Select Committee on Business and Enterprise Written Evidence


Memorandum submitted by BizzEnergy

POSSIBLE ANTI-COMPETITIVE BEHAVIOUR IN THE UK'S ENERGY MARKET

BIZZENERGY

  1.  Set up in 2000, BizzEnergy is the largest independent energy supplier in the UK. The company is aiming to make a complex market sector simple by challenging the industry norm and developing innovative, flexible and efficient ways to serve customers across the UK.

  2.  The company's aim is to deliver the highest quality service to small and large customers, and to lead market innovation. Examples of this innovation include BizzEnergy aiming to become the first electricity supplier to allow its customers to fully serve and control their accounts online, and BizzEnergy being the market leader in implementing Smart Meters as part of our supply contract.

  3.  BizzEnergy welcomes the opportunity to submit written evidence to the Business and Enterprise Select Committee Inquiry into Possible Anti-Competitive Behaviour in the UK's Energy Market, and looks forward to further engaging with the Committee on this Inquiry as it progresses. BizzEnergy is available to provide supplementary written evidence to the Committee, and would welcome the opportunity to provide oral evidence in due course.

INTRODUCTION

  4.  As the Committee will be well aware, the UK energy market is dominated by British Gas, Npower, E.ON, Scottish and Southern, Scottish Power and EDF, with few opportunities for new market entrants. The "Big 6" share about 99% of the Domestic and smaller end of the SME energy market and current low levels of fragmentation in the energy marketplace give these large utilities great power to dominate market developments and to prevent new entrants from gaining a foothold. Independent suppliers of energy in the UK have approximately only 1% of the UK's energy market share. BizzEnergy believes that this is an unnaturally low share and that figure must grow in order for the UK's energy market to develop and achieve meaningful diversity and for customers to benefit.

  5.  The current lack of competition and regulation has not escaped the observation of industry watchdogs. In September 2006, for example, energywatch demanded a full inquiry into energy market competition stating:

    "Major problems with electricity generation and upstream gas supply mean the UK energy market is anything but competitive . . . There needs to be increased competition in Gas and Electricity markets. A licence obligation, backed by effective regulatory monitoring and enforcement could achieve this".

  6.  While industry watchdogs have clearly outlined the situation, there has thus far been little action to either address the lack of competition in the marketplace or increase Ofgem's regulatory powers.

  7.  The UK energy market was originally designed around the separation of generation and supply; with the primary premise that parties could enter the market as either generators or suppliers and not necessarily both. Current trading arrangements have, however, given rise to vertical integration, which those who are vertically integrated argue makes for efficient and effective risk management and lower costs to the customer. However, the cost of this is the loss of liquidity, transparency and competition in the market—major conditions required in order to ensure a robust, liberalised and efficient market.

  8.  In addition to this, while profits within some sections of the energy industry appear to be excessive, it is very difficult to judge whether this is the case. Company accounts normally provide a strong, reassuring and robust commentary to all stakeholders but this is not possible in the UK due to the international nature of two thirds of the "Big 6".

  9.  This paper provides details of BizzEnergy's position and its response to the terms of reference for the Business and Enterprise Select Committee Inquiry into the UK energy market.

ANSWERS TO INQUIRY QUESTIONS

1.  Whether the current market structure encourages effective competition in the retail markets for gas and electricity

  10.  Whilst BizzEnergy believes that the basic UK energy market design is sound, the natural outcome of the drivers from such a design is consolidation and vertical integration. As a result of this, the market then looks to find an equilibrium and, as such, the existence of five or six players each with approximately 20% market share all similarly structured, tends to reduce the stimulus for competition.

  11.  These large players therefore, by necessity, adopt a systems-based approach to customer service and products—fitting customers to standardised products rather than bespoke solutions. Smaller suppliers are more commercially flexible and should be able to service customers' requirements more precisely. This offsets the benefits of scale and sustains the competitive market.

  12.  A further tendency for markets in this position is to:

    —  Increase barriers to entry.

    —  Develop sophisticated customer retention strategies restricting the ability of customers to switch.

    —  Introduce increasingly complex trading arrangements.

