Select Committee on Business and Enterprise Written Evidence


Memorandum submitted by Good Energy

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

EXECUTIVE SUMMARY

  1.  Good Energy believes that the current market is not fully competitive, and this is principally down to the operation of the wholesale market which favours large vertically integrated participants. This is of particular concern as we believe that this is stifling innovation in the market as it responds to the pressures to combat climate change.

ABOUT GOOD ENERGY

  2.  Good Energy is a small energy supplier, active in the electricity market since 1999. We supply 100% renewable electricity to approximately 25,000 customers in the UK, most of whom are domestic customers. We have recently received our gas supply licence and hope to offer a carbon accountable dual fuel product in the near future. The Good Energy group also owns a wind farm in Cornwall, but buys most of its energy for small size renewable generators.

  3.  We have restricted our comments to the electricity market as we do not feel sufficiently experienced to comment on the gas market, and have structured our response to match the questions posed in the call for evidence

Does the current market structure encourage effective competition in retail markets for gas and electricity?

  4.  The current retail market is dominated by the big six oligopoly, all of whom have an inert customer base inherited from their previous existence as monopoly providers of electricity or gas. There are a handful of independents and entry into the retail market is not difficult per se, although expensive as the fixed costs are high due to the requirements that need to be in place before a supplier can acquire its first customer. Good Energy estimate the breakeven point is 20,000 domestic customers or the equivalent.

  5.  There are also regulatory hurdles as smaller suppliers are required, except in a few cases, such as CERT to meet the same regulatory requirements as the big six. These however are not insurmountable provided the smaller participant is not attempting to compete with the big six on price.

  6.  The difficulty of market entry lay in entering the wholesale market, and the unpredictability of prices and lack of liquidity and transparency in that market. The number of independent generators has diminished considerably since the introduction of NETA (New Electricity Trading Arrangements), which in turn reduces the sources of generation for any new electricity suppliers entering the market. Conversely, the lack of independent suppliers is also a barrier to entry to small generators.

Is there effective competition in the wholesale markets for gas and electricity?

  7.  The current trading arrangements were designed by the regulator on the basis of ensuring that energy trading was cost effective, as opposed the previous "pool" arrangements which set a market price for energy in each half hour, which was received and paid by all participants. The result of this arrangement was twofold, consolidation by market players, and vertical integration. The reasons for this are complex, but the principle is the mitigation of risk.

  8.  Suppliers offer prices to customers which change periodically maybe two or three times a year max. However, at a wholesale level they have an exposure to the market where prices on the edges of their portfolio are unpredictable by each half hour. To mitigate this risk, then the ownership of a generation portfolio seems a logical business step. As the market was designed around large generation units, then to ensure a sufficiently sized portfolio of generation required a large customer base.

  9.  As a result this limits competition to large integrated players. New entrants on either side of the market, generation or supply find that the market is illiquid and not transparent which poses a business risk. Suppliers below a certain size are unable to buy in the small quantities required and thus are exposed to the unpredictability of the cash out market. Something that removed several players in the winter of 2005-06.

  10.  If a liquid market existed, then independent suppliers and generators could see market prices and be sure of buying or selling to hedge their position. Equally, a level of predictability of the cash out prices would remove some of the financial risk of exposure. Which can be very real.

  11.  Independent players due to the market risks are also required to provide credit to counter-parties either as cash or letters of credit. This in itself is a cash drain on players which restricts growth of new entrants.

What are the implications of growing consolidation in the energy market?

  12.  The implications of consolidation in the market are a lack of consumer choice, and a stifling of innovation. It also impacts Government ability to manage the energy aspect of the economy because it has to go "cap in hand" to the big 6 to deal with important issues such as climate change and fuel poverty. If there was effective competition in the market then specialist companies would be developing innovative tariffs for different market sectors. For example, specialists in Pre-payment metering using new technology to bring down the cost to serve or premium lifestyle tariffs linked to other product offerings.

  13.  Competition would not necessarily reduce energy prices, as the two predominant costs, fuel for generation and transportation are limited in the differential that can be applied. Although improvements in the wholesale market and reduction of risk could bring lower pricing. It could however lead to a wider spread as specialist in certain sectors focus on their offering rather than trying to be everything for everybody.

  14.  As new entrants are deterred from entering the retail market because of the wholesale market risks, then the need for innovation decreases and the expectation of customers become lower.

