House of Commons - Business and Enterprise

Select Committee on Business and Enterprise Written Evidence

Memorandum submitted by Centrica

CENTRICA'S SUBMISSION TO THE BUSINESS AND ENTERPRISE SELECT COMMITTEE INQUIRY INTO THE UK'S ENERGY MARKET

Centrica plc (Centrica) was formed in February 1997 when the former British Gas plc was demerged to form BG Group plc and Centrica. In Great Britain, Centrica trades under its brand names, British Gas, Scottish Gas and Nwy Prydain. It is the UK's largest energy supplier, supplying around 10 million gas and 6 million electricity customers in the domestic sector and has around 950,000 supply points in the non-domestic sector. It also owns upstream gas production and power generation assets to support its supply businesses.

Centrica is pleased to submit written evidence to the Business and Enterprise Select Committee inquiry into the UK's energy market. We trust that both this inquiry and the investigation into the energy markets announced by Ofgem on 21st February will reassure and satisfy consumers and opinion formers that the UK energy market is working in the best interests of customers.

Our submission covers the areas outlined in the Business and Enterprise Select Committee press release of 5 February 2008, principally:

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

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

3. The implications of growing consolidation in the energy market;

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

5. The interaction between the UK and European energy markets;

6. The effectiveness of regulatory oversight of the energy market; and

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

1. COMPETITION IN THE UK RETAIL ENERGY MARKET

1.1 The UK gas and electricity supply markets are characterised by the presence of six large retail suppliers to the domestic market, British Gas, Scottish and Southern Energy, Eon, Scottish Power (Iberdola), EdF Energy and npower (RWE) and a number of smaller niche players (for example, suppliers offering electricity from renewable sources eg Good Energy). Centrica is the smallest of the six companies by market capitalisation with four of the competitors being part of very large integrated European utilities.

1.2 In the non-domestic market, where competition was introduced much earlier than in the domestic market, there are more players. In this market, we have seen some new players independently enter the energy market in the last three years such as Utilita, Smartest and Bizz Energy.

1.3 The presence of six major competitors in the domestic market is capable of supporting effective competition. All these suppliers operate in a highly competitive market. When measured against the usual indicators of competitiveness, namely pricing, product innovation and switching, the UK's energy retail market emerges well. Indeed, as recently as 30th January 2008, research by independent energy consultancy Oxera for the Government concluded that: "the UK energy market is the most competitive in the EU and G7", and that "creating an open and competitive energy market has meant that UK consumers have consistently benefited from amongst the lowest energy prices in Europe."[13]

Pricing and product innovation

1.4 UK energy prices are still cheaper than prices in many EU Member States that have been slow to liberalise their markets. The graph below shows that the UK domestic gas price (excluding taxes) for medium consumers was the lowest in the EU 15 and 30.1% lower than the median price.[14]

ESTIMATED AVERAGE DOMESTIC GAS PRICES FOR MEDIUM CONSUMERS[15] IN THE EU AS AT 1 JANUARY 2008

1.5 In electricity, the UK price, excluding taxes, was the seventh lowest in the EU 15 and 17.0% below the median price as shown in the graph below.

ESTIMATED AVERAGE DOMESTIC ELECTRICITY PRICES FOR MEDIUM CONSUMERS[16] IN THE EU AS AT 1 JANUARY 2008

1.6 Competition in the retail energy market has also delivered an increasing range of new and innovative products and services as suppliers compete to keep customers by offering products such as fixed/capped prices and green offerings. Around 4.2 million UK households have chosen new ways to buy their energy which range from on-line, fixed and capped rate products to green energy and low-price protection packages for fuel poor customers. For example, 2.4 million customers on fixed term, fixed price contracts were protected from British Gas' most recent price increase.

1.7 Most suppliers are coming forward with green tariffs for customers who want to cut carbon emissions and this is also an area which has attracted entry from specialist green suppliers in response to growing consumer awareness of the need to cut carbon emissions. Nearly 350,000 customers in Britain have chosen a green tariff.

1.8 British Gas offers its customers two green tariffs, Future Energy and Zero Carbon, both backed by electricity from renewable sources and with a contribution into the non-profit British Gas green fund, which supports UK schools in reducing their CO2 emissions and development of new renewable technologies and resources. Additionally, Zero Carbon contains carbon offsetting.

1.9 On-line tariffs have also been introduced, originally as a niche product, and now offer the lowest prices and by doing away with paper bills, on-line tariffs also bring environmental benefits.

