House of Commons - Business and Enterprise

Select Committee on Business and Enterprise Written Evidence

Memorandum submitted by E.ON UK plc

INQUIRY INTO STRUCTURE OF UK ENERGY MARKET

SUMMARY

— Whether you look at the intense competition on price, the high amount of innovation to win customers, competition in service, the significant changes in market shares or the substantial level of switching, all indicators point to Great Britain having a highly competitive domestic energy market. This has been confirmed in independent analysis carried out for BERR and by Ofgem.

— A market of six larger players, with a number of smaller niche competitors, is consistent with a high level of competition—as is evident from the indicators already discussed.

— Competition benefits all classes of customers, through the close linkage between prices in different customer groups. It is true that switching levels have been lower for pensioners and, historically, prepayment meter (PPM) customers, but this is something that the industry is addressing and where, we believe, improvements are already being seen.

— The wholesale markets for gas and electricity are both competitive, with high levels of liquidity in gas and increasing levels of liquidity in electricity. Both markets are being affected by soaring oil and coal prices, some 83% and 63% higher in March 2008 than a year previously.

— The market for electricity generation is relatively unconcentrated, having seen significant entry since privatisation of the industry some 17 years ago. It faces real challenges going forward, with a need for substantial investment to replace closing capacity.

— There has been relatively little consolidation in the domestic retail electricity and gas markets since E.ON's acquisition of TXU in 2002. There has been no significant change in the concentration of the domestic power market over the last three years and it remains relatively disaggregated.

— Suppliers in the domestic energy market manage the risk of wholesale price changes for their customers—unlike in other volatile markets such as petrol retailing. Changes in input costs can be significant and, whilst a supplier seeks to hedge itself against these changes and shield its customers, it is impossible to manage them completely or always get it right. This leads both to price changes for customers and profit variations for suppliers, who are punished by the market when their competitors manage the risk of hedging better than they do.

— The competitiveness of the GB retail market means that, if suppliers put up their prices in response to an increase in input costs, they risk losing customers as a result.

— Suppliers in the market tend to be vertically integrated to manage risk. However, they trade extensively in the market, both reflecting their "make/buy" trade-off decision and to manage differences between their production and demand. Liquidity is increasing.

— The continental gas market (and oil prices) are having an increasing effect on the UK gas market (and consequently, the electricity market) as our domestic production reduces, we become more dependent on imports and more pipeline import capacity is built. The effect of the continental European market is likely to increase in both gas and electricity.

— Ofgem has wide-ranging regulatory and competition law powers, which it does not hesitate to use. We believe that it is right that Ofgem remains independent of Government, with a principal statutory duty of protecting present and future consumers.

— E.ON, in common with other suppliers in the market, has put in place social tariffs and assistance programmes to help poor and vulnerable customers, with our own measures being predominantly focused on the elderly.

— We believe that the most effective mitigation for poor and vulnerable customers, both in size of potential saving and in sustainability, is improved energy efficiency.

— Rising wholesale prices, to cover increases in primary fuel costs, environmental measures and large investment programmes, will inevitably feed into retail prices. It is not practicable for suppliers to protect fuel poor customers from these rises, except in very specific circumstances, and then only temporarily.

— Given that very substantial funds are already being committed to this area, both by Government and by suppliers, it is essential that further steps are well-targeted on the most vulnerable customers, seek to make the most effective use of resources, and that the Government has clearly defined the goals it wants to meet.

INTRODUCTION

1.1 The UK has the most competitive energy market in the EU and G7 countries. That was the finding of research carried out by an independent firm of economists and presented by the Secretary of State for Business, John Hutton, at the end of January 2008.[229] This also reflected the views expressed by Ofgem in January this year.[230] As recently as 15 January 2008, Ofgem looked at household energy prices in Britain and demonstrated that Britain's electricity bills were "still competitive" compared with most other European countries and that its gas bills were "among the cheapest in Europe".[231]

1.2 Equally, as we describe below, the wholesale markets in the UK are highly competitive, with low levels of market concentration[232] and growing levels of liquidity.

1.3 The Select Committee asked us to respond to seven specific questions—we deal with these below.

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

1.4 There are three retail market segments, domestic, small and medium-sized enterprises and corporates, each of which is highly competitive. In this submission we have focused on the nature of competition in the domestic market since we believe that will be of most interest to the Committee, but would be willing also to discuss competition in the other market segments if that would be helpful.

