The Office of Fair Trading (OFT) today referred local bus services to the Competition Commission and warned that limited competition was pushing up prices for bus users.

The watchdog said local bus services tended to be dominated by a small number of large players and considered complaints that new entrants were blocked from the market.

Local bus services receive at least £1.2bn in public support each year but this could represent "poor value for money for taxpayers", the OFT said.

Services in London and Northern Ireland are excluded from the probe.

In August the watchdog made an initial decision to refer local bus services to the commission, which is now set to launch a lengthy probe into major operators including Arriva, FirstGroup, Stagecoach, National Express and Go-Ahead.

Bus operators have expressed fears that a long investigation will deter investment in the industry until the commission publishes its conclusions.

Heather Clayton, a senior director at the OFT, said: "One of the concerns that we think the Competition Commission should take a look at is the tendency for local areas to become dominated by a single operator."

The OFT does not want a return to the fierce "bus wars" which broke out on many local bus routes following deregulation in the 1980s, but said large operators in the £3.6bn industry "should face a healthy level of competitive constraints".

Clayton added: "The OFT believes that it is appropriate for the Competition Commission to investigate how, in its various forms, competition can be harnessed to deliver what passengers want and the best value for money for the taxpayer."

The OFT found higher fares prevalent in areas where operators with a strong market position are not challenged. It estimated that bus fares in areas where only one of the large national groups offers services are 9% higher than in regions where two or more big players operate.

The watchdog also said there was a lack of competition to run services, with just one bidder pitching for a quarter of tenders. Major operators looking to shut out rivals could also use tactics such as flooding lucrative routes with vehicles – or "overbussing" – to deter potential entrants as travellers tended to get on the first bus which arrived, the OFT added.