House of Commons - Business and Enterprise

Select Committee on Business and Enterprise Written Evidence

Memorandum submitted by energywatch

BUSINESS AND ENTERPRISE COMMITTEE: INQUIRY INTO POSSIBLE ANTI-COMPETITIVE BEHAVIOUR IN THE ENERGY MARKETS

EXECUTIVE SUMMARY

1. energywatch welcomes the Business and Enterprise Committee inquiry into possible anti-competitive behaviour of the energy markets. Our response focuses on the fuel poverty and competition elements of the terms of reference.

Fuel poverty

2. To mitigate the impact of punitive prices on fuel poor households, Government must take the powers necessary to oblige suppliers to offer social tariffs in accordance with minimum standards. Standards should include a stipulation that a supplier's social tariff represents a rate lower than any other rate available to its other customers, regardless of the eligible customer's payment method.

3. To address the inequities faced by prepayment meter consumers:

— BERR to take steps to abolish prepayment premiums that are shown to be non-legitimate and inefficient.

— Ofgem to reinstate obligation on suppliers to provide annual statements to prepayment meter consumers and to specify that these provide pricing transparency, including: comparison of cost with other payment methods offered by supplier and breakdown of component costs that underpin the differential. The statement should also offer a comparison with competitors' prepayment meter terms.

— "Health warning" on till receipts at charging points such as shops and post offices, which state that prepayment meter is most expensive payment method, unless supplier can demonstrate otherwise.

— A condition of doorstep acquisition of prepayment meter consumers should be that the acquiring supplier guarantees in the contract a better per unit deal at time of acquisition than their current supplier offers.

— Priority given to prepayment meter consumers in smart meter roll out.

— Provide greater access for prepayment meter consumers to switch through price comparison services.

Competition

4. energywatch believes there are reasonable grounds for suspecting that a feature, or combination of features, prevents, restricts or distorts competition in the GB energy market. We believe the threshold set under the Enterprise Act 2002 for the Secretary of State for Business, Enterprise and Regulatory Reform or Ofgem to refer the GB energy market to the Competition Commission (CC) has been met.

5. energywatch recommends that the GB energy market be referred to the CC without delay for a full and independent investigation. The CC is the only body with the necessary powers, competence and resources to:

Demand

Investigate

Determine

Quantify

Decide

6. energywatch believes that consumers have been and continue to be detrimentally affected by the lack of effective competition in the GB energy markets. We are concerned that:

— Consumers pay prices above the competitive level putting affordable energy beyond the reach of many households.

— An estimated half a million households have been put into fuel poverty as a direct result of the price increases in 2008 alone.

— The near doubling of average domestic energy bills since 2003 has been mirrored in a 100% increase in the number of vulnerable households in fuel poverty.

— Prepayment meter consumers pay up to £456 more per year for their energy than consumers paying by online direct debit.

— Small businesses are frequently locked in to higher priced contracts.

— Business consumers' international competitiveness has deteriorated.

— Production has fallen contributing to over 100,000 manufacturing job losses.

— Investment has been cut back and investor confidence is now under threat.

— Lack of supplier and generator/production diversity negatively impacts innovation, delivery of the environmental and carbon agenda and security of supply.

— Customer service levels are deteriorating rather than improving with consumer contacts with energywatch increasing by nearly 50% between 2004-05 and 2007-08.

7. energywatch believes the key features of the GB energy market that need investigation by the CC are:

— The supply markets are highly concentrated and consumers are vulnerable to abuse of market power. The regional supply markets are dominated by two suppliers with British Gas and the incumbent electricity suppliers controlling at least 60% of each of the domestic supply markets.

— The electricity market is dominated by six vertically integrated firms inhibiting competition in the retail and wholesale markets.

— Firms adopt similar supply and trading policies reducing wholesale market liquidity and leaving consumers vulnerable to abuse of dominance.

— There has been no scale new entry in the 10 years since liberalisation due to high barriers to entry including credit policies, complex industry codes and information transparency. This can negatively impact prices, quality, choice and innovation.

— There is a lack of strategic storage inhibiting our ability to store summer priced gas as an alternative to high priced gas during winter.

— Where other measures are considered insufficient, separation of vertically integrated firms through divestment of plant or function.

8. energywatch believes there are remedies that the CC could put in place to help ensure there is effective competition in the GB energy markets including:

— Requirements for firms to trade minimum gas and electricity volumes through the "over the counter" markets to enhance liquidity and address concerns about the move towards long term "off market" contracting and self supply.

— Enhanced reporting and disclosure requirements for firms to aid transparency and price discovery.

— Greater transparency on gas flows from Europe and the North Sea including flows from outside of our current jurisdiction.

— Creating incentives for investment in strategic storage to ensure GB can benefit from access to lower priced gas.

— Measures to reduce search and switching costs for consumers particularly for domestic consumers paying by prepayment meter and small businesses.

OUTLINE

9. This paper sets out why energywatch believes there are reasonable grounds for suspecting that competition is not working effectively in the GB energy markets, most clearly evidenced in the electricity market. It outlines the features of the market we believe need to be investigated in a full and independent market investigation by the CC.

10. In preparing our submission, we have reviewed in detail the experience of two groups of consumers who face particular problems in the energy markets—prepayment meter consumers and small businesses. We have analysed retail and wholesale prices in GB and undertaken comparative analysis of prices across Europe. We have also tested our concerns about the lack of effective competition in the GB energy markets and the need for a CC investigation with academics, industry commentators and market participants. We provide three energywatch commissioned papers to support our submission:

Why the British energy markets in gas and electricity require a competition investigation

Competition Report on the GB Gas and Power Markets

It is time for an Energy Market Investigation by the Competition Commission

BACKGROUND

11. energywatch is the statutory independent watchdog representing gas and electricity consumers in GB. We help domestic and business consumers with their complaints against energy companies, provide them with advice and information about the market and act as an advocate for their interests to energy companies, government and regulators.

INTRODUCTION

12. GB energy markets are failing to meet the needs of GB consumers. We have seen energy bills double over the past five years yet service levels have deteriorated rather than improved. Prices are not determined on the basis of effective competition and there is distrust in the way prices are set.[79] We are continually told that we have the most competitive market in Europe yet our electricity prices remain amongst the highest in Europe. Some of our most vulnerable consumers are not able to access the cheapest tariffs in the market as they pay by prepayment meter. The price increases we have seen this year alone mean an estimated extra half a million households are now in fuel poverty. Small businesses find themselves locked into higher priced contracts due to complex contractual arrangements and business consumers more generally are concerned about their lack of choice due to the low number and type of contract offers. Our international competitiveness has deteriorated and we have seen significant job losses.

13. energywatch believes there are reasonable grounds for suspecting that competition is not working effectively in the GB energy market. This undermines consumer confidence and creates consumer detriment. energywatch recommends that the GB energy market be referred to the CC for a full and independent investigation.[80] A CC market investigation is necessary to unpick the complexities of the structure and competitiveness of the GB energy market that previous reviews, probes and investigations by the regulator and others have failed to do. The CC can put in place the remedies necessary to help ensure GB consumers benefit from effectively functioning and competitive energy markets.

14. energywatch supports markets with fair and healthy competition combined with protections for consumers who are vulnerable or have little chance of influencing a market's competitiveness or a supplier's willingness to trade fairly. We believe vigorous competition should drive firms to deliver higher quality, increased choice, greater innovation and lower prices to the benefit of all consumers. Consumers need to be confident that they are and will be well served by the market. Confident, informed and empowered consumers are a critical driver of economic change. We believe significant reform is required to ensure that prices are determined on the basis of effective competition.

COMPETITION COMMISSION

15. The CC helps ensure healthy competition between companies for the benefit of companies, consumers and the economy. We believe the CC is the only body with the necessary powers, competence[81] and resources to undertake a full and independent review of the GB energy market. The CC can[82]:

Demand

Investigate

Determine

Quantify

Consider

Decide

FEATURES

16. We set out below the key features of the GB energy markets that we believe are a concern and need investigation by the CC.

Consolidation, concentration and market shares

17. We have seen considerable consolidation in the GB energy markets since liberalisation. There has been no scale new entry and 20 suppliers[83] have exited the market since 2000 so there are now effectively six dominant firms. These firms are vertically integrated, control over 99% of the domestic supply markets, dominate the business supply markets[84] and own six of the nine power generators. There is a real threat of further consolidation and vertical integration.

18. On a national level, the combined domestic gas and electricity supply markets are highly concentrated with a Herfindahl-Hirschman Index (HHI),[85] the most commonly accepted measure of market concentration, of nearly 2,000. Looking more closely at competition across consumer groups, we see even greater levels of concentration. The domestic gas retail market has an HHI of around 2,800. The regional domestic electricity markets are dominated by two firms—BGT and the incumbent electricity firm—and have HHIs in the range of 2,500 to 6,500. Research suggests that electricity suppliers who remained vertically integrated with their local distributor have retained a higher market share than those where these functions have been undertaken by separately owned companies.[86]

19. These levels of concentration suggest the six dominant firms have considerable market power. Where this is exercised, the prices charged to consumers will be above the competitive level. We believe the CC should investigate the extent to which consumers have paid higher prices as part of a market investigation.

Prices

20. Domestic gas and electricity bills have risen by 109% and 70% in the past five years.[87] These increases equate to a combined average bill in excess of £1,000[88] meaning affordable energy is beyond the reach of many households. This year alone the six dominant firms have increased domestic prices by up to 15% for electricity and 17% for gas putting an estimated half a million households into fuel poverty.

21. The spread in prices varies across payment methods. For example there is only a £26 annual difference—a mere 50 pence per week—in the prices the dominant firms charge for dual fuel paid by direct debit but £107 by prepayment meter. The difference in price between payment types is significant. Prepayment meter consumers can pay up to £456 more[89] for their energy compared to consumers paying by online direct debit.

22. It is often stated that the GB energy market is the most competitive market in the EU.[90] The expectation is that energy prices should be lower in GB than in the rest of the EU. However, domestic electricity prices in GB excluding tax are not the most competitive in Europe and are amongst the most expensive.[91] Business consumers have been hit by even more significant price increases than domestic consumers as contract rates offered by suppliers are more closely related to forward market prices. This has had a detrimental impact on their international competitiveness putting investor confidence at risk.

23. energywatch recognises there is upward pressure on prices from the delivery of the environmental and carbon agenda, this makes it all the more important for the wholesale and retail elements of our energy bills to be competitive.

Coordinated effects

24. Given certain market conditions firms may realise that it is in their mutual best interest to "cease to compete" and sustain high prices today rather than face the threat of fierce competition tomorrow. If this behaviour is maintained without explicit agreement then the resulting impact on competition is called "coordinated effects".[92]

25. energywatch considers that the conditions necessary for coordinated effects to emerge and be sustainable are present in the GB energy market.[93] This means the market is susceptible to abuse of dominance and consumers will pay more than the competitive level for their energy. An analysis of the domestic supply markets suggests:

Awareness of competitor behaviour

Costly to deviate from prevailing market behaviour

Weak competitive constraints

26. The CC would need to undertake a more detailed analysis of the existence and effects of coordinated behaviour in the domestic supply and wider GB energy markets.

Switching

27. Though energywatch does all it can to encourage switching, we believe it is a gross error to view switching as hugely successful and many consumers who have switched have ended up paying more. After 10 years of liberalisation around 50% of consumers have never switched and this increases to 65% for consumers over the age of 60.

28. The regulator has argued there has been considerable switching and this is direct evidence of competition. We do not agree that switching is a sufficiently good barometer for healthy competition and is not a theoretically sound basis for a regulator to determine whether there is effective competition.