  13.  An effective market design needs to have transparent costs and prices in order to stimulate and encourage both competition and new entry. Unfortunately, the current design does not have the required level of transparency and therefore does not stimulate effective competition for either generation or supply from a new entry perspective.

  14.  Two thirds of the market players have integrated European financial accounts and it is therefore impossible to identify what profits are being made from the UK. Further, these accounts do not reliably or effectively separate generation or supply profits, so even if UK accounts were to be published a new entrant would need to enter both sides of the market to access any available margin with confidence.

  15.  The current market design was supposed to facilitate entry into generation or supply separately and not require parties to enter both. Bizz is, therefore, concerned that the current structure does not encourage effective competition as per the original market design.

  16.  An obligation to report segmented gas and electricity supply business accounts will further remove the ability of larger players to cross-subsidise their activities.

  17.  We are also mindful that security of supply is a big issue and that alternative market arrangements as laid out in Appendix 3 may be worth some consideration.

2.  Whether there is effective competition in the wholesale markets for gas and electricity

  18.  Vertical integration, as it exists in the UK, reduces the need for the vertically integrated players to use the wholesale market. Each company has sufficient generation to supply their domestic and SME customer base. Larger I&C customers are generally supplied on market related shorter term, index type transactions.

  19.  Companies, therefore, naturally tend to hedge their sales from their own generation first and then to the extent that there is a need to trade in the market. Thus, liquidity in the wholesale market is focused on the first season. Liquidity beyond this point is poor and declining (See Appendix 2).

  20.  To give a specific example of this, BizzEnergy seeks to benefit customers by offering them a choice of contract length of up to four years. We are risk adverse and wish to hedge out any liability incurred in the wholesale markets. The best products for us to use are a combination of baseload power (24 hours a day) and peak power (7.00 am to 7.00 pm weekdays). These products do not, however, trade reliably in the market. Peak power does not trade out beyond the first year, and contracts for two and three year baseload rarely trade. Bids and offers are always available in the market, but the spreads are usually large and the prices on offer usually significantly more than the retail margin, and the prices at which trades can be transacted frequently bear little or no relation to the offers that are being made to customers by the vertically integrated players.

  21.  The issue for new entrant generation is that in the absence of a reliable, deep and liquid market they will be forced to sell their output to one of the vertically integrated players on a long term contract, thus further depriving the market of any new liquidity.

  22.  A further issue with the current wholesale arrangements is "cashout". This is the mechanism by which any imbalance in a player's contractual position is settled. The mechanism for "cashout" is extremely complex, and is recognised as such by the regulator. The prices are supposed to represent the energy costs of settling the imbalances, but these are widely acknowledged to be polluted with other costs such as system operation costs. The impact of this pollution is increased costs on smaller parties and non-vertically integrated parties which has the effect of distorting competition. OFGEM is carrying out a review of this, but has been doing so on and off for some years, and the industry awaits its findings.

3.  The implications of growing consolidation in the energy market

  23.  BizzEnergy is frequently concerned by vertically integrated players making offers to customers below the (apparent) wholesale market level, making it exceedingly difficult to compete. Proving the existence of predatory pricing is difficult and complex. However, we did note a statement from EON in the FT in March, "the company had lost money on its retail business last year and expected to do so again this year". This was an effective admission of cross subsidy and underlines the difficulties faced by smaller players trying to enter the market who cannot subsidise their accounts in this fashion.

  24.  The main issue—from BizzEnergy's perspective—is the lack of transparency of energy suppliers' accounts and the loss of a common reference price against which to judge and measure the performance of the generation and supply arms of the vertically integrated businesses. This inhibits the opportunities to enter the market for new entrants, which we believe should be a concern to regulators, the Government and most importantly public confidence.

4.  The relationship between the wholesale and retail markets for electricity and gas

  25.  Whilst BizzEnergy cannot comment in detail as we are not active in the gas market, there can be seen a lag between price movement in the wholesale market and published tariffs (see Appendix 5).

5.  The interaction between the UK and European energy markets

  26.  BizzEnergy has found the barriers to entry in most European countries insurmountable. However, the recent passing of an anti cross-subsidy law in Holland makes the Netherlands market attractive and we are actively considering setting up in that country in the next year.

