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ECONOMY, ENERGY AND TOURISM COMMITTEE AGENDA 3rd Meeting ...€¦ · Economy, Energy and Tourism Committee Energy Prices OVERVIEW OF THE ENERGY MARKET British Gas was privatised in

May 18, 2020




  • EET/S4/11/3/A



    3rd Meeting, 2011 (Session 4)

    Wednesday 29 June 2011 The Committee will meet at 10.00 am in Committee Room 4. 1. Energy prices: The Committee will take evidence from—

    Norman Kerr, Director, Energy Action Scotland; Trisha McAuley, Deputy Director, Consumer Focus Scotland;

    and then from—

    Rupert Steele, Director of Regulation, Scottish Power; Alistair Phillips-Davies, Generation and Supply Director, Scottish and Southern Energy plc; Ian Peters, Managing Director, Energy, British Gas; Paul Williamson, Head of Customer Markets Controlling, RWE npower; Sara Vaughan, Director of Regulation and Energy Policy, E.ON; Paul Delamare, Head of Regulation, EDF Energy;

    and then from—

    Alistair Buchanan, Chief Executive, and Charles Gallacher, Director GB External Relations, Ofgem.

    2. Draft Budget Scrutiny 2012-13: The Committee will consider whether to seek approval for the appointment of a budget adviser.

    3. Work programme: The Committee will consider an update on its work


  • EET/S4/11/3/A

    Stephen Imrie

    Clerk to the Economy, Energy and Tourism Committee Room TG.01

    The Scottish Parliament Edinburgh

    Tel: 0131 348 5207 Email:

  • 1

    Agenda item 1


    Economy, Energy and Tourism Committee

    Energy Prices


    British Gas was privatised in 1986 and privatisation of the electricity companies followed in 1989. Deregulation, allowing for competition in these markets, followed in stages over the period to 1999 and price controls in retail supply markets were lifted in 2002. Since privatisation, there has been considerable merger and takeover activity. The electricity and gas supply markets are now dominated by six major suppliers1, all of whom offer both gas and electricity. Although around 40% of customers have switched suppliers, this has generally involved switching between the major operators, with the result that the market remains highly concentrated.2 New entrants have been few in number and Ofgem cite securing adequate access to wholesale energy supplies as a major barrier to entry.3 Figure 1 shows the market shares of the major operators across both markets. The ‘Big 6’ operators account for over 99% of the market. Although the Big 6 also account for the same share of the Scottish market, the shares of individual companies are quite different, as can be seen from Figure 1, and there is even greater concentration. In Scotland, Scottish Power, SSE and British Gas together account for 86% of the market.

    Figure 1: ‘Big 6’ share of GB and Scottish energy markets (August 2010)

    1 British Gas, EDF, E.ON, npower, Scottish Power and Scottish and Southern Energy 2 Ofgem ‘The Retail Market Review – Findings and Initial Proposals: Supplementary Appendices’ (2011) 3 Ofgem ‘Energy Supply Probe – Initial Findings Report’ (2008)

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    Summary financial data for these companies is given in the Annex to this paper. Four of the six major operators are under foreign ownership. All of the major suppliers are ‘vertically integrated’ i.e. they are involved in generation activities as well as supply.

    REGULATORY CONTROL Ofgas and Offer were established on privatisation to regulate the gas and electricity markets respectively. They were merged in 2000 to form Ofgem (the Office of the Gas and Electricity Markets). Ofgem has, as its primary role, to promote the interests of consumers by regulating gas and electricity companies, though it has a wider duty to contribute to sustainable development. It is funded by the companies that it regulates, who pay an annual licence fee set to cover Ofgem’s costs. Key functions include:

    • Issuing, modifying, enforcing and revoking the licences that gas and electricity companies need to operate

    • Setting price controls in the natural monopoly licensed sectors (distribution, transmission and transportation)

    • Investigating and penalising those in breach of licence conditions Ofgem carried out a major review of the energy supply markets in 2008 (the Energy Supply Probe). The review concluded that there was no evidence of a cartel in the energy supply market and that retail price rises could be justified by the movements in wholesale costs. However, it also reported that competition was not yet fully effective in all sectors of the market.

    Ofgem Market Reviews

    Building on this, Ofgem launched a Retail Market Review in November 2010 to assess how well the industry was responding to the measures put in place following the 2008 Energy Supply Probe. The Retail Market Review reported in March 2011 and found that further action is needed to make energy retail markets work more effectively in the interests of consumers. Ofgem has set out certain proposals for action which aim to:

    • Improve tariff comparability: To address the complexity of tariff information provided by suppliers they propose to make it simpler for domestic consumers to compare prices and choose a better deal.

    • Enhance liquidity: Ofgem propose improving access to wholesale market products for new entrants and independent suppliers and generators by requiring the Big 6 to auction up to 20% of their power generation in order to reduce barriers to entry.

    • Strengthen previous remedies – domestic: Reflecting poor response by the companies to the Probe remedies, Ofgem propose to make sure that previous remedies are strengthened, and where necessary enforced, so that they achieve their original objectives.

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    • Strengthen previous remedies – non-domestic: To address continued concerns they have found in the non-domestic sector they propose to take further action to prevent unfair contracting practices in the non-domestic sector.

    • Improve reporting transparency To address concerns on suppliers’ financial reporting they will investigate how to improve reporting requirements for vertically integrated utilities.

    Consultation on Ofgem’s initial findings and proposals closed on 1 June 2011. Ofgem state:

    “We would prefer to implement reform wherever appropriate with the cooperation of the supply companies. If, following consultation, we consider that reforms do not have a realistic chance of addressing the concerns identified due to industry opposition or otherwise, we will consider a referral to the Competition Commission.”

    Ofgem investigations

    In addition to market-wide investigations, Ofgem also undertake investigations into individual companies where they consider there to be specific issues of concern. Ofgem currently has 11 investigations underway, which include aspects of operation of all the Big 6 energy suppliers:

    • Scottish Power – investigations relating to misleading representation of tariff information; the extent of differential pricing between payment methods; and telephone and face-to-face sales activities

    • E.ON – investigation relating to misreporting in respect of distribution of compact fluorescent lamps

    • npower – investigations into telephone and face-to-face sales activities and handling of customer complaints

    • SSE – investigation into telephone and face-to-face sales activities

    • EDF – investigations into telephone and face-to-face sales activities and handling of customer complaints

    • British Gas – investigation into telephone and face-to-face sales activities

    Review of Ofgem

    The UK Government completed a review of Ofgem in May 2011. The review concluded that the current system of regulation should be strengthened to bring greater clarity and coherence to the distinct roles of Government and the regulator. The UK Government plans to introduce a statutory ‘Strategy and policy statement’ which will set out its policy goals for the gas and electricity markets and set out more clearly the respective roles of Government and other bodies, including Ofgem. This statement will define the policy outcomes to which Ofgem should contribute and Ofgem will be required to report annually on how it is contributing to these outcomes.

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    household bills could rise by as much as £500 a year by 2015 as suppliers pass on wholesale price rises to consumers.4


    Higher wholesale electricity and gas prices have been the largest contributor to increasing household energy bills. The UK is now a net importer of both oil and gas. According to Ofgem, wholesale costs account for around half of a consumer’s energy bill. Oil prices One of the key drivers of changing energy prices is the price of crude oil. This year has seen the price rise by almost 25% reaching $119 a barrel at the time of writing (13 June 2011). Over the past decade the price of crude peaked at $144 during July 2008 followed by a sudden drop to a low of $33 at the end of that year. Since then oil prices have been rising rapidly. Figure 3 below illustrates the changing value of crude oil prices between January 2000 and June 2011.