1.10 Suppliers are also being increasingly innovative with energy efficiency packages. British Gas, for example, introduced an Energy Savers Report to help customers save money when energy bills were rising in February 2006. Over 1.7 million customers have completed a report which gives an energy rating for the home and offers simple advice as to how to improve the energy efficiency of the home (eg by installing energy efficiency measures or by behavioural changes) which could lead to savings of £175 per annum on the average energy bill.

1.11 Additionally, suppliers are also seeking to extend and improve on existing service to the benefit of consumers. For example, British Gas has separated out its prepayment meter customer segment to become a separate unit so we can focus on the needs of that customer segment and better tailor our processes and costs. One of our first steps has been to trial the new EnergyPOINT device. This device which is easy to install and use allows customers to top up their prepayment credits at any time from their own homes saving them a trip to retail payment outlets (such as the Post Office). 10,000 EnergyPOINT units are to be trialled in customers' homes and should be made more widely available from May 2008.

Switching rates

1.12 As a consequence of this innovation and competition in the market, annual rates of switching are high. In excess of 100,000 domestic consumers are switching supplier each week, with over 4 million (some 20% of customers) switching in 2006 alone.[17] This is in comparison with only 9.2% domestic electricity customers who have switched in Germany and only 1.3% of total gas volumes (no customer figures published)[18].

1.13 Contrary to the perception that prepayment customers do not switch as much as other segments, prepayment meter switching has been growing since 2005 and is now the most active switching segment. Our own research shows us that for the three month period up to January 2008, customer defection levels for our gas prepayment business were 79% higher than for our overall gas customer base. This is 30% higher than for the same period last year. Our research also shows that for the three month period up to January 2008, customer defection levels for our electricity prepayment business were 77% higher than for our overall electricity customer base. These figures are 45% higher than for the same period last year.

1.14 This consumer appetite for switching has led to the growth in the number of switching internet sites in recent years, which now stands at 12. Sites such as uSwitch advise customers on the best deals and offer customers significant savings on energy bills if they switch to a cheaper supplier.

1.15 The exceptionally high switching rates that we have seen in the UK since the market opened are reflected in the changes in market share. In the ten years since competition was introduced, British Gas has seen its market share for gas reduce from 100% pre competition, to around 46% currently as other companies have built market share. Conversely, the introduction of competition in electricity has meant that British Gas has been able to build an electricity base from zero to a current market share of around 21%.

1.16 In our view, the levels of switching and the range of new and innovative products and services available in the market place from a range of suppliers, indicate effective competition at the retail level.

2. COMPETITION IN THE WHOLESALE GAS AND ELECTRICITY MARKET

Wholesale gas market

2.1 In the last five years, there have been significant changes in the UK's energy markets with the decline of North Sea gas reserves and an increased dependency on gas imports. By 2015, the UK market will be importing as much gas as it produced in 2007.

2.2 The UK competitive market has responded well by bringing on significant new investment with 24 companies from 11 countries currently investing over £10bn in the UK energy market. New capacity has taken the form of new pipelines (eg Langeled capable of bringing nearly a quarter of UK peak requirements from Norway), enhancements to existing interconnectors with continental Europe (eg Interconnector UK) and new LNG facilities built (eg Isle of Grain). Centrica's own gas purchase contracts with Statoil and Gasunie have helped underpin the investment case for new infrastructure, especially Langeled and BBL. The major new gas import facilities in the UK are illustrated below.

MAJOR NEW GAS IMPORT FACILITIES[19]

2.3 Importantly though, this new capacity has not necessarily translated into the same volumes of gas flowing into the UK. LNG is becoming a global gas market with increasing arbitrage opportunities between the European, American and Asian markets and the Asians are presently paying the highest prices for spot LNG. These market conditions have meant that UK LNG terminals have often been left idle this winter. The addition of Langeled and the Tampen Link Spur to add to Vesterled has led to the UK being exposed to much greater producer arbitrage. Total and individual flows from these supply sources into the UK are highly variable and difficult to predict given the lack of transparency in continental European markets. Of particular concern though has been the absence of gas flowing through the Interconnector from continental Europe, even when gas price differentials between the UK and Europe would indicate that gas should flow.

2.4 This unpredictability of flow of physical gas to the UK has led to significant volatility in the wholesale gas market and has contributed to rising wholesale gas prices. For example, prices in early 2007 fell to a low of 13 pence per therm and then rose by 47 pence to a high of 60 pence per therm at the end of the year with huge intra day volatility.