The nature of the domestic retail market—vigorous competition

1.5 The GB energy market shows all the characteristics that would be expected of a competitive energy market. Therefore, as considered by Ofgem in its last published review of the GB domestic energy retail market in July 2007 (the "July 2007 Review"), the market demonstrates competition on price, innovation to win customers, competition in service, substantial changes in market shares and significant levels of switching.

Competition on price

1.6 The analysis that Ofgem carried out, over four years up to July 2007, showed "vigorous competition" on price by energy suppliers.[233] The scale of price competition can be seen by considering the potential savings available to customers who switch from one dual fuel supplier to another (larger savings still are available for the 25%[234] of customers who have never switched): see Figure 1 below.

Figure 1 PRICE SPREAD ACROSS REGIONS AT 1 APRIL 2008

Source: E.ON UK

1.7 Ofgem's own analysis, in the July 2007 Review, showed that all energy customers "regardless of payment method, have been able to make significant savings".[235]

Innovation to win customers

1.8 Companies have to be innovative to win customers. This means new products, fresh ideas and novel propositions. These include online products, fixed tariff products, capped tariff products, green energy and different types of offerings for poor and vulnerable customers.

1.9 For example looking at E.ON UK, just since January 2007, we have:

— continually varied our on-line products, against the background challenge of fierce competition leading to unsustainable margins and low customer loyalty;

— launched new central heating and green energy products;

— reduced the higher charges to customers on independent gas transporter (IGT) networks and gas prepayment meters; and

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Competition in service

1.10 We have strived to improve our customer service. Between January 2005 and January 2007, we rose from number 6 in the energywatch ranking of supplier complaints to number 2. Since then, we have reduced our complaint levels by a further 25% but slipped to number 3 in the energywatch complaints table[241] as our competitors have improved their customer service—the bar is continually being raised. Over the past four years, the July 2007 Ofgem Review states that the number of complaints for five out of the six largest energy suppliers has fallen.

Substantial changes in market shares

1.11 As Ofgem puts it, "customers have punished firms offering high prices and poor service by switching supplier":[242]

Switching

1.12 Domestic customer switching levels in the GB domestic energy market have continued to increase: some 3.4 million electricity customers and 2.6 million gas customers switched supplier in the first eight months of 2007. These figures showed an increase on the same point in the previous year, despite 2006 being a year of historically high switching because of the level of prices.[249]

1.13 Ofgem commented in the July 2007 Review that switching does not "reveal the true extent of activity in the market because it does not include customers who have stayed with their supplier but switched to a fixed-price or online deal". Such customers have clearly engaged with the competitive market but would not appear from the figures. Switching rates in the GB energy market are higher than in many other markets, as shown in Figure 2 below.

Figure 2

COMPARISON OF SWITCHING ACROSS MARKETS

Source: Ofcom The Customer Experience: Research Report 16 November 2006

Market structure and the measurement of competition

1.14 The structure of the retail market is entirely consistent with a competitive market. In the domestic market there are six larger suppliers and a number of niche suppliers. As discussed, there have been quite large variations in market shares amongst the bigger players in response to their different market strategies (data for the smaller players is not available) and high levels of switching. Moreover, the electricity market is a relatively unconsolidated market by accepted measures of market concentration.[250]

1.15 Evidence of market entry by smaller players suggests that there are no substantial barriers to entry, but the lack of long term success by many smaller suppliers and the preference of well-known brands to work in partnership with existing suppliers (for instance Tesco with E.ON) suggest that profit levels are not viewed as sustainable at an attractive level. However, some niche players have made a success with particular products, notably green tariffs.

1.16 Competition benefits all customers, including those who do not want to switch, despite available savings. Non-switchers are protected by the close linkage between prices in different customer groups. We, for instance, have fixed differentials between quarterly credit and direct debit and single fuel and dual fuel.[251]

1.17 However, concerns have been expressed over two groups of customers—elderly and prepayment meter customers—since switching levels have historically been slightly lower. We compare them below.