6.  The effectiveness of regulatory oversight of the energy market

  27.  As a natural outcome, when a market matures into a position of considerable integration and consolidation, we would expect to see the need for increased regulatory scrutiny and advocacy of consumer positions. The current trend, however, appears to be the reverse, with light touch regulation and the abolition of the consumer advocate energywatch being prime examples.

  28.  BizzEnergy believes that OFGEM is a generally effective body, but that it has areas where its activities are restricted. For example, it appears to take a literal interpretation of the highly complex industry rules rather than a general and purposeful interpretation. Thus, parties may be carrying out operations that have the effect of inhibiting competition, but are still compliant with poorly drafted industry rules.

  29.  In order to change, OFGEM must compete with companies who, due to the nature of their size, have considerable resources. The presence of the Competition Commission and the appeals process creates an additional hurdle for OFGEM to clear if any substantive changes are to be made against the views and interests of the incumbents. This, by its nature, slows down the speed and effectiveness of the Regulator.

  30.  To date, OFGEM has used relatively simple measures of competition to assess the effectiveness of the market, for example numbers of customers switching. We believe that this is too simple for a mature market and that other more effective measures should be developed. It rarely issues any information on competition in the business markets, and it seems to make information available on domestic markets no more frequently than once a year, which is inadequate.

7.  Progress in reducing fuel poverty and the appropriate policy instruments for doing so

  31.  BizzEnergy is not an active supplier of domestic customers, although we are looking to enter the market later this year. Fuel poverty is a serious concern and we do not believe that the current definition adequately captures the extent of the issue in the UK.

  32.  For example, in its annual report published in March 2008, the Fuel Poverty Advisory Group said more than 2.3 million of the most vulnerable households in England alone are now forced to spend at least 10% of their income to heat and light their homes.

  33.  We, therefore, believe that some urgent work is required to identify those who need assistance and fall within the real fuel poverty bracket. Fuel poverty, in our view, is not just related to pre-payment meters nor to the level of disposable income spent on fuel.

  34.  Energy prices will be minimized, and therefore fuel poverty reduced, in the longer term by ensuring competitive energy supply markets prevail. Specific market segments may require innovative products and service arrangements, and these are most likely to emerge when there are no barriers to market entry or prohibitive requirements upon continued market operation. Ultimately fuel poverty is a social issue that requires a political solution; it should not be tackled primarily through legitimising more cross-subsidy in a market that already manifests insufficient transparency.

CONCLUSION

  35.  Vertically integrated parties (with more than 10% market share in supply) should be obliged to transact through an open market any volumes that they transfer between their generation and supply businesses. They should be obliged, by licence, to separate their generation and supply business accounts and operate them in a sensible manner, as if they were a standalone business [Market in Financial Instrument Directive].

  36.  In addition, they should be obliged to separate UK licensed activity accounts and make them independently available as if they were a standalone business. Segmenting accounts between supply and generation may not be sufficient for the introduction of due visibility within the "Big 6". It may be necessary to go further and separately account supply activities between:

    —  Gas and Electricity.

    —  I&C and smaller customer markets.

    —  For smaller customers, those activities where they have been historically dominant and otherwise.

  37.  This approach allows vertical integration and economies of scale, but establishes an openness and viability of the underlying nature of transactions. OFGEM has indicated that they believe I&C and gas markets are national whilst the supply of electricity to smaller customers is still a regional market and so this approach will reinforce their market overview.

  38.  BizzEnergy calls for:

    —  Clear and effective regulation from Government that will limit the negative impact of vertical integration in the UK energy market. In the current environment where no one seems willing to challenge the prevailing wisdom that markets are better than regulation, one of the unintended consequences of liberalisation is that the market is taking the easy option and passing the higher costs on to consumers.

    —  New rules on market transparency. The problem of concentration is undeniably made worse when dominant companies are not required to reveal basic supply information to smaller market players.

    —  Licensing separation. This would increase market transparency and increase market confidence.

