Letter by Ofgem
ENERGY PRICES
1. The Chairman of the Business, Enterprise
and Regulatory Reform Select Committee, Peter Luff MP, has asked
the independent energy regulator, Ofgem, to submit an information
note on certain recent developments in the energy markets. This
note addresses five particular questions:
— Why are energy prices rising?
— Is the energy market uncompetitive?
— Are suppliers quicker to pass on
wholesale price rises than wholesale price cuts?
— What can be done to help vulnerable
customers affected by higher energy prices?
— How does Britain's energy market
compare with that on the continent?
Why are energy prices rising?
2. Energy prices have risen since 2003 due
to a range of factors. Rising global demand for energy has led
to higher oil and coal prices, which in turn have put upward pressure
on gas and electricity prices.
3. High world oil prices (close to $100
a barrel) are reflected in gas prices because, outside Britain,
the price of gas is linked to the price of oil. This affects Britain
because our North Sea reserves are declining so we now have to
import a growing amount of gas from the rest of Europe via pipeline
links and from elsewhere as liquefied natural gas (LNG). Liquefying
gas, shipping it to Britain and converting it back into gas is
more expensive than transporting it by pipeline. LNG prices have
risen substantially, with pressure from Asian markets (notably
Japan) paying high prices to secure LNG imports. There have been
delays in completing the construction of two major LNG terminals
at Milford Haven in South Wales. The first phase of these two
facilities, which have a combined capacity totalling around 16.5
billion cubic meters, was scheduled to be ready for the start
of this winter (2007-08). Gas imports from the Norwegian Ormen
Lange gas field have been less than expected due to production
problems.
4. Currently gas is used to generate around
36% of Britain's electricity. Increases in wholesale gas costs
will therefore have a knock-on effect on electricity generation
costs. Prices for coal, which is used to generate around 37% of
our electricity, have also increased to record levels. In addition
the second phase of the European Emissions Trading Scheme (EU
ETS), which began in January 2008, has increased the price of
carbon which in turn increases electricity prices.
5. Whether suppliers need to put up prices
as a result of higher wholesale costs will depend on how much
gas and electricity they bought on the wholesale markets when
prices were lower earlier in 2007, and how much they have bought
more recently at higher prices. In Britain's competitive market,
if a supplier increases bills they have to weigh up how much that
increase will lead to a loss of customers. If a supplier can keep
prices lower, they will retain existing customers and attract
new ones.
6. In addition, prices have also risen as
a result of programmes introduced by the government to help tackle
climate change. For example, the Carbon Emissions Reduction Target—which
replaces the Energy Efficiency Commitment on suppliers in April
2008—doubles the cost of the scheme to customers. Defra
estimate that this will add another £20 to customers' bills
in addition to the £18 customers are already paying for EEC,
giving a total of £38. Furthermore, network charges—which
pay for the transportation of gas and electricity through the
pipes and wires—rose by an average of £22 for gas and
£2.96 for electricity in 2007-08. Increases over this period
have varied considerably between regions: in London the increase
was around £52 compared to £2 in the East Midlands.
In 2008-09 they will rise by £1 in electricity and £2
to £6 in gas, depending on the region. Taken together, all
of these wider factors mean that energy prices are unlikely to
fall back to the levels of a decade ago.
Is the energy market uncompetitive?
7. Ofgem constantly keeps the market under
surveillance, and we look at it even more closely when prices
are rising, but our monitoring has not revealed any evidence of
anti-competitive behaviour. All suppliers are facing similar cost
pressures, driven by rising wholesale gas and electricity prices,
environmental costs and energy network costs. The extent to which
they need to pass on rising wholesale prices will depend on how
smart they have been at buying their energy. So far this year,
three of the major suppliers have announced price increases; two
suppliers have made no announcement; one supplier has promised
to hold its prices at least until the end of March, when most
customers' energy consumption begins to fall.
8. Another sign of healthy competition is
that we see companies gaining and losing significant market share,
plus record switching levels and innovative deals. The supplier
which has consistently offered the lowest prices and best service
has doubled its number of customers to eight million over the
past three years. At the same time, others have been punished
severely by customers switching away to suppliers offering better
deals. What is more, this level of customer switching is on an
increasing trend. 4 million customers switched their supplier
in 2006 and 4 million customers are now on fixed price or other
innovative deals. There are now differences of around £100
per household between suppliers' prices—so customers could
still make big savings.
