Memorandum submitted by Major Energy Users'
Council (MEUC)
I am writing on behalf of the Major Energy Users'
Council (MEUC), which is an independent body representing the
interests of a large number of industrial, commercial, retail
and public sector organisations for which the use of electricity
and gas is a significant factor in their operations.
The MEUC was formed 20 years ago, shortly after
the England and Wales gas market was privatised and opened up
to competition, as there was no other body in being at that time
to represent industrial consumers' interests.
Its principal objectives are to keep members
informed of developments, to advise them on energy matters (purchasing
and energy efficiency) and where appropriate offer a consumer's
view to government and regulatory bodies.
Before answering the questions you have put
directly we should stress that we quite understand that the rise
in prices is a world wide phenomenon and that they are likely
to remain high. Our concern is for the competitiveness of British
industry.
We would add that the effect on industry's costs
became apparent about two years ago with the first steep rises
in wholesale prices. There is always a delay before the increases
are reflected in domestic prices. It is worth noting that it is
quite likely that if wholesale market prices remain at this level
for any length of time domestic consumers may well find themselves
subjected to further price increases later in the year.
1. Whether the current market structure encourages
effective competition in the retail markets for gas and electricity
The current market structure does not encourage
price competition in the retail gas and power markets as energy
prices are in the main derived from the traded screens which are
common to all suppliers. There are however a choice of contract
structures which can be used to differentiate between one supplier
and another. Some of the more flexible and innovative products
are only available to very large users. By way of example risky
"day ahead" prices may be an option for certain energy
intensive users to consider.
2. Whether there is effective competition
in the wholesale markets for gas and electricity
There are a sufficient number of generating
companies in the market place to provide effective competition
if they so choose to do so. However, many of them also have downstream
operations in the supply of electricity to customers, ie are vertically
integrated. This provides a supply demand balance position which
reduces their risk as the amount traded is limited to imbalances
only. The screen based traded market prices therefore become the
mechanism for pricing contracts and not the operational costs
of generation.
While there is no shortage of physical gas itself,
gas market liquidity is adversely affected by producers who are
adopting a virtually identical supply model that involves selling
less and less gas on the open forward market in favour of long-term
contracts, which are not traded in this open market. Consequently,
only short-dated and residual contract gas supplies are available
for sale in the wholesale market and this exacerbates price transparency
and volatility problems.. Despite having access to a variety of
gas sources, long term contracts, stored gas and the open forward
market, suppliers' offers are linked solely to the last source,
which of course is the smallest traded volume and highest price.
For annual or longer gas contracts all suppliers use an identical
pricing model, the average forward price plus transportation plus
the supplier's admin margin. Therefore the buyer finds that there
is very little difference in the offers they receive and is leading
them to question the value of changing supplier and hence competition.
The alternative available to the buyer is to increase the risk
and buy on index-linked contracts, linked to the month or day-ahead
prices on the forward market.
Constrained liquidity in the long-dated market
also serves as a barrier to entry for new entrants, energy merchants
and independent suppliers.
3. The implications of growing consolidation
in the energy market
The consolidation of the energy sector both
through mergers, acquisitions and vertical and horizontal integration
limits choice to the customers. For industrial and commercial
customers that choice now is limited to six for electricity and
a few more for gas. Even then some suppliers refuse to tender
on the basis of credit risk, unattractive load shape or don't
like the unpredictable nature of industrial loads, etc. There
appears to be an inherent reluctance from some supplies that have
upstream and downstream in balance to take on additional risk.
In these cases a quotation, even if one is submitted, can be very
unattractive.
You will be aware that EDF Energy has recently
indicated that it would like to purchase Iberdrola, the Spanish
owner of Scottish Power. Should this takeover be confirmed the
six would become five.
Small suppliers have almost disappeared from
the market. The complex supply and distribution code structures
are clearly a barrier to new entrants, who are disadvantaged anyway
by the wholesale price structure and the power of the vertically
integrated six.
4. The relationship between the wholesale
and retail markets for electricity and gas
There is a very close relationship between the
wholesale and retail markets in both gas and power especially
for Industrial and Commercial customers. As already mentioned
above customer contract prices are based on the traded market
screens even though only a small amount of volume is actively
traded there. The thin liquidity of the traded markets can be
an encouragement for the activity of financial institutions (banks
and traded funds) and produce increased volatility but they have
no direct role in the supply of gas or electricity. The forward
price of power and gas can be driven upwards by high volume purchases
by these organisations. Everyone seems to be aware that it goes
on but there are no market rules which prevent or limit this speculative
activity. This is particularly difficult for the smaller manufacturing
companies to manage and undoubtedly adds to their vulnerability.
5. The Interaction between the UK and European
Energy Markets
With an interconnected European energy network
one would have expected price convergence between member states.
A comparison between gas and electricity prices across Europe
would seem to demonstrate the opposite. One may question why the
Interconnector to Zeebrugge, which has a capacity of 76 mcm/day,
the average daily flow for the last three months has been 9 mcm,
ie 1/8th of the capacity. The attached graphs show UK forward
2008 and 2009 electricity prices in comparison to those on the
continent.
For several years the UK Government has been
striving for a liberalised market throughout Europe. As is well
known France, Germany and other countries have remained implacably
opposed to any moves to open their markets to real competition.
The effectiveness of several countries Regulators' is questionable.
The Government of France, indeed, has gone in the opposite direction
by encouraging the merger of Suez and Gaz de France and by doing
so has made it clear that its policy is to protect what it describes
as its strategic assets.
The British Government's desire for competitive
markets throughout Europe is laudable but the lack of progress
should be acknowledged and it should take a more pragmatic approach
to protect its own citizens.
6. The effectiveness of regulatory oversight
of the energy market
We acknowledge the effectiveness of Ofgem in
taking a proactive overseeing role in many instances and its work
in driving matters forward in Europe. However we believe that
there are systematic weaknesses that become apparent during periods
of high prices which it is failing to acknowledge or address.
We note that immediately following a meeting with the Chancellor
of the Exchequer on 16 January, Ofgem issued a press release stating
that the "Market is Sound". However Ofgem announced
on 21 February that there would be an Energy Supply Markets Probe.
Its call for evidence was announced on 27 March. Our concern is
that Ofgem's view of a competitive market fails to take account
of consumers' perception of fundamental flaws and seems limited
to the calculation of the number of domestic customers that switch
supplier in any one year.
In conclusion our major concern with the current
UK energy supply is the lack of liquidity in what is supposed
to be a competitive market and the dominance by a small number
of vertically integrated generation and gas supply companies.
It is not helped by restricted access to supplies from Europe.
To a certain extent the European companies are the same ones that
dominate in the UK.
We cannot see an easy solution to resolving
the issues detailed above other than by a fundamental review.
The last review on power was held in 1999 and resulted in the
New Electricity Trading Arrangements (NETA). At least in the
old days of the electricity pool, the operational costs of generation
played a more important role in marginal pricing than it does
today and now that so much electricity generation is dependent
upon gas supplies and an increasing reliance upon imported gas
a fundamental review of both gas and electricity markets would
be a necessary conclusion to draw.
27 March 2008
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