Memorandum submitted by NHS Purchasing
and Supply Agency
Please find attached written evidence to the
Select Committee from the NHS Purchasing and Supply Agency regarding
the new inquiry investigating possible anti-competitive behaviours
in the UK's energy market.
While we assume sole responsibility for its
content, we would like you to note that this evidence has been
produced in consultation with HM Treasury's Office of Government
Commerce and the Ministry of Defence, the programme lead and sponsoring
department respectively for the cross-government collaborative
procurement project for energy currently being delivered as part
of the HM Treasury policy Transforming Government Procurement,
published January 2007.
I would like to take this opportunity to confirm
that the NHS Purchasing and Supply Agency, together with representatives
from the collaborative programme, would welcome the opportunity
to present oral evidence should the Committee require it.
SUMMARY OF
MAIN POINTS
— Retail markets for gas and electricity
are dominated by a small number of suppliers.
— There is a difference between companies
registered to supply and those actually active within the market
so the number of registered companies is not an accurate measure
of customer choice or competition.
— All major electricity suppliers and
all but one major gas supplier is vertically integrated. Given
that there have been no new market entrants for large, multi-site
portfolios, vertical integration is a significant barrier to entry.
— Liquidity within the gas market has
improved but there is no effective long term market; the lack
of liquidity in the electricity market is still more pronounced.
— The speed of liberalisation and continued
lack of visibility and transparency between different markets
causes uncertainty and may be detrimental to customer interests.
— We are not convinced that the regulator
is effective in delivering value for the customer in terms of
delivered cost of the commodity.
— The regulator is focused on the domestic
market, but the final delivered price for all customers is produced
as a result of basic structural factors (in the market and in
the supply chain) which even large Industrial and Commercial (I&C)
customers are not in a position to influence significantly.
WHO WE
ARE
The NHS Purchasing and Supply Agency (NHS PASA),
established in April 2000, is an executive agency of the Department
of Health. We work to ensure that the NHS in England makes the
most effective use of its resources by getting the best possible
value for money when purchasing goods and services.
The NHS PASA Energy team provides the NHS with
a strategic service for the procurement of electricity, gas, oil
and coal. Buying energy is a highly complex and specialised area
and our strategy involves influencing this area of significant
spend through a variety of flexible procurement options (including
trading on the wholesale market) to improve service delivery
and reduce costs in the NHS.
NHS PASA is a strong and experienced advocate
of collaborative procurement across government departments and
is actively supporting HM Treasury's Transforming Government Procurement
policy, this includes developing a price risk management model
for the UK public sector.
RECOMMENDATIONS
— The UK moves to a central cleared
exchange based market to increase liquidity and access to wholesale
markets for new market entrants and customers.
— The regulator aligns its measures
for assessing the competitiveness of the market to the real underlying
factors driving delivered prices so that all consumers can be
assured that the market is operating effectively.
WRITTEN EVIDENCE
Each topic on which the Select Committee request
our view is reproduced in bold italic below. Each is followed
by our brief written evidence, produced by NHS PASA in consultation
with the Office of Government Commerce and the Ministry of Defence.
Whether the current market structure encourages
effective competition in the retail markets for gas and electricity
Response
We recognise that the current markets for gas
and electricity differ. Within electricity there are concerns
about the extent of vertical integration which exists between
generators and suppliers. Although there is no direct evidence
that this in itself has an effect upon the competitive nature
of the market, the general purpose of backward vertical integration
is to increase company profitability and its presence raises questions
over visibility and accountability (especially regarding input
costs).
The retail markets for both gas and electricity
are dominated by a small number of suppliers. In a truly competitive
market, suppliers should be seen to drive innovation in an attempt
to differentiate themselves, gain competitive advantage and win
market share. Again, while a small number of suppliers by itself
does not stifle competition, there is little evidence of suppliers
within the UK market rushing to introduce new and innovative product
offerings. Such market offerings as have been made available have
tended to come as a result of persistent customer demand.
Within the Industrial and Commercial (I&C)
arena, there is a further limitation to competitiveness—namely,
the tendency for the already small number of suppliers to segment
the market. This leads to an element of specialisation and reduces
the numbers of suppliers actively competing for some customer
segments. A recent national NHS procurement exercise for electricity
attracted only a small number of compliant bids, which—while
disappointing—is in conformity with the bidding pattern
across the UK public sector as a whole. Such apparent segmentation
is consistent with established analysis of how companies seek
to maximise profits in an oligopolistic market (c.f. Porter, Competitive
Strategy, 1980). At the very least, customer choice is constrained
(by the self de-selection of suppliers). Recent supplier meetings
conducted as part of Treasury collaborative procurement programme
indicate that suppliers are more concerned with retaining existing
customers than actively competing for new business.
There is a difference between companies registered
to supply and those active within the market, so a mere register
of suppliers with licences within the UK does not accurately reflect
customer choice or competition. Likewise, using switch rates as
a measure of competition will not show the true extent of competition
if the customer is given little or limited choice at the time
of renewal.