Table 1

COMPARISON OF PENSIONERS AND PREPAYMENT CUSTOMERS

	Pensioners	Prepayment
Customers	8.1 million households	3.6 million electricity 2.3 million gas
Switching (to end 2006)[252]	35%	33% electricity 26% gas
Product choice	Staywarm Age Concern All other products	Standard PPM
Barriers to switching	Brand preference for pre 1998 suppliers	Concerns over change of supplier process (eg payment card) 15% repaying debt[253] (average length of restriction 15 months)
Sales channels	All. Some restrictions on doorstep (cold calling zones; supplier self-regulation, for very elderly) Partnerships—Age Concern	All, except internet
Source: E.ON UK

1.18 We believe the lower switching rate for elderly customers is a natural consequence of features of the competitive market which will diminish in significance over time. In particular, we expect suppliers to improve their ability to target customer segments and develop appropriate propositions and partnerships.

1.19 We agree that, although switching is higher than in a number of other non-energy markets, as shown in Figure 2 earlier, and the price premium is lower than in many other sectors,[254] competition has yet to be fully effective for prepayment meter customers. However, this situation is changing rapidly as market solutions emerge:

— the savings available to prepayment meter customers are larger than in other parts of the residential market, as shown in Figure 3 below;

Figure 3

PRICE SPREAD AT 1 APRIL 2008

Source: E.ON UK (note that the scale is double that shown in Figure 1 for direct debit customers)

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— suppliers are investing in new metering technology and in payment infrastructure, which will allow a much wider range of prepayment meter propositions; and

— suppliers are seeking to be more innovative in the propositions offered to PPM customers. We, for instance, are negotiating with switching sites to allow click-through switching for PPM customers.

1.20 Suppliers' social programmes are also delivering lower tariffs to some prepayment meter customers,[256] but widespread reductions, based on lower costs, will require implementation of smart meters.

1.21 We believe that these market developments will remove stakeholder concerns over PPM pricing, but accept that the challenge is for us and Ofgem to show that these steps will be effective.

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

2.1 The BERR competitiveness report referred to above found that the UK had a highly liquid, transparent wholesale gas market and a highly competitive increasingly liquid electricity wholesale market.[257]

2.2 The gas and electricity markets are linked at the wholesale level, given that gas is used to generate around 36% of Britain's electricity. High world oil prices are also reflected in gas prices because, outside Britain, the price of gas tends to be linked to the price of oil and, as Britain is increasingly having to import gas,[258] this feeds through into gas prices in Britain and therefore also into electricity wholesale prices. Electricity wholesale prices are also affected by prices for coal, which is used to generate around 37% of electricity. International coal and oil prices have risen strongly. As at the end of March 2008, international coal for prompt delivery to mainland Europe stood at 137 $/tonne whilst crude oil stood at 105 $/barrel, an increase of 83% and 63% respectively over prices a year earlier. Even allowing for the effect of the appreciation of sterling against the US dollar, prices were 79% and 59% percent higher than a year earlier.

Competition in the gas wholesale market

2.3 Competition in the wholesale gas market is well developed. We do not have access to precise market share data but, based on our counterparties, we believe there are around 60 active market participants.[259] Liquidity in the wholesale gas market is increasing significantly (see Figure 4 below) with traded volumes accounting for around 10 times physical supply. The UK gas market is becoming increasingly integrated with the continental gas market, as discussed under question 5 below, and this trend will continue as UK gas production declines.

Figure 4

WHOLESALE GAS MARKET LIQUIDITY

Source: E.ON UK

Competition in the electricity wholesale market

2.4 Competition in the wholesale power market is very well developed. In terms of market structure, the wholesale power market is quite disaggregated, with low levels of concentration.[260] Since privatisation in 1991, when there were only three major generating companies in England and Wales,[261] there has been a very high degree of new entry, with twenty generators with capacity above 200MW. The level of concentration has been broadly unchanged over the last three years.

2.5 Wholesale market liquidity is a key measure of competitiveness. Concerns had been expressed in the past about whether vertical integration by companies had caused liquidity in the market to fall but, when the EC Commission looked at this issue as part of its Sector Inquiry into the Energy Industry between 2005 and 2007, it did not find vertical integration to be the cause.[262]

2.6 The Commission recognised in its Report on the Energy Sector Inquiry that, within the electricity sector, even vertically integrated companies continue to have incentives to trade on the wholesale markets, in particular to optimise their generation portfolios. The Commission comments that a vertically integrated company that owns sufficient generation capacity to produce enough electricity to cover all of its customers' requirements will benefit from buying instead of producing electricity if the wholesale market electricity price is lower than the short run marginal cost of the last generation unit in the merit order of its own generation capacity.[263] This is commonly known as the "make/buy" decision.