29. There have always been problems with the switching data as it can be inflated by involuntary and mis-selling transfers and fails to identify multiple switchers. Switching to new entrants appears to have been moderate and tends to reflect the introduction of dual fuel offers. Some consumers are unable to switch due to debt blocking,[94] others state they are very unlikely to switch[95] and some state that they will never switch.[96] Further survey evidence shows[97] that switching is often ill-advised and consumers have ended up on a worse deal.

30. Search and switching costs are a particular problem for prepayment meter consumers and for small businesses due to the application of complex contractual arrangements by suppliers, a lack of clarity on terms and conditions and a lack of comparative price and service information.

Elasticity of demand

31. Gas and electricity are "necessity goods" and consumers have little choice other than to use energy as and when they require it. In general, the demand for energy might be considered relatively inelastic, the quantity of energy demanded does not change significantly with a change in the price.[98] There is a low cross elasticity of consumption between fuels—there are effectively no substitutes. It is unlikely that a domestic consumer would change from gas to electricity for heating particularly as gas accounts for 40% of electricity production and would require considerable investment by the consumer. It is unlikely that consumers could survive without electricity and still function in the modern world. Energy is also essential to the day to day functioning of the vast majority of businesses, even if it is not a key input into making a good or delivering a service. These factors make consumers particularly vulnerable to dominant firms being able to extract monopoly rent.

Vertical integration

32. energywatch notes there may be economic rationale for vertical integration. However, it must also be recognised that vertical integration can have a negative impact on supply competition and inhibit the development of effective and healthy wholesale markets. The detrimental effects of vertical integration flow from the likelihood that a vertical structure will empower firms to behave in ways that may be damaging to competition.

Monopoly profits

Cross subsidy

Price discrimination

Barrier to entry

Vertical foreclosure

33. Despite repeated concerns being raised with the regulator,[99] it has failed to undertake any open or comprehensive review of the effects of vertical integration on the GB energy markets and consumers.

34. Through a market investigation, the CC can demand access to the relevant commercially sensitive and confidential information that would allow it to determine whether vertical integration has had an adverse effect on supply and wholesale competition and to quantify any associated detriment to non-vertically integrated firms and consumers.

Liquidity

35. energywatch believes the failings of the GB energy market can be most clearly seen in the wholesale markets. Diminished wholesale market liquidity can seriously affect the retail markets.

36. There has been a shift away from trading through the "over the counter" GB wholesale markets, particularly in electricity, in favour of "off market" contracts. There is a lack of visibility about these contracts and there is no transparency of the terms and conditions for other market participants. A lack of transparency will benefit the incumbents and undermine new entrants.[100] We have seen reduced liquidity in the wholesale markets and this has had a detrimental impact on price discovery. Illiquid markets, where there is limited trading and price is formed on the basis of a few or even a single transaction, are usually considered to be volatile and do not necessarily reflect the true market value.

37. Volumes that are being traded in electricity appear to be heavily skewed to shorter durations, particularly in the front quarter or season. The volume traded is only three times physical consumption—considerably below the ten times level said to evidence a healthy market and means liquidity is significantly less that markets such as Germany and the Netherlands that have deregulated more recently. Entrants advise that there is a mismatch between the wholesale products on offer and the volume and shape they require to meet the needs of their customers. There are few independent counter-parties to trade with and where there are volumes, the integrated players insist that monies are posted in advance because they say they are concerned with the credit status of small players in volatile markets. The dominant firms reference the forward market when changing consumer prices yet they are not exposed to these prices for significant volumes as they are vertically integrated. There is no transparency of transfer prices.

38. The wholesale gas market is considered to be more liquid than the electricity wholesale market. However, a significant proportion of gas is subject to long term contracts and the remaining 30% is primarily traded in the run up to delivery rather than months or seasons ahead.[101] Forward curve prices are therefore based on limited trading activity and may not be a robust indicator of future costs.

39. The regulator often presents prices from the wholesale forward curves to be representative of supplier costs despite the dominant firms being vertically integrated and without having analysed transfer prices or the impact of reduced liquidity in the wholesale markets.

40. Through a market investigation, the CC can demand information from firms about their trading strategies and obtain copies of their long term contracts under which the majority of gas and electricity are bought and sold to determine whether these have constrained new entry. The CC can also access information about their actual costs of supply to determine whether consumers have and continue to pay more than the competitive level.

Cash-out

41. energywatch believes there is an urgent problem with the cash-out arrangements that needs to be remedied. Market participants have compared the risk of exposure to penal cash-out prices to "playing russian roulette"—in that it may be possible for a smaller player to manage exposure to prices in five games out of six but it is the prices in that one game in six that can undermine the business and could lead to a firm exiting the market.

42. The imbalance settlement or cash-out arrangements are an important part of the wholesale trading arrangements. Problems with cash-out rules harm consumers who are ultimately exposed to the costs resulting from higher wholesale prices, contract risk premia and use of system charges. The dual cash-out arrangements are complex and can act as a barrier to entry particularly where they produce artificially high or volatile cash-out prices. They also make it difficult for new firms to invest in technology to help deliver the environmental and carbon agenda.[102]

43. The regulator has stated there `is a proven defect with the current [cash-out] arrangements, namely "system pollution".[103] energywatch is concerned about the level of detriment consumers have borne and will continue to bear from defective cash-out arrangements.[104] It is unclear whether the changes to industry codes that are currently being progressed will address all non-energy actions which may be detrimentally influencing cash-out prices, for example ability to influence prices behind a constraint in certain periods.

44. These arrangements would benefit from an independent investigation by the CC. The CC would be able to determine the extent to which complex market rules constrain new entry and quantify any associated detriment to consumers.

Storage

45. We have relatively low levels of gas storage capacity compared to European peers.[105] Investment in GB storage is expected to double capacity by 2015. However, investment appears to be more geared towards small and medium range storage rather than long range storage. Long range storage allows for low priced gas (typically in the summer in GB) to be injected to provide an alternative source to high priced gas (typically in winter in GB) particularly during periods of unexpectedly high demand. Long range storage should be viewed as an asset that can be used to capture volumes of gas at lower prices as well as better ensuring supply continuity in more testing times.

46. Given our increasing dependence on gas imports and storage, it is important to ensure that the third party access provisions cannot be used to limit market opportunities for other firms and create a barrier to entry. Further, it is important to ensure there is greater transparency of information on flows from Europe and the North Sea including flows from outside of our current jurisdiction.

47. As part of a market investigation, the CC could identify real barriers to investment, review the need to create incentives to invest in strategic storage and consider the potential for market rules on access to storage to create a barrier to entry.

CONCLUSIONS AND RECOMMENDATIONS

Fuel poverty

48. To mitigate the impact of punitive prices on fuel poor households, Government must take the powers necessary to oblige suppliers to offer social tariffs in accordance with minimum standards. Standards should include a stipulation that a supplier's social tariff represents a rate lower than any other rate available to its other customers, regardless of the eligible customer's payment method.

49. To address the inequities faced by prepayment meter consumers:

— BERR to take steps to abolish prepayment premiums that are shown to be non-legitimate and inefficient.

— "Health warning" on till receipts at charging points such as shops and post offices, which state that prepayment meter is most expensive payment method, unless supplier can demonstrate otherwise.

— Priority given to prepayment meter consumers in smart meter roll out.

— Provide greater access for prepayment meter consumers to switch through price comparison services.

Competition

50. energywatch considers the threshold set by the Enterprise Act 2002 for the Secretary of State for Business, Enterprise and Regulatory Reform or Ofgem to refer the GB energy market to the CC for investigation has been met. We believe there are reasonable grounds for suspecting that a feature, or combination of features prevents, restricts or distorts competition in the GB energy market. energywatch recommends the GB energy market be referred to the CC for a full and independent market investigation without delay.

51. The CC can investigate and determine whether any feature or combination of features of the GB energy market has an adverse effect on competition. The CC can also determine what action should be taken to remedy, mitigate or prevent adverse effects on competition or any detrimental effect on consumers. energywatch proposes that consideration be given to:

Mandatory trading

Regulatory reporting requirements

Disclosure requirements

Simplifying market rules and entry requirements

Information transparency

Investment incentives

Reduced search and switching costs

Market monitoring

Price controls

Separation of vertically integrated firms

Annex A

PROGRESS IN REDUCING FUEL POVERTY AND THE APPROPRIATE POLICY INSTRUMENTS FOR DOING SO

1. The Warm Homes and Energy Conservation Act (2000) obliged the UK Government to publish and implement a strategy for reducing fuel poverty and to set targets for the implementation of that strategy. The resultant UK Fuel Poverty Strategy saw the Government set itself binding deadlines for the eradication of fuel poverty in all vulnerable households by 2010; and in all remaining households by 2016.

WHAT IS FUEL POVERTY?

2. Fuel poverty arises when three factors—poorly insulated energy inefficient dwellings with sub-optimal heating systems, low disposable household income and the price of fuel—conspire to put thermal comfort beyond the reach of the household affected.

3. The UK Fuel Poverty Strategy classifies households as fuel poor if they would need to spend in excess of 10% of household income to maintain a satisfactory heating regime.[106] For some fuel poor households the cost of warmth can rise to 20, 30 or even 40% of income. For many low-income households, spending 10% of their income on heating remains an aspiration.

4. The lived reality of fuel poverty is cold, damp homes and the human manifestation of fuel poverty is respiratory illness, depression and heart disease, increased risk of strokes and other cold-related ill health; all of which contribute to the UK's high rate of excess winter deaths.

PRICE AND THE UK FUEL POVERTY STRATEGY

5. The UK Fuel Poverty Strategy recognised that if it were to achieve its stated targets, actions to address the three causal factors of fuel poverty would be required. Most significantly for this inquiry, a key pillar of the Strategy was built on "continuing action to maintain a downward pressure on fuel bills, ensuring fair treatment for the less well off, and supporting the development of energy industry initiatives to combat fuel poverty".

HIGH PRICES HAVE SINGLE-HANDEDLY UNDERMINED THE STRATEGY

6. Since 2003 the escalating cost of domestic gas and electricity has single-handedly undermined the progress that was being made towards meeting the Government's targets. The reality of competition thereafter has seen suppliers chasing competitors' prices ever upwards. The collapse of the Strategy's price focused pillar has left a debilitating policy vacuum at a time when action on the actual price that fuel poor households are paying for their gas and electricity is essential. However, Government have declined to take decisive steps to ensure fuel poor households can access energy at the most affordable prices in the market; relying instead on repeated appeals to suppliers to volunteer assistance.

THE REALITY OF HIGH PRICES FOR LOW-INCOME CONSUMERS

7. energywatch research published in December 2005[107] found that:

— most consumers perceive their energy bills to be rising rapidly and feel that this is having an impact on their household finances;

— organising their finances to be able to spend enough to stay warm is the top priority for most consumers of all ages and income levels, although this may not always be achieved; and

— consumers on low incomes will cut back their expenditure in other areas and budget for their gas and electricity use in order to maintain some level of warmth.

8. More recent research has shown that price increases in the period since have exacerbated the situation further. In 2006 the not-for-profit Home Heat Helpline, the supplier sponsored advice line, published research on the difficulties that single parents experienced with the cost of energy. This revealed that three quarters (73%) of the single parents polled admitted they set their heating at a lower temperature to save money. Over half (55%) also said they heat only selected rooms to reduce their bills.[108]

9. A survey published by Help the Aged in November 2007[109] established that:

— One fifth of elderly people spend their winters in one room to reduce heating costs.

— 2.2 million have turned off their central heating.

— 1 million cut back on food expenditure in order pay heating bills.

10. Similarly, research undertaken for energywatch in 2007 found that almost a fifth (18%) of energy consumers say they currently find it difficult to pay their energy bills. This figure rises to 28% of consumers with an income under £11,500.