  15.  Good Energy's concern is that this lack of competition is impeding the delivery of the UK's 2020 target by market means and requires the government to "horse trade" deals with the oligopoly to deliver. Something which only increases their hold on the market and increases the risk of non-delivery on these targets.

What is the relationship between the wholesale and retail markets for electricity and gas?

  16.  The two markets are closely interlinked and it is the problems with the wholesale market structure that are restricting competition in the retail market. The wholesale market is structured around cost reflectivity, ie That generators and suppliers buy and sell on the open market. In reality, the risk this has created has lead to vertical integration by the largest players, and as such the market has become illiquid as most energy is self-supplied and thus a market price is based on a small number of hedging trades.

  17.  It is not possible to be in the retail market without being a player in the wholesale market, and thus, the structure of the wholesale market dictates the structure of the retail market. ie The need for a balanced portfolio of generation dictates the need to have a large retail base to use that portfolio of generation.

  18.  Good Energy also believes that NETA was conceived at a time when economic priorities were the predominant driver, and sustainability and carbon markets were not high on the agenda. If the UK is to meet its 2020 and 2050 commitments, then NETA is a hindrance rather than benefit as it favours large, predictable generation at the expense of smaller, less predictable generation. To deliver a low carbon economy, NETA is not fit for purpose. It also puts NGC in a powerful position on this debate.

What is the interaction between the UK and European energy markets?

  19.  In electricity there is little interaction between the UK and European market, as the interaction is limited to capacity of the interconnectors. It is noted however, that different wholesale market structures in the EU are helping some countries to increase the levels of renewable or low carbon generation to compete better with fossil fuel based generation.

What is the effectiveness of regulatory oversight of the energy market?

  20.  In essence the market regulator, Ofgem is a financial regulator. Its role is either to regulate prices, where there is a monopoly service, or ensure that competition means that energy prices are cost reflective. Bolted on to this primary objective are social objectives surrounding fuel poverty and sustainability.

  21.  In managing its primary role, the regulatory oversight depends on the definition of competition. If competition means that customers can move from one supplier to another with ease, then the jobs is well done. If however, you define competition as being that the market is open to new entrants to offer new and innovative products to customers, then the regulatory oversight has failed.

  22.  The perception of most domestic customers is that there are six "Dinosaurs" suppliers offering very much the same deal. Parts of Ofgem itself appears to have this view as small suppliers such as Good Energy often have to gate crash meeting where Ofgem has only invited the big six suppliers to consult "the industry".

  23.  On the two secondary roles, the regulation is failing because Ofgem, as an economic regulator, and staffed by a multitude of economists, has difficulty running these objectives which are often against the grain of its primary objective. Good Energy has consistently argued that Ofgem remit should be changed to deliver a low carbon energy market as cost effectively as possible. Rather than a cost effective energy market as sustainably as possible. This would require Ofgem to provide leadership to the market, rather than act as a policing body.

What progress has been made in reducing fuel poverty and the appropriate policy instruments for doing so?

  24.  Fuel Poverty (as defined) is increasing as raw energy prices increase. This is outside the control of the market players, and competition, whilst offering a better choice, will not deal with the fundamental issue of rising energy prices. The solution to fuel poverty lies in reducing the energy demands of those in poverty. The correlation between fuel poverty and poorly insulated housing stock is high and thus improving housing must be a priority. This would also assist in reducing carbon emissions. We believe there are more efficient ways of implementing this than obligating electricity suppliers.

What is currently missing within the UK energy market is any form of heat market?

  25.  Heat is outside the remit of Ofgem, except where it coincides with the provision of power, and thus has no market driver. If, as mentioned above an energy regulator was set up to drive the UK to a low carbon energy market, then heat would be within its remit. The provision of locally distributed heat, if aimed at social housing could go a long way to drive down fuel poverty. However, the current vacuum of regulation makes investors nervous of what may be regulated. (eg Competition access etc)

RECOMMENDATIONS

  26.  Good Energy's recommendations are:

    —  Set-up an energy regulator in place of Ofgem with the remit to lead the UK to an efficient, market based, low carbon energy market.

    —  Restructure the wholesale electricity market to make it suitable for new entrants on both the supply and generation side by establishing stable pricing and market liquidity and transparency.

April 2008





 
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