    Figure 3: Daily Brent crude oil prices January 2000 - June 2011

    Source: Databank, RBS (2011a) Factors influencing wholesale prices Wholesale prices for energy are influenced by a wide range of factors on both the supply and demand side and show considerable volatility. Many of those outlined below relate specifically to oil prices but these, in turn, will influence the prices of 4

  • 6

    other forms of energy such as gas and coal. This linkage is exacerbated by major gas exporters in countries such as Norway and Russia who link their price to oil. Key factors influencing energy prices include:

    • Increasing global demand for energy: While there has been reduced growth in the demand for energy within developed countries, major developing economies such as China and India have expanded rapidly and their demand for energy has increased at a rapid pace. In 2010, total consumption of primary energy in developing nations overtook that of the developed world for the first time

    • Political instability: Political risks have significant impacts on the security of supplies of oil and gas and hence prices

    • Lack of flexibility of demand in the short-run: in the short-run, energy demand tends not to respond rapidly to price movements, although in the longer term, overall trends could be a driver for innovation in these sectors

    • Exchange rates: as oil prices are usually set in US dollars, any fluctuations in exchange rates will have an impact for UK oil imports, with the recent depreciation in sterling relative to the US dollar having pushed up the sterling price of oil

    • Speculation: Speculation on commodity markets can cause short-term price movements and thus increase the volatility of oil prices, but there is doubt that speculation has been driving any long-term changes in the price of oil

    • Inflexibility of supply: OPEC’s active market management and a lack of easily immediately accessible oil reserves makes supply of oil inflexible

    • Limited resources: The finite nature of fossil fuels, including oil, and increasingly challenging nature of exploration suggests a long run rising trend in oil prices

    • External shocks: Japan is currently the biggest Liquefied Natural Gas (LNG) importer in the world, and the earthquake and tsunami that devastated part of the eastern coast of Japan has meant that tankers have been diverted to fuel their gas powered electricity generation plants, because their nuclear plants are offline.

    The volatility of wholesale gas and electricity prices can be seen in Figure 4.

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    Figure 4: Wholesale gas and electricity prices, 2003-2010

    Policy measures

    Policy initiatives at various levels (EU, UK, Scottish Government) have a bearing on energy prices. In particular, measures to ensure security of supply and diversity of supply are aimed, in part, at seeking to protect national industries from the volatility of wholesale energy prices.

    The Scottish Government aims to generate 100% of electricity and 11% of heat from renewable sources. This will have the combined effect of reducing carbon emissions while diversifying the energy supply mix. Although at present, the cost of renewables can be higher than fossil fuels, the gap has narrowed as a consequence of improvements in efficiency in developing renewable resources and the rise in fossil fuel prices.

    Hedging strategies In order to smooth the effect of volatile wholesale energy prices, suppliers buy much of their energy requirement in advance through ‘hedging’ arrangements. This means that the current wholesale price is not always an accurate reflection of the actual price being paid by suppliers (who may be paying more or less, depending on the agreements they have entered into). Hedging strategies are one of the main areas for energy suppliers to seek to secure a competitive edge as the effectiveness of these strategies has an important role to play in profit margins. For this reason, details of these strategies are highly commercially sensitive.

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    LINK BETWEEN DOMESTIC SUPPLY PRICES AND WHOLESALE PRICES In a competitive market, prices charged by suppliers should respond to both rising and falling input costs. Reflecting concerns that this was not the case in the energy supply market, as part of their Retail Market Review, Ofgem looked at whether energy prices responded as quickly to falling wholesale energy costs as they did to rising wholesale energy costs. Their analysis showed that there was evidence of energy bills responding more quickly to rising costs than to falling costs, but noted that their conclusion depended on assumptions made regarding advance energy purchasing strategies (hedging strategies). Depending on the nature of the hedging strategy adopted, retail prices might not be expected to move directly with current wholesale prices. However, if there is an apparent link when wholesale prices increase, but no such link when they decrease, this is potentially of concern. According to Consumer Focus: ‘When wholesale prices peaked in 2008 – reaching 99p/th for gas and £92/MWh for electricity – gas bills rose by 51% and electricity by 28%. Yet, they only came down by 6% and 9% respectively over 2009 and early 2010 when wholesale costs had fallen to around half their peak prices, and remained low for a sustained period.’ Ofgem suggested that the asymmetric pattern of energy bill movements could reflect a number of factors, including:

    • a lack of competitive pressure, with new entrants finding it difficult to enter the market and undercut existing suppliers at times of falling costs

    • vertically-integrated companies seeking to balance profits across the whole business (and so seeking higher margins on the supply arm of their business when wholesale costs are falling, which would tend to reduce margins on the generation aspects of their business)

    The Ofgem report concluded that because of the range of possible factors underlying the asymmetry, it was not possible to assess the implications in terms of potential consumer harm. Ofgem publish a quarterly analysis of the electricity and gas supply markets. In this analysis, Ofgem compare average customer bills with their estimate of the costs faced by suppliers, using assumptions about the hedging strategies employed. The charts below show the analysis from the latest such analysis (June 2011), for dual fuel, electricity and gas customers, identifying the pattern of net margins alongside wholesale costs. In the charts shown, ‘Other costs and VAT’ include wholesale costs. These costs, as well as operating costs (not shown) are subtracted from customer bills to give the estimated margin. Margins on electricity supply have been generally positive over the period since mid-2004, while those for gas customers were negative for much of the period up until early 2009. As would be expected, dual fuel margins reflect a balance between these two positions. Ofgem report that all margins have narrowed in the latest quarter, although this would not reflect the latest price increases announced by Scottish Power.

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    Figure 5: Typical fuel customer bills, costs and net margins

    Source: Ofgem (2011)

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    OTHER FACTORS INFLUENCING ENERGY SUPPLY PRICES Although wholesale energy prices are the major driver behind domestic energy supply prices, other factors also have an influence. Ofgem’s analysis, shown below, shows how a typical ‘dual fuel’5 customer bill is made up. Figure 6

    In addition to wholesale cost increases, network costs and environmental obligations have added to the costs faced by suppliers.

    Network costs Ofgem is responsible for regulating the prices charged by gas and electricity network companies to the supply companies. In order to allow for the estimated £30bn of infrastructure investment required over the next decade by the network companies, prices have increased and – as a result – the network costs passed on to customers have also risen. Ofgem estimate that, over the next decade, the investment by network companies will deliver savings of £1bn to consumers.

    A review of connection and transmission charging by Ofgem has recently been carried out and the outcomes are expected to be published in the autumn of 2011. The Scottish Government has stated that “the existing approach to energy regulation for access and use of the UK electricity grid works against the interests of growing Scotland's renewable energy industry and impacts on delivery of Scottish, UK and European renewable energy and climate change policies and targets. Imposing high transmission access and use of system charges acts as a disincentive to investment in renewable energy generation in Scotland, which has some of the highest yields from renewable energy than anywhere else in Europe”.

    5 A dual fuel customer is one who uses the same supplier for both electricity and gas

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    Environmental costs The requirements placed on energy suppliers in respect of environmental obligations have increased in recent years. As knowledge about climate change has grown, governments have imposed restrictions on emissions or required polluters to pay, in turn subsidising energy efficiency programmes. Ofgem notes that this has impacted on the price suppliers charge for energy, but that demand reduction programmes will in the long run help to save money. Currently environmental costs make up 4% of gas bills and 10% of electricity bills.

    PRICING BEHAVIOUR In recent years, the domestic energy market has been characterised by clustered rounds of price movements, with price changes (both upwards and downwards) by one supplier typically followed by announcements by the other five major suppliers. This pattern of price movements can be seen in the chart below. More detail on the timing of individual price changes can be found in the Annex. Figure 7: Dual fuel, direct debit annual bills by supplier, March 2004 – March 2011

    Source: Ofgem ‘The Retail Market Review - Findings and initial proposals’ (2011) Ofgem used this analysis in its recent Retail Market Review to highlight concerns about the level of price convergence between the major suppliers. Ofgem noted that the business plans of several of the main suppliers highlighted their reluctance to be the first to announce price rises, due to the adverse publicity, but also in order to assess the nature of their own response in relation to their competitors. Ofgem highlighted that the energy retail market has a range of characteristics that might facilitate co-ordinated effects in pricing strategies, including factors such as a high degree of market concentration, the existence of significant entry barriers and the existence of switching costs for consumers. However, despite identifying market features that would increase the likelihood of co-ordinated pricing strategies, Ofgem’s Retail Market Review found no evidence of a cartel.