2.7 Liquidity did reduce following the departure of Enron and some other traders from the market in 2002-03, but is now improving quite markedly (see Figure 5 below) and, based on the number of counterparties we trade with, we believe there are about 50 active participants. Traded volumes now account for 3 times physical generation.

Figure 5

WHOLESALE ELECTRICITY MARKET LIQUIDITY

Source: E.ON UK

2.8 Competitive pressures will increase further in future if projected increases in interconnection with the continental and Irish markets go ahead. A further factor is the emerging requirement for substantial investment in new generating capacity.

2.9 The UK needs significant investment in new energy infrastructure, sustained over the long term. Between now and 2020, the UK will close up to 22GW of generation capacity due to the closure of life-expired nuclear, coal and oil plant. Between now and 2030, the majority of today's coal and nuclear capacity will be closed and the capacity gap could be up to 48GW, representing up to 60% of current capacity, if replacements are not made.

2.10 The Government's recent announcement to target 33GW of offshore wind capacity by 2020 would alone mean an investment of around £50 billion. However, given the intermittent nature of wind generation, only 11GW of this capacity could be deemed effective. Figure 6 below illustrates that this gives rise to a further investment requirement of up to 36GW of alternative technologies over the period to 2030, in order to provide for an adequate generation security margin.

2.11 By way of illustration, the level of investment required in conventional technology to 2020 could be over £10 billion, assuming replacement of closing nuclear with new nuclear (£3 billion), replacing closing coal with a mix of new gas and new coal with CCS or carbon capture capability (£8 billion). Continued investment is required after 2020 to replace further closure of nuclear and coal capacity.

Figure 6

UK SUPPLY-DEMAND TO 2030

2.12 The closure of this capacity provides a significant opportunity to reduce the carbon emissions from the UK's power sector but, at the same time, it is important to maintain diversity of sources of fuel for power generation, to help ensure secure and affordable energy supply. Replacement and additional capacity is needed in base, flexible mid-merit and peaking roles.

2.13 Given the replacement timescales, the default answer is to build more gas generation but this could result in a system that is 70% dependent on gas. This would leave UK energy supply even more highly exposed than it is at present to the price and availability of gas on international markets with unacceptable consequences, in our view, for security of supply. In terms of carbon reduction, whilst gas is less carbon intensive than traditional coal, it remains a relatively high carbon fuel. Further reductions would be possible by retrofitting CCS to gas plant but it is much less commercially attractive to fit CCS to such plant, given the lower carbon content of gas, and a much higher carbon price would be required to render it economic.

2.14 We therefore believe that there is a role for new nuclear, gas, coal (CCS ready) and renewable technologies to address the supply gap whilst meeting energy policy goals:

— new nuclear plant has a role in contributing economically to the UK's CO2 reduction targets and, in an era of high fossil fuel prices, to a diverse and secure energy supply. This should also be supported by the expected further tightening of the EU ETS in Phase 3 from 2013;

— some new gas CCGT generation capacity will be needed but reliance on gas alone will not deliver the UK's energy policy objectives;

— investment in new coal generation capacity using supercritical plant technology will enable the UK to maintain diversity in supply (and has significantly lower CO2 emissions than existing coal-fired capacity) whilst carbon capture and storage (CCS) has potentially a key role to play in enabling new coal-fired generation to reduce its carbon dioxide emissions further by around 90%; and

— the legally binding target that, by 2020, 20% of total final energy consumption should come from renewable sources, will reinforce support for investment in renewables in the UK, as will the tightening of the EU ETS.

2.15 E.ON UK itself will close over 4GW of coal and oil generation capacity by the end of 2015 and intends to be a major investor in new UK energy supply infrastructure. E.ON's investment in new capacity in the UK over the next three years to 2010 will exceed £4.5 billion, which is equivalent to reinvesting over 100% of our EBIT.

3. The implications of growing consolidation in the energy market

3.1 There has in fact been relatively little consolidation in the domestic retail electricity and gas markets since E.ON's acquisition of TXU in 2002. There has been no significant change in the concentration of the domestic power market over the last three years and it remains relatively disaggregated. There has been some consolidation at the European level but this has not led to any increase in concentration in the UK on a relevant market basis. In any event, any proposed mergers are subject to the scrutiny of the UK or EU merger control authorities, as well as to the views of Ofgem.

