Regulator Ofgem said the Competition and Markets Authority (CMA) probe should ensure "once and for all" that competition works effectively.
The investigation, expected to take around 18 months, will look at the relationship between the supply businesses and generation arms of the Big Six energy firms.
It will also study the Big Six's profits, as well as any barriers to entering the market.
Ofgem chief executive Dermot Nolan said: "Now is the right time to refer the energy market to the CMA for the benefit of consumers.
"There is near-unanimous support for a referral and the CMA investigation offers an important opportunity to clear the air. This will help rebuild consumer trust and confidence in the energy market as well as provide the certainty investors have called for.
"The energy market is also going to change rapidly over the next few years with the roll-out of smart meters, the Government's electricity market reforms, and closer integration with European energy markets.
"A CMA investigation should ensure there are no barriers to stop effective competition bearing down on prices and delivering the benefits of these changes to consumers."
Ofgem said earlier this year that soaring household bills and intensifying public distrust highlighted the need for an investigation which will determine whether the Big Six companies were making excess profits, after they quadrupled to more than £1 billion in three years.
British Gas owner Centrica has previously warned that the probe could create uncertainty and threaten the billions of pounds worth of investment needed to keep the lights on.
The CMA will begin its investigation immediately and is likely to publish final decisions by the end of 2015.
Energy Secretary Ed Davey said: "This is a major step towards ensuring that the UK's energy market really does work for consumers and springs from the first annual competition assessment which I asked Ofgem and the CMA to undertake. Having a full energy market investigation with real teeth is something that the last government failed to do time and time again.
"Everyone should give their full support to this independent investigation. While it is under way we're not slowing down the reforms that are giving people a better deal on their energy, including £50 taken off average household bills, the number of smaller energy suppliers almost trebling since 2010, faster and easier switching and simpler tariffs and bills."
The CMA can decide which features of the market to focus on in its investigation and use its powers to address any structural and behavioural issues that would undermine competition.
Ofgem said it would expect the CMA to look at the relationship between the supply businesses and generation arms of the six largest suppliers; barriers to entry and expansion for suppliers; the profitability of the six largest suppliers; whether or not there is sufficient competition between the large energy suppliers; the trend of suppliers consistently setting higher prices for consumers who have not switched, and low consumer engagement that contributes to weak competitive pressure in the market.
Caroline Flint, shadow energy and climate change secretary, said: "Rising energy bills are causing a cost-of-living crisis. That's why Labour will break up the big energy companies, put an end to their secret deals, make tariffs simpler and fairer - and freeze energy bills until 2017.
"The launch of a full market investigation is a clear admission that Britain's energy market is broken and that radical action is needed. However, it shouldn't paralyse politicians from taking action now, so while this investigation is happening, consumers should be protected from any more unfair price rises by freezing energy bills until 2017."
Which? executive director, Richard Lloyd, said: "This is a watershed moment for the broken energy market and millions of people struggling to cope with spiralling bills.
"The investigation must leave no stone unturned in establishing the truth behind energy prices, and while it takes place Ofgem must continue its renewed, tougher approach to protecting consumers. Energy companies must also not wait for the outcome of this inquiry but make urgent changes now to do better by their customers.
"We need to see radical reforms to fix the big six that will inject more competition into the market and help rebuild trust by giving consumers confidence that the price they are paying is fair."
Ofgem said the number of customers switching suppliers had fallen in recent years, while consumer trust had also slumped, with 43% saying they didn't trust energy suppliers to be open and transparent in their dealings with them.
The regulator noted that the average retail profits for the big six had increased from £233 million in 2009 to £1.1 billion in 2012, while profits for supply and generation rose from £3 billion to £3.7 billion in the same period.
The Big Six, which dominate the energy market, are British Gas, SSE, E.ON, EDF, npower and Scottish Power.
Some insiders argue that the market is already intensely competitive, with many more suppliers other than the main six, as well as a number of switching websites.
TUC general secretary Frances O'Grady said: "Energy companies have been ripping off customers for years and today's decision to refer them to the Competition and Markets Authority is long overdue.
"It's about time the Government stood up for consumers who are sick of seeing their rising bills being used to prop up bloated profits."
John Allan, chairman of the Federation of Small Businesses, said: "The CMA's investigation into the energy industry is an important step to seeing a fairer and more transparent energy market. There is currently a lack of effective competition in the energy market and there is clear evidence that small business consumers are not being well served by current levels of competition.
"We recently carried out a large-scale survey of our membership in which we sought views on the energy market. Only a quarter of small firms believe there is enough competition and four out of five of our members believe that their energy suppliers do not care about their needs."
Ofgem's announcement came as the latest official figures showed that the price paid for electricity by households in the first three months of 2014 was almost 6% higher than a year earlier.
Domestic gas prices have also risen, up almost 5% in the first quarter of 2014 compared to the same period in 2013, the figures from the Department of Energy and Climate Change revealed.
All of the Big Six put up their prices at the end of 2013 or early 2014, but four of the six brought in price reductions in the first quarter of this year after the Government changed the costs of some policies, including energy efficiency schemes which are paid for through bills.
Overall, average electricity and gas prices increased by around 5%, the statistics showed.
The data also showed that rates of switching suppliers fell back sharply in the first three months of this year, after high levels of switching at the end of last year, but were still up slightly compared to the beginning of 2013.
EDF Energy said the investigation was an "important moment" for the industry, providing an opportunity to enable a "thorough, objective" look at the energy market to identify areas where there was room for improvement in the interests of customers.
Chief executive Vincent de Rivaz said: "We will approach the investigation with an open mind, and will not be defensive. This inquiry should help identify where the market can work better for customers and strengthen areas in which it already works well.
"I do not expect the investigation alone to rebuild trust, that remains our responsibility. We will continue to take action to help customers, giving them greater simplicity, better service and competitive and fair prices. We will listen carefully to what they have to say now and during the investigation, and ensure that they have a strong voice during this process.
"The CMA investigation will allow us to show how companies like EDF Energy, that both generate and supply electricity, are able to take a long-term view that is focused on customers and serves their interests.
"We are investing in new electricity generation and will continue to make significant investments in skills, research and development, and new technology for business and residential customers."
Sam Laidlaw, chief executive of British Gas owner Centrica, welcomed the news, adding: "We want an energy market that is trusted by customers, and we believe that an in-depth and thorough review by an independent and respected authority can help to achieve this.
"We continue to focus on listening to our customers and meeting their needs. Our aim is to provide affordable energy, good service and innovative products that help customers reduce their consumption and save money on their energy bills. British Gas now has more than one million smart meters installed in our customers' homes, demonstrating our commitment to putting customers in control of their energy usage and bills."
Dr Doug Parr, chief scientist at Greenpeace UK, said : "What UK consumers need from this investigation is more than yet another ineffectual slap on the wrist for the big six's cartel. We need real change to the market so that companies offering a better deal for customers and the environment are no longer shut out of the market, but more importantly we need to clear the way for alternative business models to the big utilities."