COMPETITION LOSERS

11. The competitive energy market has shown itself to be ill-equipped to recognise and serve the needs of low-income consumers. They are frequently expected to pay more for the gas and electricity they use and are disproportionately affected by the industry's more negligent practices, such as debt arising from late token meter recalibration.

PREPAYMENT METERS

12. Prepayment meters (PPMs) present the most vivid example of punitive and discriminatory pricing policies in the energy market. There is a strong correlation between the use of prepayment meters and low-income; and when fuel poverty is measured on the "basic income" definition[110] Government data shows that around a third of the fuel poor pay for their electricity through a PPM. This consumer segment live on a budget, are forced to budget their energy use, yet are left paying the market's premium prices. Where a consumer is using a PPM for both gas and electricity they will on average pay £255 more per annum than a consumer using direct debit, online only tariffs.

13. energywatch analysis has shown that three of the six major suppliers do not accept PPM consumers seeking to switch to them via price comparison sites and in some instances will seek to vet PPM users wishing to switch. Agreements between the other three suppliers and price comparison sites to facilitate PPM switching are limited. This means that this highly promoted and commonly used route to market is closed in great part to PPM users. These practices suggest further discrimination against this consumer segment and limits their options to door step sales agents or suppliers' call centres, which can both present additional problems.

14. The accelerating trend of suppliers installing PPMs to recover debt means that close to 1 million PPM users (c 1 in 6) are effectively chained to both their current supplier and this punitive payment method. On average 1,000 prepayment meters per day were installed to recover debt in 2007.

LIMITATIONS OF SWITCHING

15. Ofgem's 2007 review of suppliers' voluntary initiatives[111] restated its view "that competition is the most effective way to ensure customers are protected from high prices". Such an outlook is at odds with the experience of the 2 million plus households that have become fuel poor as a direct result of escalating energy bills.

16. This view is also at odds with the Sustainable Development Commission which concluded that switching supplier "is not a particularly helpful or appropriate method of reducing low-income household fuel bills and that more proactive steps need to be taken to protect low income and vulnerable consumers".[112] Interestingly, the view appears to be increasingly at odds with recent statements by Energy Minister, Malcolm Wicks:

If people are concerned that they are being charged too much, considering switching is very important, but I think that I know enough about this subject to recognise that switching is easier said than done for some of the most vulnerable people, particularly if there is a record of debt payments

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17. In a number of instances switching can provide a saving and hence play a role in making energy more affordable. energywatch has pioneered projects to actively help low-income consumers make the switch to a better deal wherever that is possible. However, these projects have given energywatch unique first-hand experience about the realities of switching for low-income and vulnerable groups. It has taught us that switching is at best only a partial answer and that in some cases it's not the answer at all. Switching to a more advantageous deal is not as straightforward as its most enthusiastic champions advocate. When the factors that may hinder the process of switching for vulnerable and low-income consumers are taken into account, the picture becomes even more complicated. A paper that discusses the difficulties vulnerable and low-income consumers can face in switching is attached at Appendix 1.

18. Analysis has highlighted the difficulties that low-income and vulnerable consumers can face: Switching is most prevalent among higher social groups, particularly the professional and managerial ABs. Some of the groups least likely to switch are the state-supported social group E, those aged 65+, those in rented accommodation and PPM users.[114]

19. It must also be recognised that in a high price environment where the average bill exceeds £1k per annum,[115] the least expensive deal does not equate with affordable energy for those on low-fixed incomes. It is also somewhat academic to point to the best deals in the market and use these as the basis on which to calculate the savings that are available to low-income consumers. Personal circumstances, financial exclusion, market place exclusion and any combination thereof will mean that in reality, the lowest priced offer—internet only direct debit tariffs—are beyond the reach of those consumers who would benefit the most from them.

PROGRESS AGAINST TARGETS

20. Between 1996 and 2001 when the Strategy was published fuel poverty declined from around 7.5 million households to 3.5 million. The introduction of initiatives heralded in the Strategy contributed to continuing year on year reductions in the years 2001-03, with the global UK figure declining further to 2.75 million in 2002 and then to 2.5 million in 2003 (on the basic income definition). Appendix two provides Government data on trends in the level of fuel poverty.

21. In England reductions in fuel poverty were attributed to the following[116]:

— 61% attributable to improvements in incomes.

— 22% attributable to energy price reductions.

— 17% attributable to energy efficiency improvements.

22. This shows a benign price environment prior to 2003 actually making a positive contribution to reductions in fuel poverty, much as the Strategy had envisaged. However, since 2003 escalating prices have outstripped income growth and outpaced the rate at which energy efficiency and heating improvements can be installed in fuel poor dwellings.

23. The Government's 2007 Annual Progress Report on the UK Fuel Poverty Strategy concedes that its 2010 target to eradicate fuel poverty in vulnerable households will not now be met and estimates that up to 1.3 million vulnerable households will still be in fuel poverty in 2010.[117]

INSUFFICIENT GOVERNMENT RESPONSE TO IMPACT OF ESCALATING PRICES

24. Significantly, the Energy White Paper formally set out a challenge to suppliers to develop adequate programmes of support, with the implication being that if this did not happen, legislation could be used to ensure all suppliers offered adequate programmes of support.[118]

25. Following the White Paper, energywatch commissioned Cornwall Energy Associates to examine the adequacy of those initiatives that directly related to the actual cost of energy paid by fuel poor households, namely social tariffs and bill rebates. This review was undertaken in line with the methodology that BERR had indicated it would use to assess suppliers' responses to the White Paper challenge. The findings of the report exposed the great variability in suppliers' commitments:

— The six major suppliers are currently committing an estimated £28.1 million—or 0.11% of the domestic supply industry's £24.6 billion turnover—to social tariffs and bill rebates.

— If and when suppliers fulfil the commitments made to government, the industry will invest £62.5 million, or 0.25% of its estimated turnover, in social tariffs and bill rebates.

— For individual suppliers this ranges from British Gas committing 0.49% of its turnover to a mere 0.079% of turnover for npower and Scottish & Southern Energy.

— British Gas has committed to making assistance available to 4.7% of its consumer base, while for npower and Scottish & Southern this figure is 0.79% and 0.34% respectively.

— Only Scottish and Southern Energy and EDF Energy offer social tariffs that cost less than the best deal they offer in the open market.

— The commitments made by British Gas will equate to 71% of the total industry assistance offered, while its market share represents just 33%; whereas npower has an 11% market share but has a social package commitment that will represent 4% of the total.

26. energywatch estimate that if suppliers fulfil the commitments they have made in light of the White Paper, social tariffs will be available to, at best, only 1 in 6 fuel poor energy accounts. A full summary of findings is presented at Appendix 3.

27. Despite it being readily apparent that the White Paper challenge has not forced sufficient progress from suppliers, the Government has hesitated in obliging suppliers to do more, passing up the clear opportunity to use the Energy Bill to at least take the relevant reserve powers. However, increasing pressure, has seen the Government use the Budget to lay down another challenge to suppliers:

There is common agreement on the need to do more. Energy companies currently spend around £50 million a year on social tariffs; the Government would like to see that figure rising over the period ahead to at least £150 million a year. Acting with the companies and Ofgem, the Government will draw up a plan for voluntary and statutory action to achieve that. To underpin this as necessary, the Government will legislate to require companies to make a fair contribution

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28. Based on the expertise it has developed on the role that effective social tariffs could play in mitigating the impact of high prices on fuel poor households, it is the firm view of energywatch that the Government has to now take the powers necessary to oblige suppliers to offer social tariffs in accordance with minimum standards. This would:

— Provide a policy response to the escalating prices and ensure that the Government's fuel poverty strategy has an effective action in relation to the cost of energy to fuel poor households.

— Ensure fuel poor households have access to the most affordably priced energy, thus mitigating the detrimental impact of rising prices and discriminatory pricing.

— Complement investment in and efforts on raising incomes and the provision of energy efficiency and heating measures; ensuring a more coherent approach to tackling fuel poverty in the process. Energywatch has advocated that social tariffs should be offered as an integral part of an energy assistance package, which also comprises energy efficiency and benefit entitlement elements.

29. Following a consultation exercise with a range of stakeholders, energywatch last year published a comprehensive set of recommendations which highlighted the minimum standards required and how social tariffs could work with the grain of a competitive market. A summary of these recommendations is provided in a briefing paper at Appendix 4.

APPENDIX 1

VULNERABLE CONSUMERS AND SWITCHING

energywatch discussion paper for Ofgem Social Action Strategy Review Group 12 December 2007

WHO IS A VULNERABLE CONSUMER?

Vulnerable consumers are not a homogenous unit. There is a range of vulnerabilities that—either individually or in combination—act as barriers to the consumer's engagement with the energy market. Consequently, there is no one size fits all strategy to stimulate switching. A range of tailored approaches are required to promote and, more importantly, enable switching amongst different vulnerable groups.

That said, one facet of vulnerability that frequently occurs in combination with and exacerbates others in the energy market context, is the need to survive on low or fixed incomes and the distinct barriers that arise from this.

Ensuring low-income, vulnerable consumers can identify and then successfully secure the greatest savings available to them in the market can play an important role in reducing bills in a high price energy environment. However, stimulating switching amongst this segment remains a significant challenge. As the Ipsos Mori Switching Rates for Vulnerable Consumers[120] report for Ofgem noted earlier this year:

Switching is most prevalent among higher social groups, particularly the professional and managerial ABs. Some of the groups least likely to switch are the state-supported social group E, those aged 65+, those in rented accommodation and PPM users.

KEY ELEMENTS TO EFFECTIVE SWITCHING

Switching entails more than a simple transaction between the consumer and the chosen supplier. In reality, for a consumer to engage in an advantageous switch, the presence of the key elements discussed below is required. The absence of any of these will likely leave the consumer either locked out of the market, or in a position where the deal they choose proves to be less than advantageous (leaving the consumer disillusioned by the process):

awareness and understanding

Those close to the industry tend to take it for granted that there is a universal awareness of this, but as the work of energywatch's Priority Consumer Team with elderly consumers last winter revealed, a number of consumers still believe they are being supplied by the long defunct gas and electricity boards.

The Prepayment Meter Customer Workshop undertaken for Ofgem by Mori earlier this year revealed a low-awareness amongst PPM users of the premium they were paying:

Participants were shown evidence that on average annually prepayment meter customers pay more than direct debit, or occasionally standard credit customers. Many participants were surprised by this. In fact, only 3 of 20 gas PPM customers and 7 of 28 electricity PPM customers knew theirs was not the cheapest method of paying; many simply did not know

121

willingness/confidence

Brand awareness and familiarity appears to play a key role in whether a consumer has the confidence to switch or not, especially for elder consumers. For many, the comfort zone may seem a rational place to stay. Many of those consumers who turned to energywatch for assistance during its "Are You Missing Out?" switching campaign last winter would have realised the greatest savings by switching to Ebico. However, because this brand is largely unknown, many consumers were unwilling to opt for this supplier.

Frequent price changes can also inhibit confidence in switching—especially where the savings available are less significant. They reinforce a common consumer perception that although a supplier may appear to offer a good deal in the present, that could well change in a fast moving price environment.

Brand awareness and familiarity and the perception of changing prices also came through strongly in Mori's research for Ofgem into the experiences of PPM users:

Still other participants are sceptical about switching supplier because they do not have the information to be able to discern between an energy deal that is good for them and one that is not. For instance, participants say they know the difference between the quality of a product from Asda compared with Waitrose, but energy companies do not have a brand personality or image that they know about or can relate to. So in that sense, participants say they find it hard to compare the benefit of choosing one supplier over another. There is also some feeling that costs for suppliers are all much the same.

Personal circumstances

The ability to deduce which offer is in consumer's best interests from available information (ie reasonable literacy and numeracy skills and a working understanding of English).