3.2 To the extent that consolidation has occurred over a longer timeframe we do not see this as having been detrimental to competition. Indeed consolidation can bring important benefits in terms of efficiency (with fixed costs spread over a larger customer base) and economies of scale, which include the ability to fund the very large capital investments which the sector now requires. In any event, as discussed above, competition in both retail and wholesale markets is well developed.

3.3 In future it is important that the market structure is not frozen and is able to evolve to reflect changing market conditions and challenges. It would not be conducive to market efficiency if managements felt they were immune from acquisition.

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

4.1 Suppliers in the retail energy market seek to manage billions of pounds worth of highly uncertain costs, which make up 50-60% of the retail price to domestic customers, on behalf of those customers. There is therefore a clear relationship between wholesale and retail markets.

4.2 Some other markets have a similar scale of cost variability, for example, petrol retailing and mortgage provision. However, in both of those markets the uncertainty is wholly passed onto customers. In petrol, pump prices change frequently, whilst in the mortgage market the cost of many products will vary with changes in the Base Rate and customers have to choose the right product for them, for example, a fixed rate product, to manage the risk.[264]

4.3 One well-respected economic consultancy, Oxera, in a paper issued last year, put it as follows:

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4.4 The hesitancy can be explained by the competitiveness of the UK supply market. Whilst companies may be suffering as a result of the increased costs, their decision on whether to increase prices has to be based on their own reading of the market and of what their competitors might do. As Ofgem puts it, "In Britain's competitive market, if they increase bills they have to weigh up how much that increase will lead to a loss of customers".[266]

4.5 It is impossible for energy suppliers to manage this risk completely through hedging, even for the medium term, or always to get it right. Price changes are therefore inevitable, but suppliers will be punished whenever they misjudge their positions and their competitors manage the situation better than they do.

4.6 The scale of wholesale cost movements is such that price changes can be substantial and year to year profit variations larger still. The volatility of energy costs compared to retail prices is shown by Figure 7 below.

Figure 7

DOMESTIC DUAL FUEL—COSTS AND REVENUE

Source: E.ON UK

4.7 In a Press Release of 8 February 2007,[267] Ofgem commented on how energy companies manage the relationship between wholesale and retail markets. It said:

It is a myth that companies were swift to increase prices and slow to cut them in line with wholesale price changes. Wholesale prices started increasing sharply in June 2003 but it wasn't until June 2004 that customers saw the effects. Since then, energy companies have continued to fight to hold onto or gain customers by absorbing substantial amounts of the wholesale cost increases they were incurring. One analyst report—unchallenged—showed that all but one of the companies made a loss in their retail businesses last year".

4.8 Ofgem calculated that on average, customers had saved approximately £572 through suppliers' delay in passing through wholesale costs.

4.9 A number of market participants are active in both the wholesale and the retail electricity markets.[268] This raises the issue of vertical integration in the market and its effect on competition. Vertical integration does not, of itself, affect competition; the only questions are whether competition is effective at each level in the supply chain and whether it has led to a lack of liquidity on wholesale markets. We have already demonstrated above that competition is well developed in both the retail and wholesale markets and that liquidity in both the gas and electricity markets is increasing.

4.10 Vertical integration arises from the need to manage risk in this market. A player in the market wishes to ensure that, commercially, it has a natural hedge between the risks in the wholesale and retail markets. When wholesale prices collapsed to avoidable cost levels after the introduction of NETA in 2001, those companies with some degree of vertical integration were able to weather the storm more effectively than those such as British Energy who had not.[269] NETA, and subsequently BETTA, have made it more difficult for standalone suppliers or generators than under the previous Pool structure.

4.11 Aside from the "make/buy" decision, which has already been discussed, vertically integrated companies in the electricity wholesale market must also trade to manage differences between their production and demand, both in total and arising from the "shape" of a company's generation relative to its customers' load profile. The shape of a domestic customer's load, for example, is very peaky, with sharp increases in demand in the morning and after work, compared to a corporate profile, which is likely to be much flatter over the day.

4.12 There are major differences in the positions of the market participants who are traditionally regarded as vertically integrated (see Figure 8 below). A number of companies generate more than the volume they supply to customers while others generate significantly less.

Figure 8

MARKET POSITIONS OF VERTICALLY INTEGRATED ELECTRICITY MARKET PLAYERS

Source: E.ON chart, using Elexon data

4.13 All these factors have led to a situation of increasing, rather than decreasing liquidity in the wholesale markets, as discussed.

