House of Commons - Business and Enterprise

Select Committee on Business and Enterprise Written Evidence

Memorandum submitted by Electricity4Business

INTRODUCTION

Electricity4Business is a UK-based firm and the only energy supplier in the UK that is dedicated to the SME (Small and Medium Enterprise) sector. The company was set up to take advantage of the deregulated energy market and currently has around 34,000 customers.

Despite being a fast growing and innovative company, we believe that much more can be done to ensure genuine competition in the energy market and the best possible deals for SMEs. Many of our senior staff have moved across from the "Big Six" firms to take on and address some of the criticisms currently being leveled at these companies including cost, transparency and customer service. With 60 years of combined experience in the utilities industry between them, we can therefore provide a great deal of insight and understanding of the issues and challenges of operating successfully in the UK energy market.

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

It is well documented that all six big energy suppliers have announced significant price rises since the start of the year. In early January, Npower put prices up for its electricity customers by 12.7%, while its gas price rose by 17.2%. That same month, EDF put up electricity tariffs by 7.9% and gas prices by 12.9%. British Gas increased gas and electricity prices by 15%. Scottish Power increased gas bills by 15% and electricity bills by 14%, and E.ON put up gas bills by 15% and electricity tariffs by 9.7%. Scottish and Southern Energy was the last to make the move with an average 14.2% increase in electricity bills, and a 15.8% lift in gas charges for domestic customers coming into force on 1 April.

In justifying these increases, British Gas, EDF and Npower highlighted the fact that wholesale prices have increased significantly in the last year. EDF states that gas prices rose by 117% and electricity prices by 90% between February 2007 and February 2008.

However, this ignores the fact that Britain's energy companies are producers or generators as well as being retailers. As producers they profit when wholesale prices are high, as retailers they profit when wholesale prices are low. This helps to explain how British Gas was able to report annual profits of £571 million at its residential arm in February 2008, up from £95 million in 2006.

Ofgem regards the numbers of consumers switching supplier as the key measure of competition in the market. It suggests that four million out of 36 million energy account holders switched supplier in 2007[62]. This may be true, but the fact remains that half of consumers and 65% of pensioners have never switched supplier[63]. In addition, almost six million people on prepayment meters cannot switch using an online comparison site and two million people cannot switch because they are in debt to their supplier. With so many consumers unable to switch supplier it is therefore wrong to suggest that levels of switching amounts to effective competition.

There are additionally specific reasons why our target customers, SMEs, are not automatically switching away from big six energy suppliers in response to these significant price increases. Small businesses often have a lower level of knowledge of the opportunities open to them from energy supply competition, especially when the use of different brands by some of the major suppliers can confuse, leaving them with the perception that there is more competition in the market than is actually the case. They also have difficulties obtaining and evaluating offers from competing suppliers, given a perceived non-comparability of terms and a general lack of transparency. This means that their awareness and understanding of a recent shift to fixed price, fixed term contracts is low, leading to a greater tendency to contract disputes around invalid transfers.

Small businesses that do want to switch away are also sometimes confused by the varying cancellation requirements of the major energy suppliers (examples of which are outlined below).[64]

Supplier Cancellation Notice Requirements

British Gas (British Gas Business/Scottish Gas/Electricity Direct/Enron/Scottish Has Business) Written notice at least 90 days prior to the end of the initial contract.

EDF Energy (SWEB Energy/Seeboard Energy/London Energy) Written notice at least 28 days prior to the end of the initial contract.

Npower (Midlands Electricity/Yorkshire Electricity/Northern Electric) Written notice at least 90 days prior to the end of the initial contract.

E.ON "Powergen"
(Economy Power/Norweb, Eartern Electricity/East Midlands Electricity/Independent Energy) Notification of cancellation can be given during the "Review Period". The Review Period is defined by E.ON as:

"The Review Period is a period of not less than 14 days from the date of our written notification. Written notification will be not less than 30 days before the end of the Fixed Price Period"

Notification can be given by:
Letter
Fax
E-mail

Scottish & Southern Energy (Swalec/Southern Electric/Scottish Hydro Electric/Atlantic Gas & Electricity Written notice not less than one calendar month before the end of the initial contract.