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    FINANCIAL PERFORMANCE OF ENERGY SUPPLY COMPANIES One of the findings of Ofgem’s 2008 Energy Supply Probe was that it was difficult to assess the profitability of different areas of activities of the Big 6 vertically-integrated companies due to the way in which accounts were presented. This made it difficult to establish whether companies were making excess profits in specific areas of their activities. As a result, Ofgem placed a requirement on the Big 6 companies to produce ‘segmental accounts’ which separate out the financial performance of the generation and supply activities of these companies, and separate the latter into domestic and non-domestic activities. In March 2011, Ofgem published a review of the first set of these segmental accounts, which relate to 2009. This review highlights that there remain some issues with regard to cross-comparability of results between companies but that they nonetheless represent an important step towards greater transparency in financial reporting. The analysis highlights that, in 2009, profit margins were far higher in generation activities when compared with energy supply profit margins, although Ofgem highlight that this is largely due to the capital intensity of the generation activities, which mean that measuring profits after depreciation would show a different picture. In relation to supply segments, across the industry as a whole, profit margins were positive for domestic and non-domestic electricity supply, but negative for both domestic and non-domestic gas supply (see Figure 8). Figure 8: Aggregate revenue, cost and EBIT margin by segment, 2009

    EBIT=earnings before interest and tax (operating profit) Source: Ofgem (March 2011):

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    Analysis by company shows a mixed picture. Centrica (British Gas) was the only company to record a profit in the domestic gas supply segment. In the domestic electricity supply segment, four of the Big 6 recorded positive margins. Non-domestic margins were generally higher, with only Centrica and npower recording losses in non-domestic gas supply. Figure 9: Domestic supplier profit margins, 2009

    Figure 10: Non-domestic supplier profit margins, 2009

    Further information on financial performance can be found in the Annex.

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  • 15

    Payment methods Issues of fuel poverty may be exacerbated by the structure of tariffs for different payment methods. Lower income customers may also be less able to take advantage of the cheapest tariffs, which tend to be offered to those able to pay by direct debit. Dual fuel customers using prepayment meters typically pay an additional £83 per year relative to those paying by direct debit, according to Ofgem analysis (see Figure 12). Research by Consumer Focus found that, of households using prepayment meters,

    • 60% had a household income of less than £17,500 • More than half received some kind of means-tested benefit, or disability

    benefit • In more than half of cases, the chief income provider did not have a job • Over one-third were home to someone with a long-term physical or mental

    health condition or a disability Tariff switching Ofgem has also highlighted the lower propensity of certain groups to switch suppliers. Ofgem analysis highlighted that those in social grades D and E were less likely to have switched supplier, thereby potentially missing out on annual savings of up to £256, even if they remained on a prepayment tariff. Figure 12: Average savings in 2010 energy bill of standard duel fuel customers of the Big 6

    Source: Ofgem

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    Response to rising fuel prices Research suggests that lower income households, including those in fuel poverty, may respond to higher fuel costs by reducing consumption rather than increasing expenditure on fuel. Research undertaken by Consumer Focus found that the median household in the poorest 20% of the income distribution will reduce consumption by 6% in response to a 10% increase in fuel prices. This contrasts with the behaviour of the median household in the highest 20% of the income distribution who would maintain a constant level of consumption i.e. would bear the higher costs in full.7 In response to concerns about fuel poverty, the Big 6 suppliers are required to offer ‘social tariffs’ to vulnerable groups, which generally include those over 60, on means tested benefits or on low incomes. However, evidence suggests that many of those eligible for social tariffs do not apply and therefore do not benefit from the potential reduction in charges. Support for those affected by fuel poverty Reflecting these concerns, the voluntary social tariff system is now being replaced by a statutory Warm Home Discount scheme, which was introduced in April 2011. Under this scheme, energy companies will be required to provide a discount on electricity bills to a ‘core group’ of low income pensioners. Suppliers will also be required to provide the same discount to a ‘broader group’ although they will have discretion over which of their consumers receive the discount. The Government estimates that by 2014, two million households in Britain will receive the discount at a cost of £310 million per year or £12 per household. According to Consumer Focus, only 25 per cent of fuel poor households in England will be eligible for the scheme, and they have called for a much broader definition of the ‘core group’ of beneficiaries. Both the UK and Scottish Governments have measures targeted at those most vulnerable to fuel poverty:

    • The Scottish Government’s Energy Assistance Package offers a range of advice and financial support relating to energy efficiency measures, with the level of support available depending on circumstances.

    • Winter Fuel Payments – annual payments of £100-£300 to pensioners, depending on circumstances (UK Government).

    NON-DOMESTIC CUSTOMERS Although media coverage has tended to focus on the price rises faced by domestic consumers, non-domestic users have also faced rapidly rising fuel prices. Average

    7 Consumer Focus ‘Fuel price inflation and low income consumers’ (2011)

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    electricity and gas prices for non-domestic consumers have risen 65% and 26% in real terms respectively between Q1 2005 and Q4 2010. Figure 13 below shows the price of fuels purchased by non-domestic consumers at different levels of consumption. It illustrates that companies with smaller energy requirements tend to be charged higher prices for electricity and gas relative to larger companies as a result of different buying practices. However, larger companies are more exposed to changes in the wholesale energy market as wholesale prices make up a larger share of their bill. Ofgem has highlighted a range of concerns in relation to non-domestic customers, in particular:

    • clarity over terms and conditions, especially in respect of the options available to customers approaching the end of fixed term deals

    • potential mis-selling by third party intermediaries, such as brokers, who provide advice to business customers in relation to energy supply contracts

    • suppliers’ use of objections procedures to potentially hamper switching by non-domestic customers

    Ofgem has introduced specific measures to protect micro businesses, which they report to have been successful, but concerns remain, including for larger businesses.

    Figure 13: Price of fuels purchased by UK non-domestic consumers, 2010 Q4

    Note: Size of consumer based on consumption Source: DECC (2011)

    TARIFF COMPLEXITY AND SWITCHING An issue of concern for both domestic and non-domestic customers is the complexity of tariff information and Ofgem has expressed repeated concerns about this issue. According to Ofgem, the number of tariffs available has risen from around 180 at the

  • 18

    start of 2007 to over 400 at present. Table 1 summarises information from Consumer Focus (for direct debit dual fuel tariffs only). Ofgem is concerned that the complexity of tariff structures makes it very difficult for consumers to compare their options, with the result that – despite the wealth of tariff options available – switching rates are very low. In their Retail Market Review, Ofgem reported that 60% of energy customers had never switched supplier and that up to half of these customers claim they would be unlikely to switch in the future. Table 1

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    Source: Consumer Focus (December 2010): Alongside its recent price rise announcement, Scottish Power launched a new online tariff and a new fixed price offer. However, Ofgem raised concerns about the potential savings claimed in relation to the new online tariff and has launched an investigation.

    Nicola Hudson Alasdair Reid Greig Liddell

    SPICe Research

    28 June 2011

    Note: Committee briefing papers are provided by SPICe for the use of Scottish Parliament committees and clerking staff. They provide focused information or respond to specific questions or areas of interest to committees and are not intended to offer comprehensive coverage of a subject area.