2007 UK DAILY WHOLESALE GAS PRICES[20]

2.5 The dwindling North Sea reserves and the current supply constraints and volatility are compounded by the fact that the UK has the lowest level of gas storage capacity of any major EU economies, at around 5% of its annual demand. Even with the current planning reform proposals, the situation will take several years to improve. There are a number of storage projects in the pipeline including the recently announced plan by Centrica and its partners to look at the feasibility of converting the Bains gas field into the UK's first new offshore storage facility for over 25 years.

2.6 There is no indication or suggestion that the increase in UK wholesale market prices has been driven by anti-competitive behaviour. On the contrary, there have been numerous independent inquiries into the UK's energy market since 2001 including by the EU Commission, BERR (formerly DTI) and Ofgem and all have concluded that the UK market is fully competitive[21]. However, there are problems deriving from the largely unliberalised European energy markets which have a distorting effect on the UK market. This subject is discussed in more detail in section 5 of our submission.

2.7 We believe the UK wholesale gas market is generally operating effectively. There is good transparency of information with regular and timely notifications of UK field outages and gas flows. By contrast, we have concerns about the limited transparency in continental European gas flows and transparency could also be improved for the volumes of Norwegian gas flowing into the European market.

2.8 Liquidity of the market has also improved after a period of decline when a number of traders exited the market. Recent signs of improvement include award of 10 new supply licences and 20 new shipper licences to banks and other new entrants in the last 12 months.[22] As the graph below shows, liquidity for the early part of the year in 2007, January—April, was at its highest level to date.

Source: Heren Energy

2.9 We have, however, observed that there is a lack of long-term liquidity. This could relate to the relatively recent reduction in reliability in some of the assets in the North Sea due to age with outages and uncertainties around when flows will resume. We believe that this uncertainty, together with the significantly greater price volatility in the UK has contributed to producers' (physical players) reluctance to sell further out. In addition, the nature of trades has also changed with much of the current traded gas relating to financial positions/spark spreads (ie arbitrage between different fuels) rather than physical positions.

2.10 However, even non-physical players are reluctant to trade out much into the future. This reluctance could be eased if the uncertainty and hence risk was reduced by increased transparency and thus predictability of European and Norwegian gas flows. This in turn could reduce volatility in the wholesale market, easing producers' concerns about similar trades and thereby creating a virtuous circle. This point is expended upon in more detail in section 5 of our submission.

Wholesale power market

2.11 The wholesale power market differs from the wholesale gas market in that the power market has limited interconnection. It is also characterised by a greater degree of vertical integration where a company participates through the entire value chain from generation to supply. Despite this degree of vertical integration, it is important to note that over 40% of the generation market is held by independent generators without significant residential market positions. The generation market shares are shown in the chart below.[23]

2.12 The market is also characterised by a close linkage between gas wholesale prices and electricity prices. This is because gas-fired generation accounts for 40% of UK electricity supplies and with gas-fired generation at the margin for significant periods of time, electricity prices are driven in large part by UK gas prices and therefore are affected by the increases in wholesale gas prices. This is illustrated in the graph below.[24]

2.13 Vertical integration through asset ownership and/or by contract is a natural reaction to power price volatility as it helps companies to manage wholesale price volatility and provides greater certainty in customer prices. As a result, all the six major energy retailers are vertically integrated to a certain degree, though as the chart below shows, Centrica is the least vertically integrated of all suppliers. In fact, the level of "internal" generation cover varies between about 40% and 100% with the average at around 60%-70%.[25]

2.14 This means that the majority of the six must source additional generation from the market. This is done through trading on the BETTA market as well as other bilateral trades and contracts. Centrica welcomed the introduction of the BETTA electricity reforms in 2005 as it created a competitive wholesale market with a common set of trading rules, so that electricity could be traded across Great Britain. We believe that BETTA has played an important role in creating a level playing field for all generators and reduced barriers to entry.

2.15 A key indicator of healthy state of the UK market is the extent to which there is significant new investment including by Centrica (at Langage) and independent power generator Welsh Power (with their 800+MW gas-fired power station at Uskmouth). There is also significant plant at the planning/permitting stages such as Barking Power's 400MW plant extension and in addition, companies have plans for future build including Eon (at Grain, Kingsnorth). Of course, this is in addition to the numerous renewables developments to build onshore and offshore wind farms including Centrica's own investments (eg Lynn and Inner Dowsing which are at the final stages of construction).