Scottish Power (SP Manweb/South of Scotland Electricity) Written notice at least 60 days prior to the end of the initial contract.

Electricity4Business would also like to bring to the Committee's attention:

— The loss leader pricing strategies being adopted by the big six energy suppliers as they seek to retain and win back SME customers.

— Delaying tactics being employed in order to enable Win Back activity.

— The manipulation of the role of third party intermediaries.

Loss leader pricing strategies

Research conducted by the business intelligence company Datamonitor shows that the major energy suppliers are offering significantly lower rates to existing customers than new customers. This strategy relies on a high number of existing customers choosing not to switch away from a current supplier, even when the price increases sharply. When customers are responding negatively to the price increases, suppliers are providing a "save" offer designed to keep them from switching as demonstrates[65] in the table below. Whilst Electricity4Business support the principles of the table below actually "save" offers encountered are considerable lower than those in the table. Indeed, the large energy suppliers are offering rates to new customers at below cost price, on the basis that this revenue can be recuperated in the medium to long term. The supplier has little risk in setting massive uplifts at renewal—knowing they have the protection of "win back" and "price match" should the customer decide not to accept the increase. "Win back" is subsidised by the high renewal prices of the majority of the suppliers' customer base.

Low
use Medium
use High use

Existing customer

Default offer 32% 15% 8%

"Save" offer 16% 8% 4%

New customer

1st year -5%

2nd year 5%

3rd year 10%

Delaying tactics

Electricity4Business is aware that some of the big six energy suppliers are abusing clearly defined rules and using delaying tactics in order to win back customers who have decided to switch to Electricity4Business. Examples include: informing customers wishing to switch away that their transfer date is too early (when correct); preventing customers from moving due to outstanding debt owed to the existing supplier (even when there is no debt) and claiming not to have received termination notices, even though this is deemed to be received on posting by the customer.

The below tables provide additional insight into these activities. The first table is a break down of the percentage of Electricity4Business transfer requests blocked by existing suppliers. Supplier 1 prevents 36% of all Electricity4Business transfer requests. When this information is compared with the second table, it is apparent that Supplier 1 also scored the lowest customer satisfaction rating in a recent industry comparison survey.

ELECTRICITY4BUSINESS TRANSFER REQUESTED % BLOCKED BY SUPPLIER[66] SOURCE: E4B


Supplier	% Blocked

Supplier 1	36%
Supplier 2	13%
Supplier 3	12%
Supplier 4	8%
Supplier 5	8%
Supplier 6	6%

SME POWER CUSTOMER SATISFACTION LEAGUE TABLE, 2007[67]


	Rank	Billing	Service	Price	Average

Supplier—6	1	82%	81%	82%	82%
Supplier—4	2	78%	78%	78%	78%
Supplier—2	2	78%	76%	79%	78%
Supplier—3	4	78%	77%	76%	77%
Supplier—5	5	76%	77%	76%	76%
Supplier—1	6	76%	72%	74%	74%

The manipulation of the role of third party intermediaries

Third Party Intermediaries (eg agents, brokers and comparison sites) hold great influence within the energy industry and are estimated to be responsible for 50% of all switches. This is largely due to the fact that they have access to Contract Renewal Dates and so can target their communication with customers accordingly. Rewards available to Third Party Intermediaries can be substantial—up to £700 on a single sale of £3,500.[68] They operate in an industry that is completely unregulated and, as such, there is no safeguard against unscrupulous behaviour.

This lack of accountability results in some Third Party Intermediaries being incentivised by suppliers not to act in the best interests of customers. This is typically achieved through the use of Market Up Tariff Products and Commission Based Tariffs. Market Up Tariff Products are those for which the Third Party Intermediary is a given a base unit price from the Supplier and can add their own cut on top. Commission Based Tariffs apply when the Supplier presents the Third Party Intermediary with a product but will increase the commission payable depending on the price paid by the customer. This provides a clear disincentive for Third Party Intermediaries to achieve the lowest possible price for the customer and can be demonstrated by the information below, which shows three differing commissions offered by Npower to its Third Party Intermediaries. The bulk of the first year's additional revenue secured by the Third Party Intermediary from the customer is passed back to the intermediary in commission. Note also that the amount of energy being purchased by the customer remains constant on each table.