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    Energy Prices: Financial Annex This Annex contains details of:

    1. Profits for the ‘Big 6’ energy suppliers 2. Operating profits for energy supply segments only 3. Average annual gas and electricity price changes 4. Scottish Power average gas retail price and wholesale price since 2007 5. Scottish Power average electricity retail price and wholesale price since 2007 6. Pattern of changes to average gas prices 7. Pattern of changes to average electricity prices

    1. ‘Big 6’ total profits before tax since 2005

    £ million 2005 2006 2007 2008 2009 2010 Scottish Power 552 625 638* 753 761 RWE npower 384 449 596 567 396 432Centrica¹ 1,957 180 2,184 460 1,175 3,074Eon 869 -334 1,107 740 748 808EDF 618 594 555 465 828 SSE 724 842 1,044 1,183 1,214 1,240

    Source: Annual Accounts from Company House ¹ EBITDA * Full year figures unavailable (due to Iberdrola takeover), so figure for 2007 is estimate based on profit for 9 months to Dec 2007 plus a quarter of the previous financial year’s profit. 2. Earnings before interest and tax (EBIT) 2009 for energy supply segments only

    EBIT/Operating Profit (£ millions)

    Scottish Power 142.1 RWE npower -226 Centrica 685 Eon 30.2 EDF -35 SSE (Generation and Supply) 208 Source: Company segmental accounts available on company websites: Since last year Major energy suppliers in the UK must now publish segmented accounts six months after their financial year end. This allows for clearer analysis of the profits generated by companies in the UK energy supply markets.

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    4. Scottish Power average gas retail price and wholesale price since 2007

    Source: Consumer Focus (2011): 5. Scottish Power average electricity retail price and wholesale price since 2007

    Source: Consumer Focus (2011): 6. Pattern of changes to average gas prices

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    The tables below show periodic ‘clusters’ whereby one company’s announcement is followed closely by announcements by the other ‘Big 6’ companies.

    Dates of announcement ‘clusters’

    Increase or reduction

    Increases/decreases by company (%)

    First company to announce

    March to June 2007 Reduction BG (-19), SSE (-11.5), E.on (-16), Npower (-13.7), EDF (-10.1), SP (-4.9)

    British Gas

    January to February 2008

    Increase Npower (19), BG (15), EDF (13), SP (15), E.ON (19)


    July to September 2008 Increase EDF (21.9), BG (33.1), E.ON (27.1), SSE (28.3), npower (28.7), SP (33.4)


    February to March 2010 Reduction BG (-6), EDF (-3.6), npower (-6.5), SSE (-7), E.ON (-5.4), SP (-7)

    British GasG

    November 2010 to March 2011

    Increase SP (18.5), SSE (10.9), BG (7.7), npower (4.9), E.ON (3.3), EDF (6.3)

    Scottish Power

    Source: Consumer Focus (2011), personal correspondence 7. Pattern of changes to average electricity prices

    Dates of announcement ‘clusters’

    Increase or reduction

    Increases/decreases by company (%) (in order of announcement date)

    First company to announce

    March to June 2007 Reduction BG (-6), E.on (-5), Npower (-6), SP (-5)

    British Gas

    January to February 2008

    Increase Npower (13), BG (18), EDF (8), SP (14), E.ON (13), SSE (14)


    July to September 2008 Increase EDF (17), BG (9), E.ON (16), SSE (19), npower (16), SP (9)


    February to May 2009 Reduction EDF (-5), npower (-7), SSE (-8), BG (-10)

    EDF, npower, E.on, SSE

    December 2010 to March 2011

    Increase SP (9), BG (7), npower (5), E.ON (9)

    Scottish Power

    Source: Consumer Focus (2011), personal correspondence

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    3rd Meeting, 2011 (Session 4), Wednesday, 29 June 2011

    Energy pricing Background

    1. The Committee has received the following written submissions from today’s witnesses and others in response to the Committee’s invitation to energy companies and other relevant organisations to give evidence on energy pricing:

    • Energy Action Scotland (EAS) • Association for the Conservation of Energy (press release) • Which? • The Office of Gas and Electricity Markets (Ofgem) • Ovo Energy • Scottish and Southern Energy plc (SSE) • Scottish Gas • ScottishPower

    2. These submissions are attached in the annexe to this paper and Members are invited to take them into account in their deliberations when questioning today’s witnesses.

    Diane Barr Assistant Clerk to the Committee

    June 2011

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    SUBMISSION FROM ENERGY ACTION SCOTLAND 1. Energy Action Scotland Energy Action Scotland is the national charity campaigning for an end to fuel poverty in Scotland. It has been working with this remit since its inception in 1983. It is a membership organisation and has members in all sectors across the country. Energy Action Scotland sits on the Scottish Government’s Fuel Poverty Forum and is a member of the All Party Parliamentary Fuel Poverty and Energy Efficiency Group at Westminster. 2. Fuel Poverty in Scotland Fuel poverty is defined as having to pay 10% or more of household income on domestic fuel bills. The three main causes are poor energy efficiency of the home, low household income and high domestic fuel prices. The most recent figures from the Scottish House Condition Survey show that 770,000 Scottish households were in fuel poverty in 2009. It also calculated that for every 5% increase in fuel prices as many as 46,000 households (2%) are pushed into fuel poverty. Energy Action Scotland had therefore estimated that there were 800,000 - 1 in 3 - fuel poor households in Scotland, but the subsequent price increases will clearly have had the effect of making even more people fuel poor. The Scottish Government has a statutory duty under the Housing (Scotland) Act 2001 to end fuel poverty, as far as is practicable, by 2016. The Scottish Fuel Poverty Statement sets out how the Government will achieve this. Of the three main causes of fuel poverty, energy efficiency is a matter devolved to the Scottish Government; the other two causes - income and benefit levels and energy price and regulation – are matters reserved to the UK Government. 3. Impact of Domestic Fuel Price Increases Any increase in domestic fuel prices will have the effect of increasing the numbers of fuel poor households, all else being equal. The continued rise in fuel prices over a number of years has undone much of the benefit of other policies such as improving the energy efficiency of homes and boosting income levels and benefits take-up – although it should be noted that without these initiatives, levels of fuel poverty would in fact be much higher. Energy Action Scotland reacted with dismay to the recent announcement by ScottishPower of price rises of 19% for gas and 10% for electricity because of the magnitude of the increases. It is also widely expected that this move by ScottishPower will be followed and to a greater or lesser extent emulated by the other fuel utilities. However, Energy Action Scotland is particularly concerned because the bulk of the electricity rise on this occasion by ScottishPower appears to apply to the standing charge. This means that the increase will impact on consumers no matter how much they ration their use of electricity or take steps to be energy efficient. Energy Action Scotland (EAS) 10 June 2011

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    For immediate release: Wednesday 9 February 2011 ANGER AS FUEL POVERTY SPENDING SLASHED BY A THIRD The Association for the Conservation of Energy expressed its anger as the Scottish Budget, approved by Parliament today, slashed fuel poverty spending by nearly a third at a time when fuel poverty levels are rising. [1] [2] Reacting to the cut in fuel poverty investment, Chas Booth from the Association for the Conservation of Energy said, "These callous cuts will hit poor Scots the hardest. At a time of rising fuel bills, when a third of Scots households are struggling to heat their homes, we need more investment in tackling fuel poverty - not less. MSPs have their priorities wrong if they find it acceptable to cut funding to the most vulnerable in society." ENDS For more info: Chas Booth, Senior Press & Parliamentary Officer 07905 147552 Notes to editors Fuel poverty spending 2010-11: £70.9m Fuel poverty spending 2011-12: £48m Reduction: £22.9m (32%) The budget approved today includes £48m for Energy Assistance Package and Home Insulation Scheme, while the Universal Home Insulation Scheme has been axed. The 2010-11 budget included a total of £70.9m for Energy Assistance Package (£45.9m), Home Insulation Scheme (£15m) and Universal Home Insulation Scheme (£10m). Today's budget: 2010-11 budget (detail on page 67 table 3.05): (2) The latest Scottish House Condition Survey found that 770,000 Scots households were in fuel poverty in 2009, the last year for which figures are available:

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    > The cost of energy is UK consumers’ number one financial concern: in a survey this month 81% of people living in Scotland said they are worried about the cost of their energy bill.