Financially "included": ie a bank account with a direct debit facility that the consumer has sufficient funds to use with confidence (ie no risk of unexpected payment pushing consumer into overdraft territory), no debt to previous supplier and a credit history that demonstrates "dependability" to new supplier.

Ready access to the Internet and ability to use it effectively: the internet represents the primary source of information on which to make switching decisions and the gateway to best value tariffs. Forthcoming energywatch research indicates that only 11% of social class DE use the internet as a source of switching related information.

information

universally open

The experience of energywatch suggests that major suppliers are discriminating against PPM consumers by refusing to accept them via price comparison sites. This leaves this consumer segment at the mercy of either aggressive doorstep sales agents or suppliers' call centres, which as Mori's PPM research for Ofgem also demonstrated, can put consumers off switching.

A commitment from suppliers

The experience of PPM consumers suggests that this is not always the case. The debt assignment protocol has not worked, price comparison sites are closed doors to PPM consumers, and suppliers can be resistant to recruiting PPM consumers in certain regions (especially token meter consumers). This suggests a dearth of contestability in the PPM market, which in turn shields suppliers from competitive pressures on pricing in this arena and makes the stasis of the status quo a commercially attractive proposition. As a result PPM users are left captive to the resultant price premiums and with limited "escape" routes available to them.

It is also clear that supplier innovation has focused on developing online direct debit tariffs that deliver lower cost energy to more affluent consumers. This has left those consumers who are living on the tightest budgets and are compelled by circumstances to budget energy expenditure through a PPM, as the group least likely to enjoy access to what are effectively the market's budget tariffs.

Without supplier commitment to the unimpeded movement of consumers, any project to help low-income, vulnerable consumers become effective switchers will struggle (and the premium prices they pay will be maintained).

independent arbitrator

WHAT CAN MAKE SWITCHING DIFFICULT FOR VULNERABLE CONSUMERS?

Conclusions of University of East Anglia research[122] on the switching decisions of electricity consumers found that amongst consumers who had switched suppliers exclusively for price reasons:

Only 8-19% of consumers switched to the firm offering the highest surplus and, in aggregate, switching consumers appropriated only between 28% and 51% of the maximum gains available to them ...... (and) that 20-32% of switching consumers appear to have lost surplus through their choice of supplier. These consumers lost an average £14-35 per year in increased bills, apart from any other switching costs they may have incurred.

This suggests that switching to a more advantageous deal might not be as straightforward as its most enthusiastic champions have advocated. When the factors that may hinder the process of switching for vulnerable consumers are taken into account the picture becomes even more complicated.

For vulnerable and low-income consumers some or all of these key elements are frequently absent, effectively meaning that they either remain locked out of the market or that the switching process is short circuited. In particular, the absence of the key abilities and capabilities listed under personal circumstances can cause acute barriers to switching in general, and more so in relation to accessing tariffs that offer the greatest savings.

THE WORK OF ENERGYWATCH ON SWITCHING

Over the last seven years energywatch has been active in offering a range of services and undertaking a range of activities that have helped empower consumers to successfully attain a better deal in the energy marketplace:

Campaigns such as the Energy Smart initiative undertaken jointly with Ofgem have raised consumer awareness of the competitive energy market, the right to switch and the potential benefits that can accrue from participation in the market.

Through its media and publicity activity energywatch has consistently raised consumer awareness of the energy market and, with considerable effect, has not shied away from pinpointing overpriced, underperforming suppliers that consumers should leave behind.

energywatch has also provided consumers with a source of accessible and impartial pricing information on which switching decisions can be based. It has also introduced the Confidence Code, to reassure consumers when using accredited price comparison sites. Both are discussed in further detail below.

energywatch has also been effective in the role of independent arbitrator. At the micro-level it has resolved individual consumer grievances that have arisen from the switching experience. At the macro-level energywatch has taken the evidence presented by its caseload to stamp out the root causes of the barriers that have deterred effective switching—doorstep mis-selling and erroneous transfers being two high profile examples. This in turn has helped increase consumer confidence to switch and forced suppliers to address a number, if not yet all, of their practices that have impeded effective switching.

PRICING INFORMATION AND THE ENERGYWATCH CONFIDENCE CODE

energywatch's price comparison service has provided an impartial facility for consumers to view and compare the different prices on offer from electricity and gas suppliers. This service has helped make consumers aware of their rights as energy users and the choice of suppliers available to them.

The 28 factsheets, available from the energywatch website and in hard copy, compare annual bills for the major suppliers for three different energy usage levels—low, medium (average) and high. There are guidelines which sit behind the factsheets to ensure that suppliers featured are treated equally, and so that prices are comparable.

In relation to external price comparison sites, the energywatch Confidence Code is a set of nine requirements that participating online price comparison services must meet and which aim to ensure that consumers can fairly compare prices from all major suppliers. The Code ensures accredited internet price comparison sites deliver impartial, accurate and reliable information to the millions of energy consumers looking to save money by comparing and switching energy supplier. Although participation is voluntary, there are currently twelve service providers that have recognised the benefit of gaining accreditation. In order to be compliant with the Confidence Code, sites participate in a rigorous, independent audit process to ensure that consumers can have confidence in the services they provide.

A recent survey conducted by YouGov for energywatch, found that 60% of respondents advised that they had used price comparison sites to check domestic gas/electricity prices. Overall, 79% of consumers said that they would be more confident using a price comparison site endorsed by energywatch.

energywatch recently completed its review of the first ten months of the Code's operation and carefully considered all the points raised by the accredited service providers, consumers, suppliers and other interested parties during this time. energywatch proposed that further modifications were needed to the Confidence Code and Code Guidance, to ensure that it remained relevant, robust and transparent in today's market. The results and decision paper are nearing publication.

HELPING VULNERABLE CONSUMERS

The initiatives listed above have undoubtedly assisted the generality of consumers. However, from the outset energywatch has been conscious of the challenge posed in reaching and assisting low-income, vulnerable consumers. This segment of consumers has been the least likely to approach energywatch for assistance, either for advice, or for help when things have gone wrong.

energywatch originally sought to overcome this by taking advice and information to the consumer through broad reach out activities which delivered generic messages to vulnerable groups. This approach was necessarily constrained in the number of consumers it could reach. Its use of targeting was limited and the approach fell short of offering bespoke messages and services tailored to the specific vulnerable groups encountered.

It became clear that this approach was only partially successful in accessing those consumers who most needed our help. It was also clear that the reach out activities were not capturing the experiences of low-income vulnerable consumers in a systematic way that would enable us to change the way we worked to help them more effectively.

After a reassessment of its strategy for vulnerable and low-income consumers, energywatch introduced its Priority Consumer Team in 2005. This team has, in a short space of time, made significant headway in developing successful pathways to a range of vulnerable, low-income consumers. The team's approach has been based on developing strong partnerships with a wide range of trusted intermediaries who, through their core activities, have access to and a dialogue with otherwise hard to reach consumers. Through their partnership with the Priority Consumer Team these agencies are able to bolt on an energy dimension to their core work and in doing so take the message to those consumers who would not normally reach energywatch. The intermediaries have then been able to link vulnerable consumers back to energywatch where assistance is required. The Priority Consumer Team have then been able to offer a holistic service by, in addition to delivering its own service, linking upwards to those agencies who are able to offer further relevant assistance: typically Eaga, the DWP/Pensions Service, and in a number of instances suppliers' voluntary initiatives.

The Priority Consumer Team registered approximately 5,000 people for free services via their supplier between April 2006 and March 2007. Approximately 8,000 vulnerable consumers received direct support by being referred on for energy grants and funding support, energy audits and benefit checks.

HELPING VULNERABLE CONSUMERS SWITCH EFFECTIVELY

Last year (2006), in face-to-face interviews around the country, the Priority Consumer Team identified many older consumers on basic state pensions who could not afford to heat and power their homes, but were reluctant to switch energy supplier. Some of these consumers were paying too much for their energy and a number had a very low-awareness of the energy market. It was also apparent that older people mistrusted supplier information and were left confused by pricing information.

In response, energywatch's Priority Consumer Team devised a switching service to encourage older people to participate in the energy market that could deliver bespoke information. Its "Are You Missing Out?" campaign provided older people and their families with a hotline to call and speak to a member of the Priority Consumer Team. The campaign was promoted through local media and partner agencies. Once consumers made contact the team sourced the best possible deals based on actual consumption. After looking at every tariff to see where savings could be made and wrote to the consumer setting out the top three savings. This allowed the consumer to make an informed choice, based on independent information, in their own time. If the consumer was already with the cheapest supplier the team looked at other ways they could save energy. In addition to providing a pathway by which low-income older consumers could participate in the energy market, this campaign was invaluable in generating strategic intelligence which energywatch has used to highlight the barriers that low-income consumers can face when looking to switch.

Headline figures from the "Are You Missing Out?" campaign include:

— Close to 1,400 price comparisons were conducted, highlighting average annual savings of £115.15.

— 238 consumers transferred, achieving an average annual saving of £177.28.

— 198 consumers were already on the cheapest deal, with the cheapest supplier.

— 936 of consumers could save money by changing either their tariff or supplier with an average saving of £139.50.

— The range of savings highlighted was £4-£974.

KEY FINDINGS AND RECOMMENDATIONS FROM THE "ARE YOU MISSING OUT?" INCLUDED

Likelihood to switch increases in line with potential savings:

— Of the consumers for whom it was identified that savings of £51-£100 were possible (the majority of consumers who contacted the Priority Consumer Team)—there was a 21.7% transfer rate.

— Within the £251-£300 saving bracket there was a 36.8% transfer rate.

— Within the £451-£600 saving bracket there was a 50% transfer rate.

The campaign proved extremely time and resource intensive, leaving the Priority Consumer Team struggling to maintain its targeted response time (not least after a brief mention of the campaign in a national newspaper caused an unexpected wave of calls). It is likely that resultant delays in providing the bespoke information will have eroded the willingness of consumers affected to engage further in the process.

Key to providing a bespoke price comparison service is cooperation from consumers' current suppliers in providing historical meter readings. The team spent a disproportionate amount of time trying to source this information, despite suppliers being made aware in advance of the campaign that this would be required. The team was successful though in agreeing a referral pathway with SSE which enabled it to obtain necessary information by email. Unfortunately, despite requesting a similar referral pathway with other suppliers this did not materialise.

Internet Access: the majority of consumers contacting the team did not have internet access, or were not comfortable in accessing online accounts which offered the best deal.

PREPARING FOR THE POST-ENERGYWATCH WORLD

energywatch continues to push for its successor body, the new National Consumer Council, to carry forward and build upon a number of these initiatives and also to adopt the Priority Consumer Team. Despite this pressure and also negotiations with a range of agencies, it remains unclear which bodies will pick up where energywatch will leave off. This has a number of ramifications that will need to be resolved in the coming 10 months:

(1) Related energywatch initiatives could potentially be dispersed across different agencies—none of which will have the clear remit (or equivalent resource) energywatch has had for undertaking work of this nature.

(2) Resource intensive initiatives may be scaled back or dropped.

(3) Consumers seeking arbitration in relation to switching grievances will have no clear path of advice or redress.

(4) Partnerships established by the Priority Consumer Team that have been successful in reaching hard to reach low-income, vulnerable consumers could lose the energy dimension.

(5) The already limited support available to encourage and assist vulnerable consumers in their engagement with the energy market will be eroded.

(6) The continuous and close scrutiny of suppliers' behaviours in relation to switching will diminish.

WIDER ISSUES

As the headline figures from the "Are You Missing Out?" campaign have shown, even with intensive, bespoke advice and the availability of energywatch support, only around 1 in 6 vulnerable consumers (primarily low-income elderly consumers in this instance) switched supplier. Although this ratio appears to increase as the savings on offer become greater, half of those who could have realised a saving in excess of £450 still chose not to even attempt switching supplier. This poses some fundamental questions on what else, short of forced switching, can be done.