In Table 1, if the amount paid by the customer is £3,069 per annum the commission for the Third Party Intermediary will be £45.[69]

In Table 2, if the amount to be paid by the customer is £3,291 per annum the commission for the Third Party Intermediary will be £226.

In Table 3, if the amount to be paid by the customer is £3,570 per annum the commission for the Third Party Intermediary will be £452

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

Electricity4Business refers the Committee to text we endorse contained within the discussion paper produced in March 2007 by energywatch, entitled "How energy markets are failing consumers"[70] Page 16, paragraph 3.1.1

Liquid wholesale markets are important to supply competition as they allow suppliers and, in some cases, customers to source bulk energy. After a surge in the late 1990s, wholesale market activity in Britain has declined as the major players have bought their way to scale. Key factors behind this have been: the exit of independent trading and supply companies; the decline of merchant plant models; and vertical integration. Vertical integration through asset acquisition is effectively being used as a trading strategy by major market participants.

Electricity trading volumes have declined since 2003, as the commission's reports have highlighted. (Energywatch is referring here to the European Commission's preliminary report of its Sector Inquiry under Art 17 Regulation 1/2003 on the gas and electricity markets issued

on 16 February 2006 and repeated in its final report on 10 January 2007).

In evidence to the House of Lords in 2004, a representative of Centrica commented on wholesale gas trading, saying that "physical trading . . . is a small, 15-20% portion of the total physical volume being delivered into the UK at the moment; and then there is paper trading, where the gas is traded many times, and that is perhaps 5-10 times the total physical volume."

Since then, in its "Ensuring effective and efficient forward gas markets" report for the DTI in March 2005, Global Insight suggested that 70% of the gas landed in Britain was subject to long-term contracts. The balance, 30%, was available for forward trading. Its analysis also suggested that the majority of this gas was traded in the immediate run up to its delivery, rather than months or seasons ahead. Therefore, forward curve prices are posted based on very limited trading activity to the extent that while it characterised the spot gas market as "functionally liquid" it believed the forward market to "suffer from a lack of liquidity by global standards". Its arguments suggest that the forward curve is not a robust indicator of future wholesale costs for gas suppliers—and electricity market liquidity is even lower. But Ofgem has not challenged the appropriateness of forward curves that are not fit for purpose.

The implications of growing consolidation in the energy market

In August 2007, energywatch released a Small Business Electricity Consumers Satisfaction Survey Report[71] which highlighted many of the problems that affected this group of customers.

The report finds that small business customers:

— Do not understand the complexities and risks of associated with being a non-domestic energy customer as their understanding is likely to be modelled on being a domestic consumer;

— By contrast, do not benefit from many of the protections afforded to domestic consumers such as price comparison services, cooling off periods, industry codes of practice on selling, supply transfers and 28-day contracts;

— Are frequently unhappy with respect to inaccurate billing tied to estimate reading; issues with information provision; slow responsiveness; pressure from suppliers in a range of areas and contact issues when dissatisfied.

Electricity4Business is concerned that further consolidation in the energy market would only serve to exacerbate these existing problems for small businesses which are caused by a lack of genuine retail and wholesale competition in the energy market.

Furthermore, the DTI's 2006 Energy Review indicated that by 2025 energy demand in the UK may exceed the available supply by 30%, but research by LogicaCMG has subsequently suggested that a decade earlier the energy gap could already be 23% at peak times[72]. This highlights that the gap is widening far quicker than anticipated, and will have a significant impact on UK business and households. Based on the research LogicaCMG has estimated that by 2015, the impact on GDP could be £108 billion or £3,700 a year for every working adult in the country. The report also shows that it is not just the winter months that will be affected. If the effects (or assumed effects) of climatic change continue, longer hotter summers will mean that electricity consumption through the hottest months will increase as more air conditioning and cooling systems are used.