    > In real terms, energy prices have increased by 60% over the last ten years. Electricity prices have gone up by 45%, gas by 104% and heating oil by 108%. It is expected that prices will continue to rise steeply relative to the rate of inflation.

    > Consumers are also suffering a crisis of confidence in the energy market and do not trust energy suppliers to reveal exactly what they are charging their customers for. In the UK only 12% of people think suppliers are being honest about what makes up the cost of the bill and only 16% think that suppliers try to keep tariffs at a reasonable level.

    > It is unsurprising therefore that consumers do not feel loyalty to a particular energy company, with cost differences being the main motivation for switching supplier. Following Scottish Power’s recent price increases, for example, there has been a surge in visits to Which?’s energy switching site, Which?Switch.

    > With Ofgem currently undertaking its Retail Market Review, it is vital that the regulator pushes ahead with reforms to scrutinize energy price rises and takes steps to improve consumer engagement with the energy market.

    Key questions for the ‘Big 6’ and Ofgem: > Will the energy companies recognise consumers’ concerns and mistrust

    about prices? What more will they commit to do to demonstrate that their prices are fair?

    > What more will energy companies do to work with consumer groups, the Scottish Government and others to ensure that their customers can access all the information they need to tackle rising energy costs this winter (e.g. energy efficiency, switching, etc)?

    > Will Ofgem and the energy companies reform tariffs to ensure that consumers can easily compare them at a glance and choose the best deal for them?

    > How will Ofgem ensure that there is greater transparency about energy companies’ prices? What impact do they believe the transfer pricing investigation will have and when do they expect it to be completed?

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    Background: What currently makes up domestic energy bills? > There are a number of elements that make up domestic energy bills -

    both direct wholesale costs and wider operational costs including VAT; margins; environmental and social obligations; and fuel costs to name a few. The impact that these elements have on energy prices vary and they have different pressures upon them.

    > Ofgem’s analysis shows that the wholesale cost of energy makes up the largest single element of our energy bills. As with the cost of supply, there are a number of elements that will impact on the wholesale cost such as fuel costs (determined by the commodity market) and investment in infrastructure.

    > In the UK gas and electricity are taxed at a reduced rate of 5% - this is 15% less than the standard UK VAT rate. It is also one of the lowest VAT rates in Europe. This factor, which is beyond suppliers’ control, largely explains why UK energy prices are low relative to Europe.

    > Where we have a market mechanism for the provision of domestic energy and there is a dominance of public companies, margins will be factored into the costs. Which?’s concern is not with competitive and effective companies making a profit, rather we want to be confident that the markets are working effectively and delivering for consumers.

    > There are a number of social and environmental obligations placed on the ‘Big 6’ which aim to support consumers and which are passed through to consumers via their energy bills. These currently include Carbon Emissions Reduction Target (CERT) and offering of Feed In Tariffs (FIT) for microgeneration. Ofgem’s analysis indicated that on average CERT alone adds £45 per year to each household bill. Many consumers are not aware of these obligations and fail to access the opportunities that they present, despite the fact that they pay for them.

    > In the UK the energy mix is dominated by gas and coal. As such the price of these commodities impacts on the price consumers pay.

    > In addition, there are a number of obligations and programmes that aim to transform the energy market in order to meet our European 20:20:20 targets. These include the Renewables Obligations and the Carbon Budgets.

    Which? concerns about rising prices: Impact on consumers > Price increases are having a real impact on consumers’ quality of life.

    This ranges from anxiety to reduction in discretionary spending to self-disconnection.

    > A third of consumers are planning to make cuts in their energy bills as a way of reducing their household spending.

    > Confusion abounds about why prices bear little relation to the wholesale cost of energy and there is concern about the lack of transparency around the calculation of energy prices. Just 26% of those living in

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    Scotland think energy suppliers are trustworthy – Scottish voters have as much trust in banks as in energy companies.

    > In addition in Scotland only 35% trust their supplier to sell them the right tariff and services to suit their needs and yet they have high expectations as to the kind of positive action their supplier should be taking: 89% think their gas/electricity supplier should be responsible for notifying them if cheaper tariffs become available.

    > This disparity between expectations and reality is feeding into wider consumer mistrust and dissatisfaction with energy companies. Significantly this leaves consumers unwilling to engage with issues of energy efficiency and our future energy security.

    > We are therefore worried that this lack of trust, as well as existing poor practices by energy suppliers such as investigation into misleading sales and marketing practices, could undermine important Government energy efficiency schemes and smart metering,

    > In addition to disillusionment with the benefits of switching to another big supplier, consumers are confused by tariffs and do not feel adequately informed to be sure they will make the right decision. The energy sector has the highest proportion of consumers (38%) that do not know if they have switched to a better deal and unsurprisingly less than half of consumers have ever switched.

    > Steps must therefore be taken to restore consumer trust in the energy market, since consumer action through undertaking efficiency savings or by switching supplier are key ways to ensure that they take advantage of any opportunities to lower their bills themselves.

    Unrivalled supply chain influence and lack of transparency > The ‘Big 6’ are in a unique market position as they have the ability to

    operate all sections of the energy supply chain. A number have fuel extraction businesses and all of them have the capacity to self-supply for their retail customers’ needs, either through their own capacity or long term contracts.

    > However, in addition to selling to themselves, once they produce their energy they sell a proportion onto wholesale markets, and it is the price of energy sales in the wholesale markets that sets the price the customers pay.

    > This begs the question of what the margins are in energy companies’ generation and trading arms. Which? therefore welcomes the recognition by Ofgem that greater scrutiny and transparency is needed in the workings of the market and the prices being offered by the ‘Big 6’.

    Conflicting messages > Alongside these concerns about transparency, concerns also exist about

    whether consumers are seeing the benefit of a competitive energy market.

    > For example, profit announcements appear to be inconsistent with the argument that factors beyond energy companies’ control are responsible for price increases.

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    > Furthermore, profit figures also appear to be inconsistent with Ofgem’s findings. Ofgem reported that at least 5 of the ‘Big 6’ understated their profits last year by inaccurately displaying the information on their margins.

    > At their recent evidence session at the House of Parliament Energy Select Committee, Ofgem stood by its analysis of wholesale price movements (i.e. that bills go up quicker when wholesale prices rise than they fall when wholesale prices drop).

    Which? recommendations: > Which? has submitted a response to Ofgem’s Retail Market Review

    which details several recommendations for how to improve the energy market.

    > We welcomed the Review’s central finding that a large number of complicated tariffs prevent consumers from engaging with the energy market and driving competition between firms and innovation.

    > We also agreed with Ofgem’s view that more needs to be done to make it easier for small and independent suppliers to break in to the market and compete of a level playing field with the ‘Big 6’.

    > Our main recommendation was to reduce tariff complexity to make it far easier for consumers to compare all offers in the market. The case of Scottish Power gives good backing to the case that tariff formats should be standardised to ensure that prices are calculated in the same way for all customers on the same tariff.

    > This means an end to complex ‘tiered’ pricing that make tariffs difficult to compare and an end to discounts that are not applied to the cost of each unit of energy.

    > Ofgem must protect consumers by undertaking property scrutiny of the market, giving consumers confidence that the market is delivering for them and ensuring they are seeing the benefits.

    > Industry must recognise consumer concerns and levels of mistrust and be honest about what is causing price increases; they must demonstrate to consumers that competition is working and that vertically integrated companies will work in consumers best interests; and they must realise that if you increase bills without good justification, consumer engagement with and support of energy efficiency programmes will most likely decline.

