The "big six" power suppliers should sell off up to a fifth of their electricity output in a move to "break the stranglehold" they have over the market, the energy watchdog said today.
The major suppliers "failed to play it straight" with consumers, according to regulator Ofgem, and have eight weeks to comply with a series of radical proposals to overhaul the industry or face a referral to the Competition Commission.
The reforms include reducing the number of tariffs suppliers offer to avoid confusion over price and improving transparency by appointing an independent accounting firm to investigate the suppliers' books.
An additional investigation into Scottish Power's standard credit prices has also been launched.
Ofgem launched its review in November after it emerged that price hikes had seen suppliers' profit margins soar by 38%.
Ofgem said that, for the first time, it had evidence that the big six - British Gas, E.ON Energy, EDF Energy, Scottish Power, npower and Scottish & Southern Energy - had pushed up prices in response to rising costs more quickly than they reduced them when costs fell.
The regulator found that average industry margins on a standard dual fuel tariff rose to £90 in November, from £65 in September.
The watchdog said it would look into the "facts behind the numbers" as companies claimed that rising prices in the wholesale market - where suppliers buy their energy - left them with no choice but to hike bills.
Following publication of the findings, Ofgem chief executive Alistair Buchanan said: "Consumers must have confidence that energy companies are playing fair at a time when they are being asked to foot the £200 billion bill to pay for the investment Britain needs to ensure secure and sustainable energy supplies."
The review found that competition was being "stifled" by complex tariffs, poor supplier behaviour and a lack of transparency.
The number of tariffs available has risen by 180 to more than 300 since 2008, leaving customers "bamboozled", Ofgem said.
Ofgem said forcing the big six to sell off 20% of their electricity output would help smaller firms enter the retail market.
The consultation period for Ofgem's review closes on June 1.
The inquiry is the latest by the watchdog, which is also looking into how British Gas, EDF Energy and npower handle customers' complaints and allegations of mis-selling by EDF Energy, npower, Scottish Power and SSE.
Last month, British Gas, the UK's biggest energy supplier unveiled a record profit haul just weeks after it hiked bills amid the coldest winter in 100 years.
The company, owned by Centrica, which has nearly 16 million customer accounts, posted a 24% surge in operating profits to £742 million in 2010, two months after the supplier pushed up bills by 7%.
Energy Secretary Chris Huhne welcomed Ofgem's proposals.
He said: "Consumers deserve the best possible deal, which means rough and tough competition in the marketplace."
He added: "Making energy tariffs easier to understand and tackling poor practices will help consumers.
"And opening up the wholesale market to new entrants will encourage competition and complement our electricity market reforms to ensure consumers are getting the best deal."
Mike O'Connor, chief executive of Consumer Focus, also welcomed the "explicit" statement from Ofgem.
He said: "Companies are now on a very short leash. If they cannot show the will and capacity to change, we would expect Ofgem to refer aspects of the markets to the Competition Commission.
"Consumers have less confidence in energy companies than in any other sector - they feel that prices aren't fair, that tariffs are too complex and that the market doesn't treat them well."