SSE did not participate in the first CfD auction, this may make future participation less likely, which could lead to further capex cuts.