2.16 It is vital that investors in the electricity generating industry should have confidence in the electricity and gas markets. For this to happen they need clear and stable public policy which minimises political and regulatory risk. The industry is poised to make very large investments in new power stations in the very near future and it could be very damaging if potential investors were to be confronted with new political and regulatory risk.

2.17 We hope that this review (and the parallel investigation by Ofgem) does not lead to proposals for fundamental change. However, if the Committee were looking for one area where improvements could be made, it would be around the free allocation of carbon emission allowances to the power generation sector under the EU Emissions Trading Scheme. Centrica has lobbied both the Government and the EU for the past four years to fully auction allowances on the grounds that this free allocation of allowances distorts the market in favour of polluting incumbents and raises the barrier to new entrants. Whilst the Government decision to auction 7% of the allowances under Phase 2 of the scheme which began this year, is a step in the right direction, we would have preferred that the Government had opted for the 10% limit allowed under the EU rules and ultimately full 100% auctioning. As long as free allowances exist, gas fired generators like Centrica are placed at a competitive disadvantage compared to coal producers such as Drax and SSE.

3. IMPLICATIONS OF GROWING CONSOLIDATION IN THE MARKET

3.1 In the UK, there has not been much consolidation in recent years since the wave of changes of ownership in the electricity sector which gave rise to the present structure. Such consolidation as has happened was subject to UK merger control and was only cleared once a thorough competition analysis had been carried out. Centrica itself experienced the thoroughness of this process upon its acquisition of the Rough gas storage facility from Dynegy which was considered by the OFT and then by the Competition Commission.

3.2 To our mind, it is not the consolidation which has taken place within the UK to date which should be a cause for concern but instead the continuing consolidation across Europe within markets where competition is still extremely weak and where such consolidation reduces the number of potential competitors in other European countries. It is also of concern that such consolidations may not necessarily be subject to the same level of detailed scrutiny by other national competition authorities as we have experienced in the UK.

4. THE RELATIONSHIP BETWEEN THE WHOLESALE AND RETAIL MARKETS IN GAS AND ELECTRICITY

4.1 Wholesale price volatility has an inevitable and profound effect on UK retail prices given that around 50% of the customer's bill is the cost of the commodity. The remainder is largely fixed costs such as transportation and distribution costs which have risen by 7% or £14 alone this year and metering costs. Increasingly Government levies are an important component of the bill with the costs of the Renewables Obligation and the Carbon Emissions Reduction Target adding around £10 and £38 per annum respectively.

4.2 The chart below demonstrates how much of the retail gas price is made of the wholesale price and transportation and transmission costs. In our experience, the net margins made by the retail supply business for gas are at best a few pence per therm but the commodity price is over 40 pence per therm. What therefore really drives gas prices in our view is not retail margins, which have been consistently modest, but wholesale price movements[26].

4.3 By way of example, British Gas's average net margins over the last 6 years have only been 3.6% which is much lower than in many other industries.

4.4 We have responded to significant movements in wholesale gas prices and last March and April (2007) we announced two price reductions totalling 20%. However, very sharp increases in the wholesale cost of gas from spring onwards reduced British Gas's margins to just 1% and with wholesale prices at their current level British Gas would have been loss making in 2008 without our January tariff increase.

4.5 It is vital that Centrica as a group remains profitable in order to fund the billions of pounds we need to spend to secure vital sources of gas and power for our customers and to remain competitive in the future. By 2015, the UK will be importing around 75% of its gas from overseas[27]. We have to be able to fund the acquisition of new assets and contracts to ensure that gas is available to our customers in the years ahead.

4.6 Acquiring and building more upstream gas and power capacity to reduce exposure to volatile markets is a key strategic priority for Centrica. We already have plans in place to invest £2-3 billion upstream from 2007-2010, but it is clear we will need to invest billions more in low carbon power generation by 2020 on top of this. This will include more renewables and more storage capacity and possibly new nuclear and clean coal power plants with carbon capture and storage, all of which can cost up to 3 or 4 times as much to build as gas fired generation.

5. THE INTERACTION BETWEEN THE UK AND EU MARKET

5.1 As mentioned in section 2 of our submission, the UK market is increasingly linked to the energy markets in continental Europe.

5.2 Since the construction of the Bacton-Zeebrugge interconnector, the UK gas market has effectively become more linked to a wider North West European gas market. As a result higher oil prices which typically set the gas price in Europe have fed into UK market prices as more gas is imported from Europe.