As stated earlier, the crucial role played by personal circumstances and the consumer's abilities and capabilities therein (and the limitations these place upon a consumer's ability to access better tariffs) should make us cautious about simplistic assumptions that switching to the best deal is an option available to all vulnerable consumers. Scratching below the surface can reveal fundamental underlying problems that either need to be addressed before the consumer is in a position to switch to a more advantageous deal; or are entrenched to the point that the vulnerable consumer is unlikely to ever be able to switch to the deals that are theoretically available to them.

Also, if we are serious about including vulnerable, low-income consumers in the energy market, and increasing the proportion of this segment that switch to more advantageous deals, the market itself must offer products that are more responsive and amenable to the circumstances of this segment. It must:

(1) Offer payment methods that reflect the needs of low-income, vulnerable consumers to budget without charging the penalty premium that PPMs currently attract. Options could include a weekly direct debit system, priority access to smart metering for PPM users, and looking at new "stored value" technologies and the potential these have for enabling some low-income, vulnerable consumers to manage their accounts using mobile telephones.

(2) See a genuine commitment from suppliers to permit the free movement of consumers in the energy market. This would require full cooperation with those agencies that are helping vulnerable consumers access the best deals and a willingness to share historical consumption data with those agencies.

In this respect, there is also a clear need to develop an effective, straightforward mechanism that can replace the Byzantine and ineffectual debt assignment protocol.

(3) Ensure switching gateways—primarily the price comparison websites—are available for use by all consumers, including PPM users. They should not act as a filter by which suppliers can skim off more affluent consumers.

APPENDIX 2

TRENDS IN THE LEVEL OF FUEL POVERTY

HISTORIC AND PROJECTED NUMBERS OF HOUSEHOLDS IN FUEL POVERTY IN ENGLAND, 1996-2016

Source: DTI, 2007.

— Positions in 2005 and 2006 are based on the modelling of the impact of income, energy prices movements and energy efficiency measures on the number of vulnerable households in fuel poverty.

— Positions from 2007 to 2016 are based on modelling and show central, low and high price scenarios. These are based on the fossil-fuel price assumptions published at the same time as the White Paper.

Source: UK Government Energy White Paper, May 2007

http://www.berr.gov.uk/energy/whitepaper/page39534.html

NUMBER OF HOUSEHOLDS IN FUEL POVERTY IN THE UK, 1996-2005

Source: 5th Annual Progress Report 2007

http://www.berr.gov.uk/files/file42720.pdf

NUMBER OF HOUSEHOLDS IN FUEL POVERTY (MILLIONS)

	1996	1998*	2001	2002*	2003	2004	2005
England	5.1	3.4	1.7	1.4	1.2	1.2	1.5
	(5.5)	(4.0)	(2.3)	(2.0)	(1.5)	(1.5)	(1.8)
Scotland	0.7	—	—	0.3	0.4	0.4	—
	—	—	—	—	—	—	—
Northern	—	—	0.2	—	—	0.2	—
Ireland	—	—	—	—	—	—	—
UK	About 6½	About 4¾	About 2½	About 2¼	About 2	Aboput 2	About 2½
Estimate	(7½)	(5¾)	(3½)	(2¾)	(2½)	(2½)	(3)

Figures in brackets do not include Housing Benefit/ISMI as part of income

* Figures for England in 1998 and 2002 are estimates based on movements in energy prices, incomes and energy efficiency

Source: Fuel Poverty Monitoring—Indicators 2007
http://www.berr.gov.uk/files/file42702.pdf

APPENDIX 3

SUMMARY OF CORNWALL ENERGY ASSOCIATES' REPORT ON THE PROPORTIONALITY OF SUPPLIERS' SOCIAL TARIFFS

The Energy White Paper challenged the big six energy suppliers to offer adequate and proportionate programmes of assistance to those in most need. To assess suppliers' responses to this challenge, energywatch commissioned Cornwall Energy Associates to independently examine whether the commitments they have made are proportionate and adequate when compared against each other. Cornwall Associates have found that the industry's contribution to social tariffs represents a sub-zero percentage of turnover and that commitment and investment varies significantly at the supplier level. A copy of the full report is available at:

www.energywatch.org.uk/uploads/Proportionality_of_suppliers_social_tariffs_13_January_2008.pdf

This review has deliberately focused only on those initiatives that have a direct impact on the cost of gas and electricity to fuel poor consumers—social tariffs and bill rebates. It therefore excludes trust funds, benefit entitlement checks etc, but it should be noted that the suppliers who come out well in this report also perform well in comparisons of these additional programmes.

The methodology used by the consultants reflects the measures that BERR are likely to use in assessing suppliers' responses to the Energy White Paper—primarily the cost to the supplier as a proportion of turnover, cost per meter supplied by the company, and the benefit to the recipient relative to suppliers' open market tariffs. Using these metrics ensures that the comparisons between supplier and the gulf in performance that results is not merely a reflection of market share. As you will see, this approach has been effective in revealing the disparity between those who do most and those who do least.

The report's key findings are presented below:

ANALYSIS OF CURRENT SOCIAL TARIFF AND REBATE OFFERINGS COMBINED SHOWS THAT:

The supply industry as a whole commits 0.11% of its estimated £24.6 billion turnover to social tariffs and rebates. At the supplier level this ranges from British Gas committing 0.18% of turnover to its Essentials social tariff to RWE npower committing less than 0.003% of turnover to its First Step social tariff (prior to its new rebate and the widening of its First Step social tariff becoming available).

When the "costs" to the companies are divided by all the gas and electricity accounts they serve (described as "cost £/meters" supplied in the tables) this ranges from £1.04 for British Gas down to £0.02 for RWE npower.

The average benefit to gas and electricity social tariff recipients (excluding rebates) ranges from £181 per annum (gas and electricity) for Scottish & Southern's Energyplus Care to £98 for British Gas's Essentials. Although E.ON UK's Staywarm arrangement comes in at £424, the report was unable to make direct comparisons with the other social tariffs and highlights where further information is required from E.ON UK in relation to Staywarm.

The coverage of tariffs and rebates expressed as a proportion of each supplier's customer base ranges from 1.74% for British Gas to 0.04% for RWE npower (again, E.ON UK is highest at 2.28%, but this is skewed by the 160k recipients of its £10 Age Concern Cold Weather Payment).

ANALYSIS OF SOCIAL TARIFF AND REBATE OFFERINGS IF AND WHEN SUPPLIERS FULFIL THE COMMITMENTS MADE FOLLOWING THE ENERGY WHITE PAPER SHOWS THAT:

In response to the Energy White Paper, suppliers have committed to increasing the availability of social tariffs. If suppliers manage to achieve these targets then the commitment of the supply industry as a whole will increase to 0.25% of its estimated £24.6 billion turnover. The increase will be mirrored at the supplier level if suppliers fulfil their commitments, but with a gulf remaining in the proportion of turnover each supplier commits to these initiatives. If targets are fulfilled British Gas will be committing 0.49% of its turnover to its Essentials social tariff, while RWE npower and Scottish and Southern Energy will be committing just 0.07% of their respective turnover to their tariffs and rebates.

When the "costs" to the company are divided by all the gas and electricity accounts they supply then British Gas will be contributing at £2.77 per customer account reducing to £0.32 for RWE npower and £0.31 for Scottish and Southern Energy.

In terms of benefit to social tariff recipients (excluding rebates), the range remains the same, but will include the introduction of Scottish Power's social tariff at £109.28

The number of recipients of tariffs and rebates expressed as a proportion of each supplier's customer base increases with a range running from 4.67% for British Gas to just 0.34% for Scottish and Southern Energy if and when all commitments are fulfilled.

If the commitment each supplier has demonstrated is measured against their respective market share the disparity that exists is further emphasised:

Current Target

Market
Share Social
Package
commitment
Market
Share Social
Package
commitment

British Gas 33% 59% 33% 71%

EDF Energy 11% 13% 11% 6%

RWE npower 14% 0% 14% 4%

E.ON UK 16% 21% 16% 10%

Scottish and Southern Energy 16% 1% 16% 6%

Scottish Power 11% 5% 11% 4%

Total 100% 100% 100% 100%

PERFORMANCE AGAINST BERR'S MAY BENCHMARK

BERR have indicated that they will review supplier performance against the averages in place at May 2007 when the White Paper was published. The energywatch review shows that on the key measures analysed, both RWE npower and Scottish and Southern Energy remain below the benchmark. (NB: since the report was finalised RWE npower has indicated at its recent price rise that it will increase the value of its Spreading Warmth rebate, but by the same token British Gas has recently announced it will offer a new £90 rebate to c.25k customers).

The report considers what the world would look like if underperforming suppliers met this benchmark and forecasts that it would result in an additional commitment of between £3 million and £3.68 million depending on the measure used. It also forecasts that if the other five suppliers matched British Gas in offering assistance to 4.67% of their customer base this could result in a doubling of the number of accounts (not households) eligible for social tariffs—from the current combined target of 930k to 2.29 million. If all suppliers at least match the May 2007 average the number would increase to 1.37 million accounts (energywatch estimate that 4 million fuel poor households translates as 6.4 million energy accounts, taking account of an estimate of the number of fuel poor without access to gas).

APPENDIX 4

ENERGYWATCH BRIEFING ON SOCIAL TARIFFS JANUARY 2008

CONTEXT

The accelerating cost of energy since 2003 means that social tariffs have an urgent and essential role to play in helping address the impact of high prices on low-income households. Price rises are solely responsible for the reversal of progress towards the Government's fuel poverty targets. The limitations and disparities of the current approach to providing social tariffs—reliant on pressuring suppliers to develop products voluntarily, as part of their corporate social responsibility activity—are now clear and the government must use the Energy Bill to require suppliers to offer social tariffs in accordance with minimum standards.

SOCIAL TARIFFS WOULD BOLSTER THE UK FUEL POVERTY STRATEGY

The government's 2001 UK Fuel Poverty Strategy was built on three pillars, each of which sought to address the three factors that conspire to cause fuel poverty: energy inefficient homes with sub-optimal heating systems, the low level of income on which the fuel poor subside, and the cost of energy to fuel poor consumers. The pillar reliant on "continuing action to maintain the downward pressure on fuel bills"[123] has long since crumbled. As Malcolm Wicks felt it reasonable to predict in 2007: "the era of cheap energy has gone for ever".[124]

Price increases have outstripped income growth and outpaced the rate at which energy efficiency and heating improvements can be installed. The net effect has been an increase in fuel poverty, with the 2007 Energy White Paper observing that UK fuel poverty was back at the 4 million household mark—double the 2004 figure and a return to pre-Strategy levels.

THE PROBLEM(S) WITH A VOLUNTARY APPROACH TO SOCIAL TARIFF PROVISION

The lack of any framework or guiding principles on what constitutes a meaningful social tariff has resulted in a situation where, despite reference to "social tariffs" becoming a staple in the narrative of stakeholders, suppliers have been free to appropriate the term as they see fit and apply it to a divergent range of tariff offers. Research has shown that a number of currently available products see recipients of "social tariffs" actually paying more than the open market tariffs available to other, more affluent consumers with the same supplier in most cases.

energywatch is concerned that the status quo is riddled with inconsistency: inconsistency in the nature of assistance offered, inconsistency in the level and quality of assistance offered, inconsistency in entitlement, and inconsistency in the length of time for which the product is available to recipients.

Concerns of this nature are not limited to the "fuel poverty lobby"—both EDFE, British Gas and RWE npower have expressed similar views:

British Gas will review its Essentials tariff model in March 2009. In the meantime it will be seeking agreement with other suppliers and stakeholders for industry-wide introduction of social tariffs to broadly common standards which would allow social tariff customers the same choice in the market as other customers.