    June 2011

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    Ofgem - our role and duties Ofgem is the independent economic regulator of the gas and electricity markets. Our principal duty is to protect the interests of existing and future consumers. We welcome this opportunity to brief Committee Members on our work. We have two key functions. We regulate the monopoly companies that own and run the gas and electricity networks (the infrastructure that delivers gas and electricity to our homes and businesses). We also promote competition in the parts of the gas and electricity markets which aren’t natural monopolies, such as supply and generation. Other duties and concerns that guide our work are:

    • promoting security of supply • promoting sustainable development and combating climate change • having special regard for vulnerable consumers and contributing to the

    Government’s fuel poverty targets. Retail Market Review On 26 November 2010 Ofgem announced the Retail Market Review (RMR) - an investigation into the markets for electricity and gas for households and small businesses in Great Britain. This work was built on the findings of our 2008 Energy Supply Probe1, launched by Ofgem amid serious concerns about the state of the market at that time. In March 2011, we published our RMR findings and initial proposals which won wide support from consumers, small suppliers, independent generators and businesses. We believe this shows increasing consensus across consumer and business groups that in a period of rising energy prices energy suppliers have to transform the way they deal with consumers. Our RMR concluded that competition in the energy retail market was being stifled by a combination of a number of factors:

    • tariff complexity • poor supplier behaviour • lack of transparency, and • the degree of influence of the big six energy suppliers on the market.


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    We found that further action is needed to make energy retail markets in Great Britain work more effectively in the interests of consumers. In more detail, some of the key findings were:

    • complex tariffs are putting off consumers from taking part in the energy market

    • the Big Six generally make higher margins from customers who take only their electricity or gas (as a single fuel product) from the former monopoly provider. This may give the Big Six an advantage over new firms entering the market

    • sixty per cent of consumers are disengaged from the market according to our consumer research

    • lack of effective competition means that for the first time Ofgem has found evidence that suppliers are putting up prices quicker in response to wholesale price rises than they are cutting them when wholesale prices fall

    • concerns that suppliers are not adhering to standards of conduct for business customers.

    Proposals for action We set out our proposals for action. These are designed to sweep away complex tariffs in order to expose energy suppliers’ prices to consumer power make it easier for new suppliers to enter the market; enforce and strengthen 2008 Energy Supply Probe remedies in both the domestic and non-domestic market; and increase the transparency of company accounting practices. Ofgem’s five proposed reforms are: 1. Price simplification We propose to address confusion in the market by restricting the number of tariffs for standard evergreen products2 from each supplier to just one per payment method in relation to domestic customers. We would also standardise the format of these tariffs across suppliers, with suppliers allowed to compete on just a single "per unit" price. Consumers would then be able to tell at a glance whether they can save money by switching supplier or moving to a new deal. This would be a major reform benefiting the three quarters (75 per cent) of customers currently on standard evergreen products. The payment methods are: Prepayment, Standard Credit and Direct Debit.

    2 Evergreen products are companies open-ended, non time limited tariff offerings.

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    In order to allow genuine innovation and choice for customers, suppliers would still be free to offer an unrestricted number of fixed-term products. However, our focus would be on ensuring that domestic customers only buy into these products with full knowledge and agreement to their terms and conditions. We would ban automatic rollovers to a new fixed-term product at the end of the period, with customers defaulting back to a standard product unless they make a positive choice for a new fixed term product. We propose requiring suppliers to quote prices for all fixed-term products on a basis that is readily comparable to the unit price for standard evergreen products. This will allow direct comparisons between all tariffs in the market. 2. Breaking the power of the Big Six over the wholesale electricity

    market Ofgem is proposing a new licence condition that would require the Big Six to make available between 10 per cent and 20 per cent of their power generation into the market through a regular Mandatory Auction (MA). Ofgem is also consulting on Mandatory Market Making Arrangements to ensure that smaller players in the energy market have access to a transparent and accessible platform that allows continuous trading. 3. Tougher enforcement and more requirements to ensure companies

    play straight with consumers The performance by suppliers in response to our 2008 Energy Supply Probe reforms has been patchy, and in some cases poor. We consider there is scope for strengthening a number of the licence conditions to give suppliers less freedom in how they interpret these obligations. We consider this is necessary in both the domestic and non-domestic sector in order to ensure the suppliers abide by the licence conditions. Failure to abide by these conditions is likely to be backed by appropriate enforcement action. On 22 June we launched an Enterprise Act investigation into Scottish Power over potentially misleading marketing at the time of its recent price rise. The fact that Ofgem has launched investigations should not in any way be taken as implying that any supplier has breached its licence obligation. As part of the investigation process the evidence will be examined before conclusions are reached. 4. Reduce unfair contracting Following the 2008 Energy Supply Probe, we introduced a range of remedies to address contracting practices that were adversely affecting micro-business consumers. We are concerned that performance against these remedies has not been as we wanted. As a result, and as in the domestic sector, we intend

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    to take action to ensure compliance with existing licence conditions and to consider whether further licence amendments are needed. 5. Improve transparency Ofgem remains concerned that transparency regarding the way they account for the cost of gas and power in their supply business remains limited by company–specific policies, especially when they supply energy from another part of the same business. As a result, we feel that consumers are not provided with sufficient clarity about how retail prices relate to suppliers’ costs. Ofgem will therefore appoint an independent accounting firm to investigate further as well as looking at how new EU legislation can help increase transparency. Consultation on proposed reforms We issued a consultation in March, inviting responses from industry and wider stakeholders. We would prefer to implement reform wherever appropriate with the cooperation of the supply companies. However, we stated in our consultation document that we will consider a referral to the Competition Commission if, following consultation, we consider that our proposed reforms do not have a realistic chance of addressing the concerns we identified due to industry opposition or otherwise. The consultation period for the Review closed on 1 June 2011. We received nearly 70 formal responses and over 40 detailed emails and phone calls from consumers. We have also held bilateral meetings with the Big Six energy suppliers and a number of consumer organisations and small suppliers. June 22 announcement On June 22, Ofgem signalled its determination to press ahead with these reforms, following wide support from consumers, Consumer Focus, Which?, CAB, Age UK and uSwitch along with independent generators and small energy suppliers. Ofgem’s Chief Executive Alistair Buchanan commented: “Responses to our reforms show that there is increasing consensus across a range of consumer and business groups that in a period of rising energy prices energy suppliers have to transform the way they deal with consumers. We are also seeing signs that the penny has dropped with the Big Six and they are ready to take part constructively in the debate. “This is why Ofgem is pressing ahead with its consultations to sweep away complex tariffs in order to expose energy suppliers’ prices to consumer power. We will also pursue breaking up the stranglehold of the Big Six on the electricity market to encourage more firms, like new arrival the Co-op, to enter the energy market and increase the competitive pressure on the Big Six.

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    “Our latest report on prices also gives even more impetus to the need for radical reform as it shows that turmoil in global energy markets during 2011 has pushed up wholesale costs by 30 per cent since December 2010. Now more than ever, consumers need to have confidence that competition can operate effectively in setting energy prices.” Ofgem will now develop its proposals on the retail market drawing on the responses it has received from its consultation. We will also carry out further consumer testing of our proposals. By the end of the year we will publish impact assessments alongside detailed proposals for consultation. In 2012 we will publish proposals to put in place its reforms. The Big Six can then decide whether to accept Ofgem’s proposals or appeal some or all of our reforms to the Competition Commission. Supply Market Report On June 22 we also published our quarterly supply market report, which tracks the indicators of energy supply net margins for a typical dual fuel, electricity and gas customer account. This shows that wholesale costs are rising. Gas for delivery this winter has risen from 60 pence per therm in January of this year to over 70 pence per therm. This compares to gas for last winter which was 55p per therm by June 2010. This is a 30 per cent increase in wholesale gas prices. Ofgem’s modelling shows that this increase in wholesale prices and other costs means that an estimated margin for supplying a typical, standard tariff dual fuel customer is approximately £15 per customer for the year from June 2011.