5.3 A report by Global Insight in August 2005 explained the implications of the oil-gas linkage as follows:

5.4 Moreover, gas flows from the continent to the UK have been highly variable and difficult to predict given lack of transparency of information in EU markets. For example, gas flows information is currently published at less than 40% of the pipeline interconnection points in Belgium, Germany and the Netherlands. Contrast this with the UK National Transmission System, where inflows at the various terminals and sub-terminals are now made available every twelve minutes.

5.5 This unpredictability of flow has contributed towards a UK anxiety premium. For example, in Winter 2005/6 despite UK spot prices being as high as 200 pence per therm within day, we could not rely on European gas to flow into the UK. As recently as quarter four of 2007, Interconnector UK imports remained low despite high gas price differentials.

5.6 A recent example of this was Saturday 29 March, when there were relatively low levels of demand of around 300 mcm and prices peaked at 60.5 p/th on the OCM within day balancing market. Despite the within day market trading at more than a 5p premium to the forward month there were still no increase in flows from Europe coming through the Interconnector.

5.7 We believe that major continental suppliers have secured gas under long-term contracts at oil-linked prices, which effectively take precedence over gas being made available to the UK. The UK then becomes the swing destination for Norwegian gas with this supply acting like a supplier nomination contract. Our increasing import dependence means that the traditional gas on gas competition enjoyed in the UK as a result of a diversity of upstream gas suppliers is being superseded by oil-linked contracts from national oil companies within which the final destination of the gas can be varied.

5.8 In the last 100 days since 1 October, the Interconnector has exported more gas to Europe than it has imported, despite the wholesale price on occasions being over 3p/therm higher here than on the continent. Indeed, despite there being a +3p/therm difference in the wholesale gas price in the UK compared to Europe at times, the Interconnector has not flowed into the UK at any higher than 26% capacity. In comparison, its highest export flow was around 66% on 16th October.

5.9 Until there is a well-functioning competitive wholesale gas market in North West Europe, players on the continent will use the UK as a gas supplier of last resort at short notice but may not be able or willing to provide the reciprocal service to the UK in response to price signals. In this way, the UK suffers from being the gas bank for North West Europe.

5.10 This situation is caused by physical and contractual congestion on the continent, limited co-ordination of "open season" processes, secondary continental markets that are hardly functioning as well as varying security of supply standards in continental Europe.

5.11 In this context we acknowledge the efforts of the European Commission who have been vigorously pressing for competitive energy markets in the form of ownership unbundling. This is opposed by some European Governments who are reluctant to accept this critical step in the transition to more competitive markets.

5.12 We have seen some encouraging signs such as the decision by Eon to divest their electricity transmission business in Germany which should give greater transparency and potentially improve access by third parties to key infrastructure. However, there remains strong opposition, led by France and Germany, to enforced ownership unbundling, and numerous obstacles to the realisation of the internal gas market in particular.

5.13 The French and Germans have pushed for a so-called "Third Way". This is inadequate as it does nothing to address the serious concerns highlighted by the European Commission's lengthy recent investigation into the energy market. These proposals even fall far short of how the European regulators group, ERGEG, recently suggested that the existing second package legislation should be implemented.

5.14 Effective unbundling of transmission, with ownership unbundling being the cleanest and most effective solution, is key to unlocking many of the current problems but it will not be enough. Unless there are strong and independent energy regulators whose powers extend to promoting competition in the wholesale and retail markets, there will not be sufficient confidence to ensure a properly competitive retail market.

5.15 Centrica warmly welcomes the package of reforms proposed by the European Commission late last year. We agree with the Commission that the necessary reforms also include increased market transparency to bring European information up to the very high levels found in the UK market, adequate access to gas storage and effective separation of distribution from supply, the latter not having had the attention it deserves.

5.16 Whilst it is important to implement these changes in electricity, it is even more critical in gas, particularly for the UK. A country can, if required, increase its own generation using a diversity of technologies. However, as gas import dependency grows, most countries are increasingly dependent on cross-border flows to access the significant volumes of gas just outside Europe's borders. The best guarantee of adequate gas supplies from Europe into the UK is ownership unbundling of the gas transmission networks on the continent.

6. THE EFFECTIVENESS OF REGULATORY OVERSIGHT

6.1 Economic theory demonstrates, and competition authorities regard, competition as providing the best protection for consumers leading to better service, lower prices and/or a wider range of products or services. In the energy sector, given the monopoly nature of networks this must be coupled with soundly based price controls of network infrastructure, which accounts for a major proportion of the retail price. On network regulation in general, Ofgem has fulfilled its responsibilities in a broadly satisfactory and rigorous manner. It continues to develop a strong incentives based regime in this area as a proxy for competition. Whilst additional efforts are required in some areas, for example, cost of capital and gas quality, overall we support Ofgem's approach in this area.