British Gas press release, 08.02.07

There should be a common industry approach to offering assistance to the fuel poor. This would bring benefits such as clarity to consumers, particularly vulnerable ones, and also to those assessing the effectiveness of social programmes. In addition, it would create a level playing field which all suppliers would compete equally within this market segment.

We believe that after establishing the agreed definition, scale and structure, all suppliers should be required to participate in the scheme. Having led the industry in offering a social tariff we are disappointed that all industry colleagues have not followed suit, indicating that the competitive market needs adjusting.

Levels of benefit available, and eligibility for benefits should be defined by Government.

EDFE response to energywatch social tariff consultation, January 2007

At present, government is encouraging the delivery of a social action solution within a voluntary framework. It is doubtful whether this is the most efficient approach and it is also seemingly inconsistent with a market framework. We believe that the interest of the fuel poor is best served by a mandatory social tariff and this is the only means by which the Government's 2010 and 2016 objectives can be achieved. There is no obvious reason why these targets will be delivered within a competitive retail market.

RWE npower response to Ofgem's Five Year Strategy, September 2007

THE ENERGY WHITE PAPER AND OFGEM'S REVIEW OF SUPPLIERS' INITIATIVES

The Energy White Paper[125] noted the commitment that certain suppliers had demonstrated in relation to assisting their fuel poor consumers. Significantly, it also challenged suppliers who had done little in this respect to develop adequate programmes of support, with the implication being that if this did not happen, legislation could be used to ensure all suppliers offered adequate programmes of support. This challenge has been effective in driving differing degrees of improvement from suppliers (most notably ScottishPower's U-turn on social tariffs). The White Paper also tasked Ofgem with evaluating and comparing suppliers' voluntary measures.

The subsequent Ofgem review declined to rank the quality of suppliers' initiatives, to declare which suppliers are offering proportional assistance, to highlight best practice, or to examine the effectiveness of each initiative. Also, despite the intention expressed in the Energy White Paper—that Ofgem would evaluate each company's Corporate Social Responsibility measures to see exactly how these compare, drawing attention to the most effective initiatives and highlighting where improvements are needed—the Regulator has neither drawn attention to the most effective initiatives nor highlighted where improvements are needed. This lack of differentiation has granted it the space to underplay the gulf in performance and in so doing present the voluntary approach as an effective response.

Ofgem's review also advocated competition as the best way to ensure fuel-poor consumers are protected from high prices. Interestingly, the Sustainable Development Commission's recent report (Lost in Transmission—The role of Ofgem in a changing climate) concluded that switching supplier "is not a particularly helpful or appropriate method of reducing low-income household fuel bills and that more proactive steps need to be taken to protect low income and vulnerable consumers". The barriers to this consumer segment switching—frequently lack of access to direct debit and the internet—are well established.

Reliance on the voluntary approach also carries an inherent risk of "backsliding", either where suppliers renege completely on commitments—especially if rising wholesale prices put the bite on voluntary initiatives; or where the best scale back their activities, causing a levelling down rather than the desired levelling up.

The frustrations voiced by British Gas and EDFE, both of whom have declared they will review their own activities, the disparities in supplier commitment highlighted by energywatch's own work, and that the status quo hands a competitive advantage to those who do least, all point to a strong likelihood of backsliding unless the government intervene to level up the performance of those suppliers who do least.

THE ENERGYWATCH VIEW (AND REVIEW)

Because Ofgem's review failed to bring the disparities between supplier performance and the resultant lack of proportionality to the fore, energywatch commissioned Cornwall Energy Associates to examine the adequacy of each supplier's social tariffs and whether these were proportional when compared to each other. This review was undertaken in line with the methodology that BERR is likely to use. The Cornwall report exposes the pronounced gulf between what suppliers are committed to offering meaningful assistance and reinforces the case for the Secretary of State taking powers in the Energy Bill.

This report has shown that if energy suppliers fulfil the commitments made to government, the industry will invest 0.25% of its estimated turnover in social tariffs and rebates—the initiatives that offer direct assistance with the cost of energy to fuel poor households. For individual suppliers this ranges from British Gas committing 0.49% of its turnover to a mere 0.079% of turnover for npower and Scottish & Southern Energy. British Gas is committed to making assistance available to 4.7% of its consumer base, while for npower and Scottish & Southern this figure is 0.79% and 0.34% respectively. The commitments made by British Gas will equate to 71% of the total industry assistance offered, while its market share represents just 33%; whereas npower has an 11% market share but has a social package commitment that will represent 4% of the total.

BERR has indicated that its own assessment will examine whether suppliers' social package are at or above the average in May 2007 when the White Paper was published. Energywatch's findings are that npower and Scottish & Southern (who offer a generous social tariff, but on a very limited scale) remain below even this level. If all suppliers met at least this average, social tariffs and rebates would be available to the equivalent of 1 in 5 fuel poor accounts. If suppliers matched the commitment shown by British Gas this figure would rise to 1 in 3.

A copy of the full analysis is available at:

www.energywatch.org.uk/uploads/Proportionality_o_suppliers_social_tariffs_13_January—2008.pdf

ENERGYWATCH RECOMMENDATIONS: MINIMUM STANDARDS FOR MAXIMUM IMPACT

energywatch advocates that the Secretary of State takes powers in the Energy Bill that will enable him to require suppliers to offer social tariffs in accordance with minimum standards. This will preserve the momentum created by the Energy White Paper challenge and even out the divergence in suppliers' commitments. Social tariffs represent the clearest way of addressing the Fuel Poverty Strategy's failure in relation to pressure on prices and, if mandatory, will ensure that all suppliers make affordable energy available to a significant number of those consumers for whom the high cost of energy has presented the greatest challenge.

Valid concerns exist over whether social tariffs can be accurately targeted and the extent to which they would distort the market. The accurate targeting of any non-universal welfare mechanism is difficult, but that does not mean it is impossible. As the more progressive energy suppliers are demonstrating, there are ways and means of identifying and reaching households in most need. The White Paper's commitment to facilitate data sharing with the DWP will undoubtedly refine this process further.

In relation to market distortion, if the social tariff is indexed at a set rate against each supplier's open market rates (Scottish & Southern Energy's 20% against the recipient's existing tariff, for example) and made available on a scale that is relative to a supplier's market share this should not be an issue as the obligation will fall fairly across all suppliers and reflect their overall competitive position.

The social tariff model that energywatch has recommended would be built on, but not limited by, minimum standards. Our proposals go with the grain of competition rather than work against it, with the use of targets on suppliers forcing them to compete for a group of consumers that have hitherto been largely excluded from the market. Targets would also ensure that no supplier is unduly disadvantaged by such an obligation.

Social tariffs offered in isolation will not eradicate fuel poverty and neither should they be expected to do so. That is why the proposals put forth by energywatch would see social tariffs form an integral part of an Energy Assistance Package, with the package creating the vehicle for ensuring that the three underlying causes of fuel poverty are tackled.

A full copy of the energywatch report and recommendations on social tariffs—A Social Responsibility?—is available at:

http://www.energywatch.org.uk/uploads/A_Social_Responsibility_the_energywatch_consultation_on_ the_nature_of_social_tariffs_in_the_energy_market_report_and_recommendations_9_May_20071.pdf

Annex B

MARKET SHARES AND CONCENTRATION

Not printed here.

Annex C

LESSONS FROM CC INVESTIGATIONS AND CASE LAW

PURPOSE

This annex considers:

— the findings of two key merger control judgements by the Court of First Instance relating to collective dominance;

— the CC's investigations of coordinated effects and consumer detriment; and

— the application of these cases and investigations to the GB energy markets.

CASE LAW ANALYSIS OF COLLECTIVE DOMINANCE

The Airtours v Commission judgement identified three conditions necessary to establish collective dominance (see paragraph 62):

Knowledge of others adopting the common strategy

Incentive to maintain the common strategy

Inability of competitors to jeopardise the outcome of the common strategy

The Impala v Commission (Case T-464/04) judgement appears to lower the test for proving collective dominance (see paragraphs 251 and 252) by stating that:

Collective dominance may be established indirectly

Collective dominance may be demonstrated through pricing data

MARKET INVESTIGATION INFORMATION GATHERING

The Competition Commission procedures[126] highlight that information gathering, analysis and validation is a key part of the investigation. The CC requires access to detailed information regarding the companies and markets in question to make its statutory decisions on the competition and remedies questions. The CC collects information in a variety of ways including:

— Letters and questionnaires to the main parties in an investigation and sometime to third parties.

— Press notices, advertisements and website requesting information.

— Publicly available sources of information.

— Surveys can be commissioned to provide evidence about a particular market.

— Visits to the main parties to gain a first-hand experience of the workings of the company and industry in question.

— Commissioning of expert advice.

— Hearings with the parties.

MARKET INVESTIGATION ANALYSIS OF COORDINATED EFFECTS

The Competition Commission provisional findings report on the supply of groceries in the UK considers the three conditions necessary for coordinated effects to emerge and be sustainable (see paragraph 33 and Section 7 of the provisional findings and paragraphs 3.53 to 3.73 of the Competition Commission guidelines on market investigation references):

Awareness of competitors' behaviour

Costly to deviate from prevailing market behaviour

Weak competitive constraints

With respect to possible coordination strategies, the Competition Commission noted in its provisional findings that (Section 7):

— Coordination is more likely to emerge if competitors have similar views of what actions would make coordination work: for example, setting prices around a focal point.

— Retailers could, in principle, seek to coordinate on large numbers of the products.

— In practice, coordinated action over a vast number of prices would be difficult to achieve.

— A coordination strategy that might potentially be easier to implement would be to focus coordination on a subset of products.

With reference to the supply of groceries in the UK, the Competition Commission notes that (see paragraph 34 to 37 and Section 8):

— There is evidence that suppliers facilitate the exchange of information on retail prices charged by rival retailers. Given the presence of the necessary conditions for co-ordination in grocery retailing, we consider that this exchange of information on retail prices would assist retailers in establishing terms of tacit coordination on a small number of products.

— There is a trend of consolidation among upstream intermediaries in milk and other sectors, particularly in fresh produce. Further consolidation may be a cause for concern if it means that coordination is more likely to emerge in other product categories.

— While there is no direct evidence of tacit coordination at present, we are concerned that, given the structure of the grocery retailing market, such behaviour could occur in the future.

The Competition Commission provisionally found that a combination of one or more features prevent, restrict or distort competition in certain local markets for the supply of groceries (see paragraphs 47 to 49 and Sections 5, 6 and 9):

— A significant number of local markets have high levels of concentration and these high levels of concentration have persisted over a number of years.

— The control of land in highly-concentrated local markets by incumbent retailers acts as a barrier to entry, by limiting entrants' access to potential sites for new stores.

The Competition Commission also found (see paragraph 50 and Section 9) that the exercise of buyer power by certain grocery retailers and symbol groups with respect to their suppliers of groceries, through the adoption of supply chain practices that transfer excessive risks and unexpected costs to those suppliers, is a feature of the markets for the supply of groceries by all grocery stores, which prevents, restricts or distorts competition in connection with the acquisition of groceries by those grocery retailers and symbol groups.

Application to the GB energy markets

Table 1 considers whether the conditions necessary for facilitating coordinated effects may be present in the GB energy market with particular reference to the domestic gas and electricity retail markets.