  39.  Competition does benefit consumers. However increased competition and an end to the privileged position held by certain suppliers would offer higher quality and more varied services to energy users at lower prices. This would lead to a better functioning competitive market, which would ensure sufficient investments in power plants and transmission networks thereby helping to avoid interruptions in power supplies and protecting security of supply. An increased degree of transparency would, additionally, minimise distortions in the market, and thus, the market would be more robust, and ultimately, the customer would be better served.

  40.  BizzEnergy thanks the Chair of the Committee for the opportunity to provide this written evidence to the Business and Enterprise Select Committee, and would welcome any further enquiries from members on the issues raised. Additionally, Bizz would happily provide oral evidence to the Committee as part of the ongoing Inquiry.

APPENDIX 1

STATEMENT PREPARED BY DEEPAK LAL OF ECLIPSE ENERGY FOR BIZZENERGY

  The below is an excerpt from a BizzEnergy-commissioned article by Eclipse Energy.

What is wrong with the power market?

  The market is dominated by six big players. Such market concentration is anti-competitive and it is deterring new entry into the market. It is also making the market opaque to the detriment of independent players and customers. We need to borrow ideas from other markets to address the short-comings of the power market.

Conventional wisdom?

  The changes that we would like to see in the power market are based on conventional wisdom. Some of this wisdom has appeared in the principles underpinning the Market in Financial Instrument Directive 2004/39/EC (MIFID) regulations. The objective of MIFID was to create an open competitive market in the financial services industry to safeguard the interests of stakeholders and consumers. The impact of MIFID is to enhance the:

    —  competitive landscape;

    —  transparency of the market;

    —  market liquidity; and

    —  protection of customers.

  Whilst the details of MIFID are specific to the financial services market, the objectives are common to many markets. Indeed, the wholesalers in the energy market are not dissimilar to the brokers in the financial services market in terms of meeting the needs of their customers through the traded market. Many power market commentators will be making similar points because the underlying objectives are broadly the same.

What needs to change in the power market?

  The competitive landscape is such that the power market is dominated by six vertically integrated players. The Hirschmann-Herfindal Index (HHI) is a commonly used index that provides a measure by which it is possible to judge whether there is effective competition in a market. The HHI for retailing power in the UK shows that the market is far too concentrated. An Ofgem report on the domestic retail market put the HHI at about 1765 in March 2007[10] and this level of concentration is undermining competition. New entrants find it hard to challenge the dominance of the incumbents. Further market consolidation (such as the takeover of Scottish Power by EDF) is not in the interests of the end-consumer. The question is whether specific action should be taken to reduce market shares of the big six.

  The concentration of market shares in retail is inevitably going to have an impact upstream in both trading and generation activities. This is evident by the poor level of liquidity in the wholesale market.

  The big six players are ensuring that the market is opaque by doing bilateral deals. Such deals are not visible to the rest of the market. The most insidious deals are those done between the different divisions of the same company, particularly between the generation and retail divisions. The lack of transparency here means that independent players, particularly in the retail market, are at a serious disadvantage because they do not know whether they can procure energy on the same terms as the retail divisions of the big six. The current arrangements also allow the existing players to arbitrarily move profit margins between the two divisions to the disadvantage of competitors.[11] Enhanced reporting through a separation between the accounts of the retail and generation divisions and an obligation to treat all trading counter parties equally is likely to make a significant difference to the creation of a fair competitive environment.

  MIFID has shown the way by expecting better reporting on deals to safeguard the market and the interests of the stakeholders in the market. Further, a "best execution" obligation under MIFID has put an onus on the service provider to demonstrate that the service provider is getting the best prices for its clients which implicitly requires audit trails to demonstrate compliance with the obligation. In addition, under MIFID, a Systematic Internaliser is a firm that may execute orders from its clients against its own book. Such players are required to meet the requirements for trading transparency.

  The bilateral deals between the big six players and also between the various divisions of the big six players are having a major impact on the lack of trading liquidity. The lack of liquidity and transparency is deterring new entrants into the market which is compounding the impact of market concentration. Vertical integration in-itself may not be a bad attribute of the market. Indeed, vertical integration might be encouraged, but only if it is coupled with transparency and liquidity. The alternative is the break-up of vertical integration companies as a means to force transparency and liquidity into the market.