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    Hyperlinks to documents published on June 22 Electricity and Gas Supply Market Report June 2011 - (Reference number: 81/11)

    Ofgem’s Retail Market Review – update and next steps (non-liquidity proposals)

    Ofgem’s Retail Market Review – update and next steps (liquidity proposals)

    GB wholesale market electricity: summer 2011 assessment - (Reference number: 82/11)

    Scottish Power investigation Ofgem also reinforced the commitment it made in March to take a tough approach to enforcement action by launching an Enterprise Act investigation into Scottish Power over potentially misleading marketing at the time of its recent price rise. The investigation will focus on the claim of £459 savings from the “Direct October 2012 offer”. The Enterprise Act gives Ofgem powers to seek enforceable undertakings in relation to misleading acts or omissions which may harm consumers. Scottish Power is also under investigation about whether the difference between their Standard Credit and Direct Debit tariffs are cost reflective and, along with EDF Energy, npower, and SSE, as to whether the company has missold energy to customers. Ofgem has also received broad encouragement from consumer groups and businesses to look at more options to help vulnerable consumers and small firms.

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    1. We welcome the lead taken by the Economy, Energy and Tourism Committee to publicly address the issue of energy price increases, consumer rights, and the need for a genuinely competitive retail market which works in the best interests of consumers.

    2. Launched in September 2009, Ovo already has over 40,000 customers and was voted the UK’s joint ‘Top Energy Provider 2010’ in the Which? Switch customer satisfaction survey. Ovo is an energy company created by customers for customers, dedicated to providing consumers with cheaper, greener, simpler energy.

    3. The company has been built with a ‘customer first’ mentality. While the Big 6 energy companies offer almost 400 complicated tariffs, Ovo has just two very straightforward tariffs that everyone can understand. Energy bills are notoriously difficult to comprehend, but Ovo’s bills are easy to read and our customers know exactly what they’re paying.

    4. Our customers tell us our success is due to Ovo challenging the status quo by offering a fresh, consumer-centric perspective in a market consumers otherwise view with distrust.

    5. We have attached our original response to Ofgem’s Retail Market Review, which sets out our analysis of key issues, and proposes two simple solutions which we believe would have a dramatic and immediate beneficial effect for the majority of consumers.

    6. However, there have been developments since Ofgem’s consultation process closed on 1 June, which directly impact on the issues we raised. New Developments

    7. Ovo’s arguments are based on the premise that all consumers need to be treated fairly. Our concerns are that the majority of consumers are charged more in order for the Big 6 companies to cross-subsidise loss-leading tariffs. Such a practice not only unfairly burdens more vulnerable consumers, but allows the Big 6 to undercut new entrants, amounting in our view to anti-competitive pricing.

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    8. Ofgem’s announcement of 22 June that it was investigating the new tariff

    which was introduced by Scottish Power on the same day the company announced major price increases, underlines the need for a limit to be set on the difference between their “standard” and online tariffs.

    9. Ofgem already limits the difference between standard and pre-payment tariffs, to stop energy companies from exploiting vulnerable consumers, and we would encourage the Committee to press the Regulator on this point.

    10. Alastair Buchanan, Ofgem Chief Executive, also made clear on 22 June that the increase in the number of tariffs coincides with the decline in the number of people switching suppliers. He states that this has been a deliberate tactic by the energy companies.

    11. This evidence undermines the long-standing claim by the Big 6 that lots of tariffs show the market’s competitiveness and the range of choice available to consumers.

    12. 99% of consumers are tied to the Big 6. Two-thirds of people are with the same regional supplier as before privatisation. The Big 6 are not ‘normal’ businesses. They have inherited their customer base. They have not ’won’ consumers as other normal businesses do. Since the Big 6 are not subject to the same commercial pressures as normal businesses to reduce costs and eliminate wasteful processes, they can more readily pass on costs to their customers, rather than find efficiencies within their own operations.

    13. Stimulation of genuine competition in the retail energy market, as happened in telecommunications, will drive innovation, customer service quality, and do more to ensure energy prices remain as competitive as possible. Ovo welcomes Ofgem’s stated intent to do more to increase competition, but urges the Committee to press the Regulator on this issue. Possible Questions

    14. The Committee’s Hearing provides a timely opportunity to give Ofgem a clear message that they are expected to intervene more forcefully to ensure consumers get a fairer deal, and that there is a level playing field which allows new companies to offer consumers genuine choice.

    15. If it helps the Committee, we suggest the following questions be put to Ofgem:

    • How can energy suppliers justify the huge differential between prices that different customers are charged? This implies that vulnerable customers are more likely to be paying the highest prices. What can be done about this?

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    • Headline-grabbing ‘cheaper’ tariffs have long been presented as showing that

    competition works, and yet Ofgem now accepts there is not a properly functioning competitive market. If Ofgem does accept that the best way to keep downward pressure on costs and upward pressure on consumer innovations is to more actively nurture new entrants, what steps will it be taking to achieve this?

    • 13 Years of light touch regulation has failed to create an environment where new entrants come into the market and flourish. What now needs to be done?

    16. Questions for the Minister:

    • Ofgem’s previous approach to regulation has, by their own admission, failed. What political direction, leadership or guidance is the Government going to provide Ofgem? The regulatory model for telecoms has created a consumer-focused market, driven by innovation, customer service and genuine competition for the consumers’ money. Is this a model the Government would welcome in energy?

    • How does Ofgem prove it can protect ordinary customers’ interests at the same time as ensuring Britain has secure energy supplies in the future? Conclusion

    17. Ovo would be very happy to provide additional briefing and to explain these questions a little further if the Committee requires. Ofgem admits that it has failed consumers, and we need the regulator to be more assertive in protecting consumer interests and creating a level competitive playing field. We thank the Committee for taking such an active interest. 23 June 2011

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    1. Ovo Energy welcomes Ofgem’s acknowledgement that the current retail energy market is failing consumers and is not delivering a functioning competitive market.

    2. While supporting the proposals set out in the RMR, we urge Ofgem to go further and to be more assertive in creating an environment where competition works for the consumer by ensuring there is a level playing field for all retail suppliers.

    3. We propose two specific immediate actions for Ofgem to take as a first step to developing effective retail competition:

    • limiting the price differential between of the median and lowest tariffs offered by any supplier

    • a tariff comparison measure based on the ‘APR’ and ‘AER’ systems used in the retail financial services market

    4. If Ofgem is more assertive in creating a truly competitive retail market it will help foster a more vibrant and confident investment environment in infrastructure and the wider energy market.

    5. The current dominant energy companies -- the ‘Big 6’ -- have an important role in the future development of the energy market, but the retail market and consumers will benefit from new business models and visions of how to cost-effectively deliver safe, secure and sustainable energy.

    6. The time has come for Ofgem to look beyond the ‘Big 6’ to find ‘consumer-friendly’ solutions.

    7. True competition should mean that if the ‘Big 6’ want to maintain their profit margins they will need to find efficiencies from within their own businesses rather than simply passing the costs onto consumers. Market overview

    8. Despite the best intentions of the architects of the 1980’s energy privatisations, 99% of Britain’s consumers remain customers of the direct descendants of the old state monopolies – and two-thirds of consumers are with the same regional supplier they had before privatisation.

    9. The ‘Big 6’ have not achieved growth, as normal companies do in other consumer markets, by acquiring customers through offering attractive new services or enhanced customer service. They have simply inherited their large customer base, with no incentive to innovate or serve customers well.

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    10. The best way to change any consumer market is to actively encourage the creation of a competitive level playing field driven by new entrants -- this requires incumbent operators to adapt and respond to commercial competition rather than regulation.

    11. While we generally welcome Ofgem’s proposals, as a way of addressing issues in the short-term, we believe Ofgem must now take a more strategic interventionist approach in order to nurture competition. This will also enhance prospective new investor’s confidence in the wider energy market, potentially providing more new money than can be provided by the ‘Big 6’ alone. Strategic market management

    12. Telecommunications provides a blueprint and precedent of how a regulator can work with new entrants to create a competitive level playing field, initially by stopping incumbent dominant operators from stifling fledgling companies, and allowing those dominant incumbents time to make the changes they need to make to operate successfully in a fully competitive marketplace.