Table 1

HIGH LEVEL COORDINATED EFFECTS ANALYSIS

Condition	Analysis
Awareness of competitors' behaviour	— Firms are well aware of their competitors' behaviour. — Products essentially homogenous and there is a high level of interaction. — The domestic gas and electricity retail markets are highly concentrated with six firms supplying more than 99% of the market. — Supply licence condition 22.7 states "If a person requests a copy of any form of Domestic Supply Contract that the licensee may offer under paragraph 22.2, the licensee must send a copy of that form of contract to that person within a reasonable period of time after receiving the request". Supply licence condition 22.4(b)(i) requires a Domestic Supply Contract to identify the charge for the supply of gas or electricity and the charge for any other good or service to be provided. — There are a number of price comparison services that allow users to compare prices across suppliers quickly and easily. There are also a number of firms that provide pricing databases and analysis. — Suppliers issue press releases announcing changes in prices and there is considerable media coverage concerning price.
Costly to deviate from prevailing market behaviour	— Suppliers are aware that it is in their interests to act in a similar way. — Five of the main six suppliers increased their prices in January or February 2008. Headline price increases for domestic consumers ranged from 12.9 to 17.2% for gas and 7.9% to 15% for electricity. The remaining supplier increased its prices in April 2008 by up to 15.8% for gas and 14.2% for electricity. Charts 1 and 2 show movements in gas and electricity prices across the last five years. — Price differentials vary across tariffs. There is a £13 annual difference in the dual fuel direct debit offering of five of the main six suppliers—this is equivalent to 25p per week. There is only a £26 annual difference across the six suppliers equivalent to 50p a week. — Energy prices can change quickly so that suppliers not complying with prevailing market behaviour can be punished.
Weak competitive constraints	— No scale new entry—entrants control less than 1% of the domestic supply market. — The domestic gas and electricity markets have been characterised by supplier exit rather than entry so entry does not provide competitive constraint. — Suppliers appear to be seeking to move together within a short period of time of each other and in parallel. This is a kind of "risk minimisation strategy" where they do not seek to be particularly better or worse than their competitors. — There does not appear to be any strong competitive constraint that impacts the strategy adopted by the dominant six suppliers.

Chart 1

CUMULATIVE INCREASES IN DOMESTIC GAS PRICES 2003 TO 2008

Source: energywatch analysis of suppliers headline price increases as reported in the press

Chart 2

CUMULATIVE INCREASES IN DOMESTIC ELECTRICITY PRICES 2003 TO 2008

Source: energywatch analysis of suppliers headline price increases as reported in the press

energywatch considers that the conditions necessary for coordinated effects to emerge and be sustainable are present in the domestic gas and electricity supply market. This means the market is susceptible to abuse of dominance and consumers will pay more than the competitive level for their energy. The CC would be able to undertake a more detailed analysis of coordinated effects in the domestic supply and wider GB energy market as part of a market investigation.

MARKET INVESTIGATION ANALYSIS OF CONSUMER DETRIMENT

Excessive prices

In Store Cards the OFT referred the supply of store card services to the Competition Commission following its conclusion that there are features of the sector, both in the supply of store card credit to consumers and in the supply of store card services to retailers, that appear to prevent, restrict or distort competition.[127] In paragraph 1.13 of its report the OFT stated that "there is insufficient competition to ensure that consumers get good value from store cards and that such lack of competition may lead to increased profits for retailers and store card providers".[128] For the OFT then, the possible harm to consumers resulting from the perceived lack of competition in this sector revolved around the concept of value for money. The idea of "good value" brings to mind the definition of an "unfair price" in the case United Brands Co. v Commission; it concerns a price that is "excessive in relation to the economic value of the product supplied".[129] In other words, the OFT formulated the possible consumer detriment in this sector in terms of unfair or excessive prices for consumers.[130] In its investigation the Competition Commission tried to quantify this consumer detriment by comparing the prices actually paid by cardholders who pay interest and insurance charges on store cards with the prices they would have paid had these reflected costs, including the cost of capital.[131]

Subsequent market investigation references submitted to the Competition Commission have also concerned the impact of (weak) competition on prices paid by consumers; see for example Supply of Liquefied Petroleum Gas[132] or Northern Ireland Banking.[133] In the former case the OFT suspected that "the high switching costs [between different gas companies in the market for the supply of domestic bulk liquefied petroleum gas] may form a barrier to entry, so that competition is restricted and many consumers face higher prices overall than they would in a similar market without switching costs".[134] In the latter case, the OFT held that the conditions for a referral were met as high levels of concentration, significant entry barriers, price parallelism and consumer inertia appear together to result in limited price competition and weak switching competition between the big four banks in Northern Ireland.[135] Both investigations are ongoing.

In Home Collected Credit[136] the Competition Commission actually attempted to quantify the overcharge suffered by customers in the relevant market; according to the CC customers suffered from "substantial overcharging":

[overcharging] may have amounted to as much as £100 million a year over the last five years across the whole market, which would imply that a home credit customer pays over £25 too much for an average loan, or £9 per £100 borrowed, and that home credit lenders have been able to earn more than £500 million in profits in excess of the cost of capital in the last five years

137

This case thus highlights that the Competition Commission: (i) considers overcharging as a form of consumer detriment; and (ii) is willing to quantify the extent of the overcharge when possible. Home Collected Credit also demonstrates that the CC will consider the effects of weak competition on particular categories of consumers as well as consumers in general. Indeed, on the facts before it the Competition Commission expressed its belief that the overcharge may have more of an effect on single mothers under 35:

Home credit customers were more likely than the population as a whole to be female, to be under 35, to have young families, to fall into socio-economic groups D and E, to live in a low-income household and to live in housing rented from a local council or housing association

138

Non-price factors

In Home Collected Credit signalled how the Competition Commission will also consider different forms of consumer detriment where relevant:

We shall determine whether any effect on advertisers or users [ie consumers] in the form of higher prices, lower quality or less choice of goods and services, or less innovation has resulted from, or may be expected to result from, any adverse effects on competition in the relevant market or markets

139

Indeed, if the Competition Commission decides that there is an adverse effect on competition it must "take action to `remedy, mitigate or prevent' the adverse effect on competition and to `remedy, mitigate or prevent any detrimental effects on customers' so far as those effects have resulted from the adverse effect".[140] By definition "any detrimental effects" must also include those detrimental effects which cannot be classed solely as effects on the prices paid by consumers.

In the provisional findings on the supply of groceries investigation, the Competition Commission recommends a number of competition policy solutions, including the introduction of a "competition test" when local planning authorities are assessing planning applications for new large grocery stores, and A requirement on grocery retailers to lift existing exclusivity arrangements that have been in place for more than five years, where these have been identified as a barrier to entry by a competing retailer in areas of high concentration. In addition, however, the Competition Commission has recommended remedies that go beyond what competition law itself could do: namely that the Department for Business, Enterprise and Regulatory Reform amend the Land Agreements Exclusion Order so that agreements which restrict grocery retailing should no longer benefit from exclusion from the Competition Act.[141]

Application to the GB energy markets

energywatch considers some of the key features that led the OFT to make recent market investigations references to the CC are also evident in the GB energy market. Table 2 provides a high level analysis of these features and some of the areas of consumer detriment that the CC has considered in recent market investigations. energywatch believes that these issues need further investigation along with a quantification of the associated consumer detriment as part of a GB energy market investigation by the CC. Although energywatch has only limited information gathering powers, the CC would be able to demand access to the all the relevant commercially sensitive and confidential information held by market participants.

Table 2

HIGH LEVEL ANALYSIS OF CONSUMER DETRIMENT

Feature	Analysis
Unfair or excessive pricing	— Prepayment meter consumers can pay up to £456 for their energy than a consumer paying by online direct debit. Ofgem has estimated that the additional cost to serve a prepayment meter is estimated to be no more than £85 although this was based on limited information. It is not clear that this estimate is based on efficiently incurred costs ie costs will be higher where is no incentive on the firm to become more efficient if it is confident that it will be able to recoup the cost from a captive consumer. — Firms reference increases in wholesale prices linked to the forward curve when increases retail prices. Forward prices are not a robust indicator of future costs as they are based on limited trading activity and the level of vertical integration means that the dominant firms are not exposed to these prices for significant volumes. There is no transparency of transfer prices.
High switching costs	— Small business consumers face significant search and switching costs due to the application of complex contractual arrangements by suppliers, a lack of clarity on terms and conditions and a lack of comparative price and service information. — Survey evidence demonstrates that domestic consumers also face high switching costs—amongst electricity consumers who had switched suppliers exclusively for price reasons only up to a fifth had switched to the supplier offering the greatest saving and up to one third had switched to deal that had left them worse off.
Consumer inertia	— Survey evidence found that 55% of domestic consumers are "very unlikely" to change their gas or electricity suppliers in the near future and that 14% consumers stated they would never switch.
High level of concentration	— 6 firms control over 99% of the domestic gas and electricity markets and 95% of the business electricity market. — The combined gas and electricity domestic supply markets have a national HHI of nearly 2,000. The national domestic gas market has an HHI of 2,800 and the regional electricity markets are estimated to have HHIs of 2,500 to 6,500.
Significant barriers to entry	— There has been no new scale entry to the GB energy markets. — Entrants advise that there are high barriers to entry including lack of liquidity in the wholesale markets, dominance of vertically integrated players, lack of independent counterparties to trade with, information asymmetry, credit policies of the dominant firms, complex industry codes and cash-out arrangements.
Price parallelism	— Suppliers tend to change prices within similar ranges and timeframes. Charts 1 and 2 show how headline prices have changed across the last five years.
	— Conditions for coordinated effects to emerge and be sustainable through time are present in the domestic supply markets.

Annex D

TERMS OF REFERENCE FOR A CC MARKET INVESTIGATION

PURPOSE

This annex:

— considers the four criteria the OFT considers need to be met before deciding to make a reference to the Competition Commission; and

— sets out possible terms of reference for a GB energy market referral to the CC.

APPROPRIATENESS OF A REFERENCE

To make a CC reference there must be "reasonable grounds for suspecting that any feature, or combination of features, of a market in the UK for goods or services prevents, restricts or distorts competition in connection with the supply or acquisition of any goods or services in the UK or part of the UK" (Sections 131 or 132 of the Enterprise Act 2002). Where this threshold is met, the OFT (or the relevant sectoral regulator) has discretion as to whether to make a reference or not.

The OFT has set out four additional criteria that would normally have to be met before it would decide to make a reference[142]:

proportionality

availability of remedies

alternative powers

undertakings in lieu

These four factors are considered below in relation to a GB energy market referral.

Proportionality

energywatch recognises that a reference to the CC would impose a substantial burden on the businesses affected, particularly in terms or management time, and have considerable recourse implications for the CC itself. However, energy is a necessity product for domestic and business consumers and represents around 3.5% of expenditure for the average household and more than 10% of income for the fuel poor—for some fuel poor households the cost of warmth can rise to 20, 30 or even 40% of income. The energy sector represents about 4% of UK GDP but is a required input to the other 96%. The benefits of remedying any adverse effects which might be found to exist in the GB energy markets would, therefore, be expected to outweigh these costs.

Availability of remedies

energywatch believes there is a reasonable chance that appropriate remedies will be available. Some possible remedies are considered in Annex E.

The CC has a wide range of discretion and the necessary powers to adopt a wide range of measures designed to remedy identified defects in the market. The CC can:

— Make a significant and direct change to the structure of a market (eg through divestment and unbundling).

— Change the structure of the market indirectly (eg through reducing barriers to entry or search and switching costs).

— Direct firms to discontinue certain behaviour (eg giving adequate notice of price changes and the timeframe in which a change of supplier can be made) or to adopt certain behaviour (eg more prominently displaying prices and other terms and conditions of sale).

— Restrain the way in which firms would otherwise behave (eg the imposition of a price cap).

— Monitor (eg requirement to provide the regulator with information on prices or profits).

