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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