6.2 In the retail energy market, Ofgem's regular reviews of the domestic market in the UK (for which all suppliers are required to provide information to Ofgem) continue to find competition in the retail energy market to be effective. This has been the case since Ofgem undertook analysis of the market which resulted in total removal of retail price controls over six years ago. Those price controls were removed because competition was found to be effective and capable of protecting consumers.

6.3 Since then the Competition Act has acted as the deterrent to anti-competitive behaviour underpinned by its strong information request powers coupled with the threat of significant penalties. Ofgem has exercised those powers in relation to a number of matters within the energy market.

6.4 Additionally, on each occasion that there has been consolidation in the energy market, this has been subject to analysis of the effect on competition at the time as part of the merger control process. Having been through the process itself, Centrica regards that process as robust and thorough. However, a separate consequence of the acquisition of UK energy retailers by European companies is that Centrica is now unique among the six major suppliers to the UK market in the level of segmental detail disclosed in its published accounts. To varying degrees, our competitors aggregate their operating performance by regions, market sectors and across the value chain with the result that it is not readily possible to determine their downstream supply margins in the UK market.

6.5 A number of activities within the energy market are licensed—with licence conditions supplementing competition law by setting out requirements relating to, amongst others, standards of service and customer protection. As with competition law, compliance with these licences is underpinned by the threat of investigation and penalties for non-compliance. The recent review by Ofgem of the supply licences to simplify them and make them more relevant to today's market conditions was an exercise we welcomed and supported. The review was a natural one to undertake given the nature of established competition in the market.

6.6 In addition to competition law and the licence framework, there are a number of industry arrangements which support the competitive market—these are subject to separate governance arrangements and/or self regulation. In our view, some of the industry arrangements supporting the UK energy markets are complex and can be costly to operate for existing suppliers as well as potential new market entrants. Ofgem is currently reviewing the nature of industry governance in this area and we believe that is an appropriate exercise of its regulatory oversight. In this area, it is our view that aspects of the industry arrangements have become overly complicated especially in the electricity market, where for example 25 separate data flows are required to complete a customer transfer. However, we believe it is important to also recognise that whilst complex, some aspects of the arrangements reflect the complexities of market design rather than any undue or intentional barrier. The governance processes themselves are becoming suffocated by the burden of maintaining over 10,000 pages of documentation and as a result parties may be deterred from initiating change proposals that would be of benefit to the market. Governance arrangements also differ sharply between codes, principally as a product of history rather than design.

6.7 Increased levels of self governance would be a positive step forward, particularly in areas where there is lower materiality, risk or contention. However, the issues of access and transparency would need to be properly addressed first. In addition, an enduring right of appeal to Ofgem must be in place for all matters that relate to industry arrangements.

6.8 In this area, we believe that the regulatory oversight should assist in ensuring that industry arrangements are proportionate and not over-complex. Given the presence of effective competition in the market, we believe that this is an appropriate focus for Ofgem.

7. PROGRESS IN REDUCING FUEL POVERTY

7.1 Much progress has been made in reducing the numbers in fuel poverty from 1996 when numbers stood at around 5.1 million[29]. However, with higher energy prices and lower disposable income, the number of households in fuel poverty has been rising with the Fuel Poverty Advisory Group estimating that around 2.9 million people in England are in fuel poverty in 2007 of which 2.3 were vulnerable.[30] The Government's target to eradicate fuel poverty amongst vulnerable households by 2010 looks increasingly challenging.

7.2 Fuel poverty is part of a wider problem of poverty and social exclusion which has been exacerbated by above inflation increases in the prices of many foodstuffs and other essentials. Poverty is an issue for government and requires a focus on increasing the incomes of those most critically affected and improving housing. However, energy suppliers play their part through Government schemes such as the Carbon Emission Reduction Commitment (CERT), and through suppliers' own corporate social responsibility (CSR) activity.

CERT

7.3 Energy suppliers currently offer a range of programmes through the Carbon Emissions Reduction Target (CERT) programme to support the fuel poor. Under CERT, vulnerable households are eligible for free insulation and energy efficiency advice from their energy suppliers. The Government is anticipating that 2.5 million insulation measures will be installed in vulnerable households during the CERT period from 2008-2011 under a doubling of the previous programme. This could potentially save householders up to £200 per year on their fuel bills, a significant saving for a vulnerable household.