Alternative powers

Competition law is more usually applied to vertical agreements that restrain competition rather than integrated firms. Concerns about firm conduct relate to the process of competition between firms across GB as a whole and are not merely isolated local matters.

Undertakings in lieu

energywatch is not aware of specific undertakings that would remove the need for a market investigation reference.

energywatch considers that a market investigation reference would be the most appropriate route for addressing the concerns raised about the features of the GB energy market that appear to be preventing, restricting or distorting competition in the market.

TERMS OF REFERENCE

The Secretary of State for Business, Enterprise and Regulatory Reform, in exercise of his powers under Section 132 of the Enterprise Act 2002, hereby makes a reference to the Competition Commission for an investigation into the supply of gas and electricity in Great Britain (GB).

The Secretary of State has reasonable grounds for suspecting that a feature or a combination of features of the GB energy market or markets prevents, restricts or distorts competition in the supply of gas and electricity in GB.

For the purpose of this reference the expression "GB energy market":

— Includes the wholesale and retail markets for gas and electricity in GB.

— Excludes the gas and electricity networks in GB.

Issues

The key issues for consideration in a GB energy market investigation appear to be:

Market structure

— How the level of concentration has changed over the past few years and how it might be expected to change in the future.

— Whether the level of concentration has an effect on the conduct of some or all of the firms in the GB energy markets.

— Whether the level of concentration might be indicative of any features of the market that might prevent, distort of restrict competition.

— Whether horizontal concentrations, vertical integration or contracting strategies has reduced competition or created inefficiencies.

Barriers to entry

— What new entry has there been over the past few years and what can be expected in the future.

— What were the key reasons for firms exiting the market over the past few years and what can be expected in the future.

— What the barriers are to new entry and expansion.

— Whether incumbent firms benefit from economies of scale or scope and information asymmetries.

Conduct

— Whether firms compete fairly and vigorously.

— Whether movements in price are consistent with effective competition.

— Whether firms compete on price and whether other aspects such as service and quality are also important.

— Whether there is any variation between regions in how products are offered or promoted or in the application of charges and whether any variation might be due to the extent of local competition.

— Whether service quality as measured by customer satisfaction, mistakes, complaints or adherence to industry codes and redress schemes is at a level consistent with active competition.

— Whether there is a lack of innovation or choice.

— Whether there is sufficient transparency or gaps in information flows.

— Whether there are conditions present that facilitate coordinated effects.

Remedies

The CC can determine what action should be taken to remedy, mitigate or prevent adverse effects on competition or any detrimental effect on consumers. Consideration may be given to:

— Mandatory trading.

— Enhanced reporting and disclosure requirements to aid price discovery.

— Simplifying market rules and entry requirements.

— Greater transparency of information on gas flows.

— Investment incentives for long term strategic storage.

— Reducing search and switching costs.

— Regular market monitoring of the business sector.

— Reintroduction of supply price controls for certain consumer groups if other measures are considered insufficient.

— Divestment of plant or function if other measures are considered insufficient.

Annex E

HIGH LEVEL ANALYSIS OF POSSIBLE REMEDIES*

This annex considers possible remedies that could be put in place to help ensure there is effective competition in the GB energy markets and to address concerns about fuel poverty.

Area Consequence Remedy Vehicle Timeframe Benefits Counterarguments

Fuel poverty More consumers being thrown into fuel poverty as a result of high prices.
Government fuel poverty targets will not be met.
Breakdown of government strategy to eradicate fuel poverty. Mandate social tariffs with minimum standards Government: Primary legislation (the Energy Bill was a missed opportunity) Short to medium Fuel poor have access to more affordable tarrifs. Some industry and government resistance on innovation grounds—suppliers are not doing sufficient to protect the fuel poor at present and the standards only set a minimum against which suppliers can innovate.

Gas flows Wholesale gas prices and in turn wholesale electricity and retail prices will be higher and more volatile than they need to be if prices are driven by market sentiment rather than sound information. Enhanced information on gas flows from Europe and the North Sea. Government/Ofgem: Secure agreement from other European governments (particularly Norway) and through the European Commission to provide enhanced disclosure of information on gas flows into GB. Short to medium Greater transparency and reduced information asymmetry.
Reduced volatility in wholesale prices.
Wholesale and retail prices should more closely reflect cost. Commercially sensitive information—information can be published on a suitably aggregated basis where there is evidence that confidential information would be divulged.

Small business search and switching costs Small businesses face high search and switching costs due to a lack of comparative price information and are unable to make informed decisions. Introduce a independently accredited price comparison services for small business consumers OFT/Ofgem: Develop independent accreditation for price comparison services for small business consumers—this could be taken forward as part of the wider work recommended by the National Audit Office in "Protecting consumers? Removing Price controls" to reduce potential consumer confusion by formulating and negotiating ownership of a single code to cover price comparison websites Short Reduced search and switching costs for small businesses.
Small businesses consumers more able to make informed switching decisions and access more affordable contracts. No obvious counterarguments.

Small business contractual arrangements Small business locked in to higher priced contracts due to complex contractual arrangements. Introduce standard terms and conditions for small businesses that are fair and easy to understand. Competition Commission: Direct small business suppliers to offer standard terms and conditions and publicise appropriately Short Greater visibility of terms and conditions.
Small businesses consumers more able to make informed switching decisions and access more affordable contracts. Industry likely to resist on grounds of innovation—small businesses are disproportionately disadvantaged in dealing with their energy suppliers because they are neither protected by effective competition, adequate regulation nor general consumer law. Evidence suggests that small businesses operate with a domestic consumer mindset when purchasing energy.

Domestic prices Domestic consumers paying more than they need to for their energy due to high search and switching costs. Suppliers to provide additional information to consumers on household bills on alternative offers that may save consumers Competition Commission: Direct suppliers to provide information on alternative offers on household bills Short to medium Reduce consumer search and switching costs for domestic consumers.
Domestic consumers more able to access more affordable tariffs. Potentially complex interaction between tariffs—it will be possible to at least provide some clear messages on alternative offers that could save consumers money. Ofgem play a role in the development of the information to be provided and regularly monitor information provision.

Business competition No clear basis for identifying problems business consumers face so no route to address consumer detriment Regular market monitoring of the business market Competition Commission: Direct firms to submit regular information to Ofgem on competition in the business market Short Greater understanding and visibility of the problems business consumers face and the detriment this causes.
Provides basis for making positive changes to the benefit of business consumers. Potential resistance to new regular reporting requirements—the frequency and form of reporting can be set so as to minimise any additional regulatory burden.

Gas storage Relative lack of long term strategic storage in GB means we are less able to store low priced gas as an alternative to high priced gas during the winter or periods of unexpectedly high demand and maintain security of supply Create incentives to invest in long term strategic storage Competition Commission: Direct government to introduce an obligation on firms to hold a defined proportion of gas in long term strategic storage either through a licence condition or underpinned by legislation if required Medium Enhance security of supply.
Reduce dependence on high priced gas during winter and periods of unexpectedly high periods of demand.
Retail prices should more stable. Government may be reluctant to revisit the case for long term strategic storage given it considered this as part of the Energy White Paper 2007—the environment has changed and there have been further increases in wholesale prices since the case for long term strategic storage was reviewed. It is expected that the benefits of investing in long term strategic storage would outweigh the costs.

Trading Lack of liquidity in the wholesale markets means that prices are higher and more volatile than they need to be. Requirement for firms to trade a defined level of output through the over the counter wholesale markets. Competition Commission: Direct firms to trade defined level of output to be monitored by the FSA and/or Ofgem Medium Enhanced liquidity.
Reduced volatility in wholesale prices.
Prices should be more stable and competitive.
Reduce barriers to entry. Interaction with existing contracts and firms commercial decision making processes—there are clear benefits to enhancing liquidity in the wholesale markets.

Market rules Complex market rules and entry requirements create significant barriers to entry which make it difficult for smaller and low carbon operators to access markets and consumers fairly—this reduces diversity which has a negative impact on innovation, choice and the delivery of the environmental and carbon agenda Fundamental make-over of the market rules and entry requirements including the cash-out arrangements and third party access provisions Competition Commission: Direct government and Ofgem to reform market rules Medium to long term Reduce barriers to entry and promote new entry.
Increase diversity and improved prospect for delivering the environmental and carbon agenda. Difficult and costly exercise—there should be long term benefits arising from simplification of market rules and entry requirements.

Disclosure Consumers pay prices that are higher than the competitive level due to poor price discovery. Requirements on firms to disclose and publish trading data including prices and segmented financial and operating data about their electricity and gas production and retailing operations. Competition Commission: Direct firms to publish specific data Short Reduce barriers to entry and promote new entry.
Prices more reflective of cost. Publication of commercially sensitive data—information can be provided in a sufficiently aggregated manner.

Reporting Consumers pay prices that are higher than the competitive level as suppliers reference increases in forward wholesale prices that are not reflective of their actual costs Requirements for firms to submit data to Ofgem on cost to serve and purchase costs to ensure only efficient cost pass through. Competition Commission: Direct firms to regularly report cost to serve and purchase cost information to Ofgem for scrutiny and public reporting of its findings. Short Greater understanding of firms' costs and margins throughout the supply chain.

Prices more reflective of cost.
Increase consumer confidence. Potential resistance to new regular reporting requirements—there used to be regulatory scrutiny of purchase costs and this should be reinstated.

* Where other measures are considered to be insufficient the CC may wish to consider divestment of plant or function and the reintroduction of supply price controls for certain consumer groups. The former should help to promote new entry and the latter would help rebuild consumer confidence in the markets.

79 European Commission, Competition: energy sector inquiry confirms serious problems and sets out way forward, press release 16 February 2006. Back

80 It is important to note that the threshold for making a reference to the CC under the Enterprise Act 2002 is based on there being reasonable grounds for suspecting" competition is not working effectively (Section 131). The threshold is not based on the provision of hard and absolute evidence. It is part of the role of the CC in undertaking an investigation to gather, analyse and validate information and evidence so that it can answer the questions it is obliged to determine under statute (Section 134) namely whether there has been an adverse effect on competition and whether remedial action should be taken. Back

81 The CC has s special utilities panel, made up of CC members expert in the energy and related sectors. Most usually the panel deals with water, electricity, gas and energy code modifications but these members would clearly be involved in any market investigation into the energy sector, thus ensuring an expert and thorough review. Back

82 Section 134 of the Enterprise Act 2002 and OFT, The Interface between Competition and Consumer Policies, OECD Global Forum on Competition 2008. Back

83 Appendix 2-Why the British markets in gas and electricity require a competition investigation. Back

84 Ofgem data for January 2008 shows that the six vertically integrated firms control over 95% of the business electricity supply market. The corresponding data for gas was not available as Ofgem does not regularly monitor the business market. Back

85 HHI is a commonly accepted measure of market concentration used by economists. It is the sum of the square of each firm's market share and therefore takes account of the relative size and distribution of the firms in a market. The HHI increases as the number of firms decreases and the disparity in size between firms increases. As noted by the OFT, the US Merger Guidelines characterise as "highly concentrated" a market with an HHI of over 1,800. Back

86 Davies and Price, Does ownership unbundling matter? Evidence from UK energy markets, November 2007. Back

87 energywatch analysis of supplier's announced headline price changes between 2003 and 2008. Back

88 This is expected to be a low estimate of an average bill as it is based on a conservative estimate of electricity consumption. Back

89 On average consumers paying by prepayment meter pay £255 more than consumers paying by online direct debit. It is not clear that the differential reflects efficient or legitimate additional cost to supply. Back

90 Forward projections of energy market competitiveness rankings-Prepared for the Department for Business, Enterprise and Regulatory Reform, Oxera, 10 December 2007. The Oxera analysis is based on a high level analysis of structural features and fails to consider key factors such as liquidity in the wholesale markets or competitiveness of price. Back