5. The interaction between the UK and European energy markets

5.1 In relation to gas, as indicated already,[270] the decline of the amount of gas in the UK Continental Shelf has meant that the UK is increasingly having to import gas. The UK has a more significant interconnection with the continental market in gas than in electricity. There are four import pipelines; three from gas fields in the Norwegian Continental Shelf (Langeled, Tampen Link and Vesterled) and one from the Netherlands, the Bacton Balgzand Line (BBL). In addition, there is one interconnector with Belgium (Interconnector UK ("IUK")).

5.2 BBL operates on the basis of advance contractual commitments for its capacity and is predominantly insensitive to price. By contrast, the three Norwegian pipelines are sensitive both to prevailing prices within Europe and to contractual requirements since they can both import either into the UK or into Continental Europe. IUK is highly responsive to price changes and can also be used to export gas from the UK to Europe.

5.3 The other way that gas comes into the UK is through cargoes of LNG. There are two existing operative LNG terminals, at Grain and Teesside, and five others are being built or are in the advanced stages of development. National Grid forecasts that LNG will constitute up to 39% of UK gas supplies by 2017. However, whether an LNG cargo actually makes it to the UK market will depend on demand for LNG elsewhere in the world. The Times reported on 9 March 2008[271] that, although Grain had been set up to receive at least a cargo a week, in fact, at that date, the last time a ship had docked had been 29 January 2008, since intervening cargoes had gone to countries prepared to pay more, such as Japan and Korea.

5.4 As the UK has become a significant importer of gas, market conditions in the UK have become increasingly determined by European market conditions. When the UK market requires continental gas imports to meet marginal UK gas demand, UK gas prices rise to parity with (or slightly above) European contract price levels. If European demand for gas is itself very high, for example because of unusually cold weather, prices may rise to very high levels. If UK gas demand is low and/or there is a surplus of gas supplies from other sources (UK, Norway and LNG), gas prices will fall below European contract prices and surplus gas may be exported to the continent. European gas contracts are often indexed to oil products and European gas prices have therefore shown a close historic relationship with Brent crude prices, with a lag to allow for the indexation delay.

5.5 Figure 9 below shows the inter-relation between year ahead prices for National Balancing Point (NBP) gas, and for oil, coal and power. This reveals strong correlation between gas and oil prices, strong correlation between oil and coal prices from mid 2005 onwards and very strong correlation between coal, gas, oil and power from January 2007 onwards. Thus, whilst the UK gas and power prices are not directly linked to oil, there is a strong indirect influence.

Figure 9

RELATIVE COMMODITY PRICES 2005-07

5.6 Continental gas market conditions are therefore of increasing significance for UK gas and power consumers given that gas prices are a major determinant of power prices as discussed above. Liberalisation of European gas markets will lead to more liquidity and increasing competition but it seems likely that the main external gas producers to the EU, who will account for an increasing proportion of EU supply, will continue to have a significant influence on end prices to consumers.

5.7 The right response to this from a UK and continental perspective is to encourage alternative sources of gas, particularly LNG, to increase investment in gas storage and to diversify away from sole or excessive reliance on gas in the power market, by investing in alternative generation, including renewables, nuclear and cleaner coal-fired generation.

5.8 In electricity, the main effect of interconnection on the UK power market is observed in the short term markets—this is because the UK does not need to import significant volumes of power. This has resulted in the 2GW interconnector between England and France being a point of price arbitrage between the UK and French markets. Historically, flows over the interconnector have been predominantly toward the UK, reflecting the availability in France of a large volume of nuclear generation at low avoidable cost. This has the effect of reducing UK power prices. Whether this position persists will depend partly on whether sufficient investment will be made in continental power markets to meet substantial future capacity requirements there.

5.9 In future, increasing levels of interconnection with continental Europe and Ireland and the development of common market rules and more harmonised regulatory structures are likely to mean that the UK power market is increasingly influenced by continental market conditions, in effect becoming part of a regional European market encompassing North Western Europe, France, the UK and Ireland.

6. The effectiveness of regulatory oversight of the energy market

6.1 Ofgem has wide-ranging powers under a range of utility and competition legislation, which are broader than those of most other EU regulators, and is well-resourced. It does not hesitate to make use of these powers as is evident from its current inquiry into the retail energy market under which it has expressed its intention to use its powers under the Enterprise Act, and its recent fine of NGC in respect of the gas metering market. Whilst independent, it is also sensitive to changing political priorities and consumer perceptions. On balance, we think this is a good thing as consumer perceptions are important. Nevertheless, we expect it to retain an evidence-based approach to its work in response to pressures to intervene in the market which are always most apparent when prices are rising rather than falling.