British Gas voluntary initiatives

7.4 British Gas is firmly committed to playing its part by helping its more vulnerable customers through voluntary programmes as part of our corporate social responsibility agenda and since 2002 we have helped over 1.3 million fuel poor customers. We contribute the most of all the energy suppliers towards fuel poverty measures. In fact, around £7 in every £10 spent by energy suppliers on vulnerable customers initiatives is spent by British Gas.

7.5 A recent report from energywatch reviewing the six main energy suppliers' voluntary initiatives for vulnerable and fuel poor customers found that "British Gas has and will have made the most significant voluntary commitment to measures to reduce the impact of fuel bills on its vulnerable customers". In addition, the report found that at 0.49%, British Gas already contributes the largest proportion of turnover of all suppliers with the next highest, EdF at 0.16% and npower and SSE at 0.07%.[31]

7.6 Energywatch has calculated that if all other energy suppliers matched British Gas' spend as a percentage of turnover, another £72.3million would be spent on fuel poverty.

7.7 British Gas' Essentials social tariff is the largest on the energy market and offers up to 750,000 of our most vulnerable customers access to our lowest standard rates which is monthly direct debit. We also delayed our recent price rise for 350,000 of our Essentials customers until after the worst of the winter months.

7.8 In addition, we have also extended our financial commitment to the British Gas Energy Trust for a further four years, bringing our total investment in the Trust to £21.3 million. The Trust provides grants and advice on energy efficiency to help customers in debt pay their utility bills.

7.9 This winter we have also offered 25,000 of our most vulnerable elderly customers an additional support package. This initiative includes free loft and cavity wall insulation, a credit of up to £90 and advice for customers on how to manage their energy use and finances.

7.10 This commitment is in addition to an extensive programme of activity with our charity partners which include Help the Aged and Save the Children. For example, British Gas and Help the Aged are now in their eighth year of their strategic partnership to support the elderly and address winter deaths. More than £7 million has been invested in improving the lives of 1.9 million people.

2008 Budget proposals

7.11 In the Budget statement of the 12th March, the Chancellor announced that he wants suppliers to increase their spend on social tariffs from £50million to £150million per annum. He also stated that 5 million customers on prepayment meters should be given "a fairer deal."

7.12 This announcement reflects a worrying tendency towards short-term fiscal interventions or now even the suggestion of price controls for certain groups of customers in what is held to be a competitive market. Such intervention is contrary to the spirit of liberalised markets and could undermine investor confidence and even risk jeopardising construction of the critical generation and gas supply infrastructure we need. The announcement also comes at a time when the Government has recently reduced its spending on fuel poverty by cutting the budget for Warm Front which it acknowledges to be its main weapon for tackling fuel poverty by 20%.

7.13 We remain opposed in principle to any form of social tariff mandation; however, if legislation is brought forward and social tariffs are introduced in the Energy Bill we believe that our Essentials social tariff, referred to above, should be used as the industry standard. At the time of writing, discussions are ongoing between Government, Ofgem and energy suppliers in an attempt to reach a voluntary solution.

Prepayment meter equalisation

7.14 With regard to prepayment meters it is important to note that prepayment is not synonymous with fuel poverty, as only 25% of customers on prepayment meters are deemed to be fuel poor. Prepayment meter customers incur a higher cost to serve for suppliers through higher rental charges for the meters themselves, collecting cash payments, providing a 24/7 contact service and managing higher call volumes. According to Ofgem figures, there can be as much as a £85 cost to serve differential for prepayment meter customers compared to direct debit and around £65 difference for standard credit.[32] We believe this additional cost does not include the higher switching rates and therefore cost to serve of prepayment customers above.

7.15 Since the majority of fuel poor customers do not use prepayment meters, equalising prepayment meter tariffs to monthly direct debit would actually mean that the majority of the fuel poor customers—those not on prepayment meters—would end up paying more for their energy. This is because it would become more costly for energy suppliers to offer such low direct debit and standard credit prices as they currently do if they were forced to offer the same price to prepayment customers also (given the higher costs of serving prepayment meter customers).

7.16 Ofgem has raised this as a concern and has estimated that equalisation would make the 3 million monthly direct debit and standard credit customers who are fuel poor worse off, while only benefiting the small proportion of fuel poor customers that are on prepayment meters better. We would also give serious consideration to curtailing our targeting of prepayment meter customers for new business as these would simply drive higher losses.