  Enhancements to the competitive environment in the power market would have a major impact on customer protection. We believe that the interests of the customers are best served by transparent and fair competition between suppliers backed up by the supply licence conditions to ensure that suppliers meet their reasonable social obligations.

  It has been a long-standing goal that there should be light-touch regulation in the power market and that the accepted view was that regulation was a poor substitute for robust competition. Light-touch regulation can only follow when there is confidence that the competitive market is working. The lack of transparency undermines the confidence in the workings of the market amongst the customers, the industry players, the regulator and the government.

APPENDIX 2

STATISTICS

  The following tables use market data to provide evidence that current markets:

    —  do not bring forward the products required to service long-term supply contracts (see table 1);

    —  when appropriate wholesale products are available, they are only liquid close to delivery ie a very short-term perspective (see table 2); and

    —  do not provide sufficient depth of liquidity to facilitate a normal wholesale market environment (see table 3).

TOTAL NUMBER OF TRADES OCCURRING IN EACH YEAR FOR ANNUAL PRODUCTS
Count2004 20052006 2007
Base 1 Yr1,369 5131,279 1,691
Base 2 Yr199 26321 325These figures shown that peak products for periods longer than a year simply
Base 3 Yr16 0310 do not exist, and that even baseload products of longer than a year are rare.
Peak 1 Yr77 204831 The tools to back out a customer contract of longer than a year on the day it
Peak 2 Yr20 10 is signed therefore do not exist.
Peak 3 Yr00 00
Necessary products do not exist
LS44 1 Yr62 154430
LS44 2 Yr20 10
LS44 3 Yr00 00
MWhTotal Volume
Traded
Total System
Demand

%

(Total traded volume calculated as a sum of all baseload and peak trades reported for a given season)

S04
158,163,408 142,816,565111
S05157,960,920 157,760,747100
S0688,452,624 157,207,03756
S07147,806,256 152,095,63797 The number of times each individual unit required is traded has been decreasing steadily over the
past few years, although has enjoyed a slight upswing on the recent couple of seasons. During the low
W04275,739,360 177,108,878156 point in 2006 it was not possible to trade sufficient volume to cover the demands of the national customer
W05205,233,600 191,580,945107 base. Even at the high point of trading in Winter 2004 the average unit of demand was only traded 1 and
W06138,756,072 183,080,67876 a half times which is much lower than the figure expected of a liquid market.
W07232,180,104 184,735,447126



CUMULATIVE PROPORTION OF TOTAL TRADE COUNT OF SEASONAL BASELOAD TRADE AS
%S06W06 S07W07
M-50 %(Here M-x indicates the period x months before deliver)
M-49 0%See also Graph "Trade Proportions"
M-48 0%
M-47 0%
M-46 0%From this table it can be seen that 75-80% of trades in a seasonabl product occur in the 12 months prior to delivery, with as much as 30%
M-45 0%of the total trades that occur not taking place until the three month period prior to delivery. So even where a product does exist within the
M-44 0%0%market the window where it is available is frequently short and not open for regular backing out of customer contracts.
M-43 0%0%
M-42 0%0%
M-41 0%0%
M-41 0%0%
M-40 0%0%
M-39 0%0%Existing products are not available when the would be useful
M-380% 1%0%
M-370% 2%0%
M-360% 2%0%
M-350% 3%0%
M-340% 3%0%
M-330% 3%0%
M-320%2% 3%1%
M-310%2% 3%1%
M-300%3% 3%1%
M-292%3% 3%1%
M-283%3% 3%1%
M-274%4% 3%1%
M-268%5% 3%1%
M-2511%5% 4%1%
M-2414%6% 4%2%
M-2315%6% 4%2%
M-2216%7% 4%3%
M-2120%8% 4%4%
M-2022%9% 4%5%
M-1924%11% 4%6%
M-1825%14% 6%8%
M-1727%18% 7%10%
M-1628%22% 9%12%
M-1530%22% 13%14%
M-1431%22% 15%17%
M-1332%22% 18%20%
M-1237%30% 21%23%
M-1143%35% 24%26%
M-1054%39% 27%29%
M-955%46% 32%38%
M-855%52% 36%49%
M-755%60% 46%61%
M-663%66% 50%66%
M-572%73% 57%72%
M-476%80% 62%76%
M-384%90% 79%86%
M-293%95% 90%94%
M-1100%100% 100%100%