6.2 Ofgem's principal statutory objective duty is to protect the interests of the consumer, wherever appropriate by promoting effective competition. Consumer includes for these purposes both present and future consumers. It performs that function as an autonomous economic regulator, independent of Government. We believe that it is right that Ofgem should maintain that independence and its focus on protecting customers.

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

7.1 E.ON, in common with other suppliers in the market, has in place social tariffs and assistance programmes to help poor and vulnerable customers. Our Staywarm tariff and partnership with Age Concern are predominantly focused on the elderly, whilst all vulnerable customers are encouraged to call our "Caring Energy" helpline, which provides a benefits entitlement check as well as energy efficiency advice and which also manages referrals to our hardship fund.

7.2 We believe that the most effective mitigation for poor and vulnerable customers, both in size of potential saving and in sustainability, is improved energy efficiency. The Government's own strategy has a strong focus on improving the energy efficiency of property as the means of reducing fuel poverty. Expenditure on the CERT priority group, WarmFront and the Decent Homes programme will total around £900 million/year, with suppliers through CERT playing the largest part in this programme, around £500 million/year.

7.3 Rising wholesale prices, to cover increases in primary fuel costs, environmental measures and large investment programmes, will inevitably feed into retail prices. It is not practicable for suppliers to protect fuel poor customers from these rises, except in very specific circumstances, and then only temporarily. Indeed, it is unhelpful to customers to suggest that this can be done. Both CERT and WarmFront substantially depend on customer pull—ie customers wanting measures to be put in place to reduce their expenditure.

7.4 Given that very substantial funds are already being committed to this area, both by Government and by suppliers, it is essential that further steps are well-targeted on the most vulnerable customers and seek to make the most effective use of resources. Market intervention, in the form, for example, of a mandatory social tariff, would impose additional costs on other customers who may be more in need and have side-effects which distort the energy market by removing from the competitive market customers who qualify for the social tariff. Further, it would be likely to be unsustainable and potentially detract from the long term goal of eradicating fuel poverty.

7.5 We expect to participate fully in any taskforce established to consider these issues. We will also continue to develop our social programme and seek to target it on customers in greatest need. However, we do not believe that social programmes can sustainably protect consumers from increases in energy prices, whether due to rising wholesale or environmental costs. This can only be achieved through improvement to the quality of housing.

7.6 We believe that the Government needs to reassess how it can more effectively focus resources and the efforts of the many parties involved to deliver lasting solutions for those in real need, avoiding quick fix market interventions which will in the end do little to address the underlying problem. The Government is beginning to make very significant progress in improving the energy efficiency of the UK's housing occupied by consumers on low incomes through the programmes described above but needs to consider a number of potential areas for change:

— targeting policy in a way which recognises the circumstances of different customer groups, for instance, that elderly owner occupiers are in a quite different situation from tenant families;

— increasing emphasis on higher cost measures needed for "hard to heat" homes (such as homes off the gas grid or with solid walls), given that these customers may be in the greatest need (the flexibility mechanism within the CERT priority group, which gives an incentive to solid wall insulation and ground source heat pumps, is a useful step);

— exploring more imaginative approaches to incentivising customers themselves to finance necessary investment in their properties. For example, the Government could support schemes enabling customers to fund energy efficiency improvements by releasing value in their properties, with additional interest costs funded by lower energy costs; financial support could be directed at households with low value properties while a measure of compulsion might apply for landlords;

— enhancing the benefits system to give more explicit recognition to energy costs which have to be met by low income consumers, for example, adjusting housing related benefits to recognise that lower cost poorer quality housing is often offset by high energy costs; and

— clarifying its view of the ultimate policy objective. The Government has a target of eradicating fuel poverty, as far as reasonably practicable, for vulnerable households by 2010 and for all households by 2016. However, while the Government can have a significant impact on housing energy efficiency standards and benefit levels, it has little influence over energy prices prevailing in international markets. The Government should define more specifically what outcomes it wants to achieve over the next eight years, to 2016, given the levers that it has and does not have, and then focus policy on delivering these outcomes.

March 2008