Electricity4Business believes that these challenges will only be overcome by a competitive and dynamic market for energy in the UK and that increased consolidation will hinder our collective efforts in this regard.

It is also worth noting that indicators of impending market consolidation:

— the interest in Centrica from the Russian energy giant Gazprom;

— market speculation regarding EDF acquisition of Iberdrola (owners of Scottish Power);

— British Energy—acquisition by one of the big six

This could leave UK business energy supply in the hands of a few foreign businesses with the potential to operate as a cosy oligopoly—this is not the free market that businesses should have access to.

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

Electricity4Business would like to draw the Committee's attention to this paragraph on page 17 of the energywatch discussion paper, "How energy markets are failing consumers".

Feedback from independent market participants suggests that this fall in traded market liquidity is making it more difficult for suppliers to source wholesale energy for onward sale to customers. They claim it is not only more difficult to buy wholesale energy but the markets have become more unpredictable as the exit of operators with a trading background has led to a decline in the quality and volume of market activity. This, they argue, makes wholesale markets inherently more volatile.

Our experience at Electricity4Business confirms these fears expressed by energywatch and we regard this wholesale market volatility as a significant commercial barrier to our company and to genuine retail competition in the sector of the market in which we operate.

The interaction between the UK and European energy markets

Electricity4Business refers the Committee to the "five main barriers to a fully functioning internal energy market" outlined by the European Commission in its the preliminary report of its Sector Inquiry under Art 17 Regulation 1/2003 on the gas and electricity markets issued on 16 February 2006 and in its final report on 10 January 2007.

It is our belief that each of these five barriers—market concentration, vertical foreclosure, market integration, (lack of) transparency and (complexity of) price formation—is now clearly present in the UK energy market.

Below, for information, is additional detail on how and when the European Commission believes these barriers can prevent an internal energy market from operating as it should:

— Market Concentration

At the wholesale level, markets generally maintain the high level of concentration of the pre-liberalisation period.

— Vertical Foreclosure

Lack of liquidity and limited access to infrastructure prevent new entrant suppliers from offering their services to the consumer.

— Market integration

Cross-border sales do not presently exert any significant competitive pressure.

— Transparency

There is a lack of reliable and timely information on the markets—normally the lifeblood of healthy competition.

— Price formation

More effective and transparent price formation is needed in order to deliver the full advantages of market opening to consumers.

The effectiveness of regulatory oversight of the energy market

It should be clear from the remainder of this submission that Electricity4Business regards the existing regulatory oversight of the UK energy market as inadequate. In January, Ofgem asserted that the UK energy market is sound[73] and reported to the Chancellor that there was no evidence of collusion or price fixing. However, Electricity4Business agrees with a range of other stakeholders including British Energy (the largest independent electricity generator), energywatch, other small independent energy suppliers, academics, Unison and the National Right to Fuel Campaign that there are structural features of the market which constrain the extent of effective competition. The focus on collusion is a red herring, as even if it can be proven that there is no collusion, that alone does not dictate that the existing regulatory regime is sufficiently robust.

Electricty4Business joins energywatch and others in calling for the energy market to be the subject of an inquiry by the Competition Commission who could consider:

— Whether the reduction from more than 20 suppliers to six, or less, concentrates the market in too few hands.

— Whether suppliers with electricity generation or gas production interests, or with long term contracts with independent generators, have excessive information and control over the market.

— Why £10 billion investment in gas infrastructure failed to smooth out volatility in gas supply?

— Why small suppliers have either been forced out of the market or struggle to survive?

— Why new entry is regarded as nigh on impossible?

— Whether the above issues create a comfort zone for the Big Six suppliers which limits effective competition and consumer benefits.

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

Electricity4Business is aware that the Government is currently considering levying a windfall tax on large energy suppliers to combat growing fuel poverty amongst vulnerable people following the latest energy price rises. We would endorse such a plan. The latest figures show that more than four million people are fuel poor[74]—spending more than 10% of their income on energy bills. We would also urge the Committee to consider that many small businesses do not generate substantial profits for their owners and that fuel poverty can be the result of an increase in the costs of fuel for an individual's business, as equally as if these costs were related to domestic consumption.

March 2008