    13. One obvious example of how Ofgem can operate strategically to nurture new entrants in the retail energy market and support the development of a truly competitive market responsive to consumer needs, is to stop the ‘Big 6’ energy companies from simply under-pricing new entrants.

    14. Figures in Ofgem’s Review make clear that the ‘Big 6’ energy companies currently overcharge the majority of Britain’s energy users (ie they make greater margin from those customers) in order to subsidise acquiring new customers with the cheapest (ie lowest margin) tariffs. It cannot be right that the most ‘passive’ consumers should pay for this ‘illusion of competition’. These subsidised tariffs also make it more difficult for new, innovative companies to offer consumers real choice and better value on a sustainable basis.

    15. We propose that Ofgem introduce controls which limit the price difference between all suppliers’ median and lowest tariffs.

    16. This should provide immediate benefit for the millions of consumers on higher margin tariffs, offering them better value for money, and being inherently fairer. It would also provide the level playing field new entrants require to enter and grow in the market, by stopping this effectively ‘anti-competitive’ pricing by dominant incumbents.

    17. A similar strategic market management approach by the telecoms regulator Oftel was critical to ensuring the growth, the investment, the innovative new services and the improved customer experience we all now take for granted. Oftel ensured, until the new competitive market was sufficiently viable, that BT could not simply price new entrants out of the market. Consumer choice and comparative measures

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    18. While we broadly welcome and support the initiatives proposed by Ofgem, we

    have several observations to preserve consumer choice and service innovation.

    19. In proposing to standardise evergreen contracts across suppliers, care should be taken to ensure that this does not lead to homogenisation and the reduction of consumer choice.

    20. We would propose that Ofgem establish an “APR-equivalent” as the basis for comparison between energy suppliers.

    21. In the financial services market, ‘APR’ is a standard comparative measure which helps consumers understand, in a simple and clear way, the cost/impact of an otherwise complex financial product. It takes account of variable rates, and other incentive/penalty charges in order to provide the consumer with a headline point of comparison.

    22. Such an “Energy APR” would be based on each suppliers’ guaranteed or underlying price per KwH over one year, taking account of all discounts or other tariff-specific features. Energy tariffs will necessarily remain complex products, just as with financial products. However, adopting this ‘APR’ approach would provide consumers with an easy to use and understand comparative measure, without constraining suppliers’ ability to innovate. Wholesale market

    23. Liquidity in the wholesale market is critical. It is self-evident that greater transparency and openness will help create a more level playing field for new retail entrants and hence create better choice and value for consumers.

    24. We look forward to seeing the details of how Ofgem proposes to improve access to and understanding of the wholesale market. We expect safeguards to ensure that the market cannot be manipulated or distorted by third parties either within or from outside the energy market, eg it would not be in consumers’ interests if an MMA allowed financial speculators to acquire capacity for immediate re-sell to an energy retailer, with the speculator’s additional profit margin added to the wholesale price. Policing and enforcement of licence conditions

    25. Enhanced policing and enforcement will be necessary in the short-term. However, if Ofgem were to take a more strategic market management approach which nurtured true competition, by supporting new entrants, it is much more likely that normal market mechanisms and operations will evolve in a relatively short timescale, therefore significantly reducing the need (and costs) of prolonged detailed regulatory oversight. Switching sites

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    26. It is vital that switching sites, or any other comparison mechanism, have the trust of consumers. This will require the early adoption of a transparent and easily understood mechanism for fairly, and consistently, comparing tariffs.

    27. We have indicated our preference for something similar to the ‘APR’ system used in the consumer financial services market, which takes account of discounts/etc to provide a standard comparative base across different products, services and tariffs.

    28. We welcome the work being done on this issue by Consumer Focus, but remain concerned about who will take this work forward after the planned demise of Consumer Focus.

    29. The ways in which comparison sites are governed, and standard comparative indices are utilised in other consumer markets (insurance, travel, etc) may provide insight on the best way forward within the energy market. Appointment of independent accountants

    30. If Ofgem brings forward proposals to improve liquidity in the wholesale market, bringing greater transparency to pricing and the market, this should help in providing a better understanding of the transfer pricing and hedge accounting practices of the ‘Big 6’ energy companies. We see no immediate reason to appoint independent accountants. Conclusion

    31. Ovo Energy prides itself on being a good example of how a new energy company can deliver value, innovation and customer benefit, and help change the face of the energy market. We have led the industry in simplifying bills, standardising tariffs and providing the best customer service, culminating in Which? Switch recently giving Ovo Energy a 5-stars rating.

    32. So while we welcome Ofgem’s proposals to require the industry to move in line with Ovo’s consumer-centric approach, our more important message is that Ofgem can achieve its consumer objectives by assertively creating a competitive level playing field for all energy suppliers.

    33. It will be necessary in the short-term for Ofgem to impose and police licence conditions on the ‘Big 6’. But in the longer-term, if Ofgem creates the right environment where market forces drive innovation, regulatory intervention will decline as the ‘Big 6’ respond commercially to market developments and consumer demands without the need for ‘coercive’ licence conditions.

    34. We believe the first steps in the process should be:

    • the adoption of a financial services-style ‘APR’ comparative measure for energy tariffs, to give consumers clarity and confidence in evaluating choice;

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    • a limit on the price difference between suppliers’ median and lowest tariffs, so that passive consumers are not ‘victimised’ and all suppliers can compete on an equal basis. These two simple steps alone would have a dramatic positive impact on the market.

    35. Consumers have the right to expect choice, innovation and value for money. The best way to deliver this will be for Ofgem to strategically manage the market to create the conditions which encourages new players, and allows a truly viable competitive market to develop.

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    COVERING LETTER FROM SCOTTISH AND SOUTHERN ENERGY PLC Dear Gavin Please find enclosed the response from SSE to a number of issues raised by Committee members in advance of the evidence session on pricing on 29 June. SSE welcomes the opportunity to discuss household energy prices, energy consumption and support for households in fuel poverty in more detail. I am aware, however, that the Committee’s decision to invite energy companies to the meeting on 29 June followed Scottish Power’s announcement of 7 June. As you will know, the energy supply market in Great Britain is one of the most competitive in Europe. Therefore, while it will be possible for me to make general observations about the issues affecting household energy prices, such as wholesale energy, distribution and environment-related costs, it will not be possible – in the context of a competitive market – for me to discuss with the Committee the household prices SSE may charge in the future. I look forward to appearing before the Committee on 29 June. Yours sincerely Alistair Phillips-Davies Supply and Generation Director

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    SUBMISSION FROM SCOTTISH AND SOUTHERN ENERGY PLC Factors influencing household energy prices A typical bill is made up of:

    • Wholesale energy costs including the cost of buying electricity and gas from the global market.

    • Network charges which are set by Ofgem and levied on suppliers for using the network of gas pipes and overhead lines and underground cables to deliver energy into the home. These vary according to regions.

    • Environmental and social costs for government programmes such as Carbon Emissions Reduction Target (CERT), Warm Homes Discount, Community Energy Saving Programme (CESP), Renewables Obligation, Feed-in Tariff and the EU Emissions Trading Scheme. The costs of these required socio-environmental schemes, set by Government, are expected to be passed through to consumers.

    • VAT • Other costs including metering provision and other costs associated with running

    a retail business eg meter reading, billing and customer service The changing structure of a Bill The below table and corresponding graph show the changing nature of energy bills between October 2008 and 2011 for a dual fuel typical customer.

    Factor 2008 Yr Tariff

    2011 Yr Tariff

    Retail Price £1,119 £1,094 VAT £53 £52 % of retail price 5% 5% Network Use of System Costs (UoS) £186 £239 %

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