7.17 In addition we believe that equalisation of prepayment prices to on-line direct debit is the wrong benchmark as our on-line product is a niche product with only 120,000 customers. If British Gas was compelled to equalise prepayment meter prices in this way, it is likely that we would stop providing the on-line tariff, which, if other suppliers followed, would threaten the business model for switching sites.

7.18 As mentioned above, British Gas's Essentials social tariff already equalises tariffs for vulnerable customers on pre payment or cash/cheque payments to our lowest offline direct debit tariff. We have 350,000 Essentials accounts to date and are committed to increase this to 750,000 by 2010. We are happy to have further discussion on the potential to rollout Essentials as a model for the industry standard.

7.19 Ofgem is currently conducting a review of price differentials and we are feeding into this process. They are also holding a summit on fuel poverty in April to which we will be contributing. We believe that this is the most appropriate forum for a proper and considered dialogue around the best and most appropriate way to help the fuel poor so that suppliers and Government resources can be targeted at those who need it most.

Role of Government

7.20 Identifying vulnerable and fuel poor customers has always been a challenge for the industry and it is keen to share more data with Government Departments to help improve targeting. Currently there is huge wasted effort and cost associated with searching for these customers and without access to benefits data to more accurately target eligible households these costs will escalate substantially. We have been attempting to work with the Department for Work and Pensions to achieve a greater level of access to its benefits data to enable us to better target the fuel poor. If successful, this will help to ensure that a greater proportion of the money invested in addressing fuel poverty goes to providing financial assistance rather than to funding targeting and marketing initiatives by suppliers which are currently inefficient.

7.21 Government aid could also be more efficient if better targeted. A recent study undertaken by the London School of Economics on behalf of the British Gas Help the Aged Partnership shows that individual pensioners could be losing up to £50,000 on benefits over a lifetime by not claiming their entitlement. These benefits currently sit in the Government's pot of £4.5 billion unclaimed benefits for older people, but 1 in 3 pensioners are not aware of who to turn to for help and advice on how to access these entitlements which could amount to between £5,000 and £50,000 per individual over a lifetime.

7.22 Currently everyone over the age of 65 receives an annual payment of £200 increasing to £300 for the over 80s, irrespective of income. This contribution goes some way to cover the annual cost of energy bills but often is not used to pay energy bills. We believe that winter fuel allowance should be paid directly to suppliers so that we can offset this against their energy bills.

CONCLUSION

Centrica believes that both the UK's retail and wholesale markets are operating competitively and are working in the best interests of customers. With amongst the cheapest energy prices in the EU, high rates of switching and suppliers offering a wide range of innovative products and services, the presence of six major competitors in the retail market is more than sufficient to sustain effective competition.

The UK's competitive market has responded to declining North Sea gas reserves by bringing on significant investment in new sources of gas. However this new capacity has not translated into equivalent gas volumes, leading to significant volatility in the market and rising wholesale gas prices. This has been compounded by the relatively low levels of gas storage in the UK. Increases in wholesale gas prices have also contributed to high electricity prices.

Wholesale costs account for around 50% of the customer's bill; therefore volatile wholesale markets have had an inevitable impact on consumer prices. Centrica has been quick to pass on reductions in wholesale costs to consumers. However it is vital that the company remains profitable in order to fund the billions of pounds needed to secure vital sources of gas and power for our customers.

We do, however, have continued concerns about the limited transparency in continental gas flows. The UK's market is increasingly linked to continental energy markets and a lack of transparency about continental gas flows has added to an anxiety premium in the UK market. In addition, lower than expected flows from Norway has exacerbated the problem.

Although we welcome the progress the European Commission has made to date in pressing for competitive EU energy markets, effective ownership unbundling with strong and independent energy regulators remains crucial to ensure competitive retail markets in the UK. The limited consolidation in the UK's energy market has been subject to rigorous scrutiny by the competition authorities, which is in stark contrast with the continent, where entry into the market remains difficult.

In these difficult times for the energy market, we remain firmly committed to playing our part in helping the Government meet its increasingly challenging fuel poverty targets. British Gas contributes the most of any supplier to voluntary initiatives and our Essentials social tariff is the largest on the energy market.

We remain opposed to any moves by Government to mandate social tariffs and believe that any short-term fiscal intervention in the market is contrary to the spirit of liberalised markets. We also believe that any move to equalise prepayment tariffs rates could have an adverse impact on fuel poverty as only 25% of prepayment meter customers are fuel poor.

Going forward some form of data-sharing with Government remains crucial to ensure that those eligible can access the help available to them in the most cost-effective way.