APPENDIX 3

ALTERNATIVE MARKET FOR NEW PLANT

  There is now an urgent requirement to commence construction of a new generation of low carbon power stations to replace the current coal and ageing nuclear stations retiring between 2015 and 2020. The only two realistic options available to provide sufficient electricity to meet the nations needs are nuclear or fossil fuel plant with carbon capture and storage. Both these solutions are highly capital intensive compared to CCGTs and developers are understandably looking for government assurance and guarantees on market prices before risking the capital investment required. Unfortunately such assurances tend to reinforce the current oligopoly and make competition from new entrants more difficult.

  BizzEnergy is very anxious that no plant shortage develops as plant shortages will only contribute to higher retail prices. Our position is simple, we need a market based solution which kicks start the construction of new plant whilst maintaining liquidity in the whole sale markets and increasing opportunity for new entrants in both supply and generation.

  Such criteria could be easily met by the introduction of capacity tickets to be auctioned by NGC for the first 5000MW of new low carbon plant. Tickets would be open to developers with sites capable of achieving planning permission and auctions held regularly in tranches up to the 5000MW limit. It might be fair to exclude companies from European countries where access to energy markets remains restricted.

  Once commissioned, NGC would trade the output from the new stations via the exchanges. If the output receipts exceed the price of the capacity tickets the surplus would go toward reducing the BSUOS cost. If below the sum of ticket and marginal costs, BSUOS would be increased to cover the total cost. It is envisaged these capacity tickets would last between 8 to 12 years to provide developers with confidence to commence construction.

  The requirement to trade all the output from the new stations (around 30TWh) would improve the liquidity in the wholesales market and give a clearer indication of future market prices to allow new low carbon plant to be constructed.

APPENDIX 4

FOR INFORMATION ONLY

THE HHI

  Effective competitive markets are predicated on having sufficient competing actors. The risk of market dominance is a major issue in most competitive markets. A commonly used index for measuring market dominance is the Hirschmann-Herfindal Index (HHI). The market share (%) of each market participant is squared and summed to produce a score on the index.

    —  100,000 is a monopoly.

    —  1,800 and above is a highly concentrated market and in the USA, a merger leading to a score greater than 2000 would probably be challenged.

    —  A score of 500 to 1,000 is deemed a highly competitive industry.

RETAIL POWER HHI

  Ofgem carried out a review of the HHI for the non-domestic retail market in November 2005. The HHI score in the electricity market decreased from 1695 in November 2003 to 1575 by the end of 2004. The implication is that the market was not as competitive as the regulator may have wished.

  Figure 1 charts the changing HHI scores for the domestic market. The data were taken from an Ofgem report on domestic retail competition in June 2007. The ultimate source of the data was the Distribution Network Operators.

Figure 1

HHI NATIONAL MARKET SHARES IN DOMESTIC ELECTRICITY MARKET


Source: Ofgem report

  The process of market consolidation has lead to an increase in the HHI score in electricity as the big players take over more businesses. The HHI is high and it has been reasonably stable in the 1,700 to 1,800 range for some time. A reduction in the value of the index is desirable and any increase would be a significant cause for concern. Over the period from December 2002, the market share of the independents outside of "Big Six" retailers has hovered between 0 and 1.5%. It shows that over a sustained period of time, the market is not conducive to new entry.

  Based on the HHI scores, it seems that the retail market in electricity supply is too concentrated and new entry into the market might be desirable.

APPENDIX 5

WHOLESALE VERSUS RETAIL PRICES

  Trends in baseload (year ahead) wholesale gas prices and household price increases since September 2004 are demonstrated below:



Source: Cornwall Energy Associates

  Trends in baseload (year ahead) wholesale electricity prices and household price increases since September 2004 are demonstrated below:







10   The HHI has been consistently above this level since 2002. Back

11   Some commentators have challenged the profits made by industry players as excessive and detrimental to the end-consumer. We do not believe that making profits in a competitive market is acting against the interest of the consumer. What we are concerned about is making profits in a non-transparent way. Back


 
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