We also note that all major electricity suppliers
are vertically integrated, and all but one of the gas suppliers
is as well. Backward vertical integration is a trend that has
expanded significantly over the last five years. At the same time,
we note increasing supply market concentration. There have been
no new market entrants for large multi site portfolios such as
the public sector, which raises the questions about barriers to
entry—one of which is precisely the need to be vertically
integrated!
Whether there is effective competition in the
wholesale markets for gas and electricity
Response
Customers within the I&C market have pushed
for contracts which allow them access to the wholesale market.
This option is now available to a large majority of customers
and has enabled some benefits, especially around risk management.
For a customer purchasing gas in the wholesale market competition
can be seen to be represented by choice. This choice can be measured
in terms of visibility, availability and number of trades. Within
the gas market, we make the following observations:
— the day ahead and prompt market are
working effectively, at least in relative terms; and
— it is possible to obtain pricing
for periods further out in the curve, but liquidity is very thin.
It is our view, therefore, that while liquidity
has improved within the gas market over the last couple of years,
there is no effective longer-term market. Consequently, the ability
to optimise the management of risk is constrained even for large
users, potentially increasing final out-turn costs.
In the electricity market, we have yet to see
even these minor improvements in liquidity. We acknowledge that
the electricity market is less mature than that for gas, but this
cannot be accepted indefinitely as an excuse for limited visibility
and availability of offers.
The lack of liquidity is perhaps more effectively
explained by the vertically integrated structure of the electricity
market. This reduces the need to trade volumes in the open market
and results in a lack of visibility. The consequent market inefficiency
can be viewed as a goal of vertical integration as it tends to
deliver more control over price and output to suppliers. Liquidity
in electricity is limited even for the first 12 months forward,
and it is almost impossible to purchase peak load beyond the next
12 months making it impossible for large customers to manage their
longer-term cost exposure risk effectively.
As more customers move towards contracts which
include a wholesale market approach to the purchase of the commodity
element, and develop a longer term approach to spreading risk
by purchasing further out in the market, the limitations within
both the gas and electricity markets will become a still more
significant problem in securing value from the wholesale markets.
We also think that moving to a central cleared
exchange based market would significantly increase liquidity and
access to the wholesale markets for new market entrants and customers.
Nord pool serves as a good example of this—and liquidity
is significantly higher compared to the UK.
The implications of growing consolidation in the
energy market
Response
Consolidation of suppliers within both the gas
and electricity markets has been a concern for a number of years.
It can be argued that an element of the supplier consolidation
within both gas and electricity markets has been offset by new
entrants, especially those from Europe. However, in reality the
out-turn position has been left very much unchanged and if anything
the general decline in suppliers within the market since liberalisation
is evident. Combined with our observations on customer segmentation—or
"cherry-picking", as it is sometimes known in the market—we
are of the view that consolidation is more likely to diminish
choice and increase costs for customers than it is to deliver
efficiency benefits.
It should be noted that there have been no major
new entrants to the market in the last five years. Some niche
players (such as GazProm or Wingas) have entered the gas market,
but only where they have access to production and are thus vertically
integrated. There have been no new entrants to the electricity
market of sufficient size to meet large scale customer volumes.
The relationship between the wholesale and retail
markets for electricity and gas
PASA Response
Our contracts facilitate interaction at wholesale
market level and as such we cannot make further comment on this
issue.
The interaction between the UK and European energy
markets
PASA Response
The liberalisation of the European energy market
has been slow. As the UK has become more reliant on gas flows
from Europe the speed of liberalisation and the continued lack
of visibility and transparency between the different markets creates
uncertainties. Market regulation within the various member states
appears to differ. These differences, coupled with the apparent
lack of visibility (of, for example, information on real gas flows
within Europe), do raise questions as to whether the UK market
is operating on a level playing field with its European counterparts.
A typical frustration arises when the UK and continental market
prices diverge (eg UK prices are higher) but the expectation of
gas flowing to the higher priced market does not materialise and
is not adequately explained (gas is not delivered to the UK).
We are concerned that supplier control of much of the infrastructure
may be detrimental to customer interests.
The effectiveness of regulatory oversight of the
energy market
Response
We have insufficient evidence on which to make
a judgement of the effectiveness of current regulatory oversight.
We offer the following observations:
1. The UK regulator appears however to be
hampered by the complexities and slow pace at which other nations
states are approaching liberalisation.
2. We have no evidence that the regulator
has any control over the upward pressures on energy prices—at
least one of which is the market structure (vertical integration,
supplier concentration, high barriers to entry, limited competition).
3. We welcome the recent action aimed at
driving competitive behaviour associated with Meter Asset Management.
4. We observe that one of the drivers of
price is speculative trading which impacts on consumer value and
yet it is an area outside of regulatory control.
5. The focus of the UK regulator seems to
be on the domestic rather than the I&C market.
Progress in reducing fuel poverty and the appropriate
policy instruments for doing so
Response
We have neither expertise nor responsibility
in this field and as such we can offer no further comment.
28 March 2008
| 