9. Although this evidence suggests a strongly
competitive market, Ofgem continues to monitor it constantly and
regularly publish our analysis. If anybody has evidence of anti-competitive
behaviour, we urge them to send it to us. We have a tough set
of penalties at our disposal, including our formal statutory powers
as well as the informal pressure we can exercise as a regulator.
For example, last year we "named and shamed" two suppliers—EDF
Energy and Scottish Power—who had not passed through falling
wholesale prices to their customers. Within days they had announced
retail price cuts for their customers. More formally, the Competition
Act gives Ofgem the power to impose fines of up to 10% of a company's
turnover if they break the law by abusing their dominance or engaging
in agreements which distort competition. We will not hesitate
to use our powers to investigate and, if necessary, impose penalties
on any supplier that has been found to have broken competition
law.
Are suppliers quicker to pass on wholesale price
rises than wholesale price cuts?
10. Not necessarily. If a supplier buys
badly and has to keep its prices up, it risks losing customers
and their cash.
11. Wholesale energy prices began to rise
in 2003, due mainly to a decline in Britain's gas reserves at
a time of rising global demand. From 2004, retail prices began
to increase significantly for customers. In 2006, wholesale gas
prices began to fall and in 2007 all suppliers reduced bills at
least once. However, in 2007 wholesale prices rose again. Comparing
average day-ahead prices over in January 2008 with the same period
in 2007 shows that wholesale gas prices have increased by 66%
and wholesale electricity prices have increased by 64%.
12. Suppliers will be affected by these
price changes differently because they have different buying strategies.
Some buy most of their energy in advance and others are more exposed
to day-to-day fluctuations in wholesale prices. Those who have
been smarter at buying their energy have been able to offer lower
prices and gain market share. Contrariwise, more expensive suppliers
have been punished severely by customers switching away to cheaper
deals. For example, in 7 of the 14 British regions, the old incumbent
suppliers have lost more than half their market share. The cheapest
major supplier, on the other hand, has gained four million extra
customers in Britain in the last three years.
13. Ofgem believes these challenging conditions
will clearly show which companies have been the most successful
in buying their energy ahead at keen prices, as they will be able
to keep prices low. Much of the increase in wholesale prices is
due to high global commodity prices particularly for both coal
and gas. Pressure on prices could ease if global prices for these
commodities fall.
What can be done to help vulnerable customers
affected by higher energy prices?
14. Fuel poverty has three main causes:
high energy prices, low incomes and poor housing. Prices are unlikely
to return to the lower levels of the 1990s because of rising global
energy demand and higher commodity prices (see above). An enduring
and sustainable solution to fuel poverty will, therefore, need
to focus on the issues of housing and incomes.
15. Significant strides have been made to
improve the energy efficiency of housing and to install cost effective
heating systems through the Decent Homes standard, the Warm Front
programme and the Energy Efficiency Commitment. However, Warm
Front is focussed on private sector housing. Social housing, on
the other hand, is covered by the Decent Homes Standard and this
provides for lower standards of thermal comfort. We would therefore
encourage Government to take a "find and fix" approach,
ensuring that where work is being done on a property under the
Decent Homes Standard, a comprehensive solution is provided. We
would also encourage government to ensure effective inter-working
between the various schemes.
16. In addition, Government should keep
focussed on the vital role of the tax and benefit system in raising
incomes. Benefit entitlement checks can help ensure vulnerable
customers are getting their fair share of the millions of pounds
of unclaimed benefits. Government could also review the Winter
Fuel Payment and refocus the payments on those who need them the
most. Furthermore, additional funding for fuel poverty programmes
could be made available by recycling revenues from environmental
schemes. For example, Ofgem identified a windfall to electricity
generators of up to £9 billion of permits which are allocated
for free under Phase II of the European Emissions Trading Scheme
(EU ETS) which runs from 2008 to 2012. This windfall could be
used to help customers in fuel poverty. If Government were to
auction allowances for the following phase of EU ETS, some of
the revenue generated from this could also be used to fund further
measures to help tackle fuel poverty and environmental improvements—as
recommended by Ofgem in our submission to the Government's 2006
Energy Review.
17. On prices, vulnerable customers can
make big savings if they are in a position to switch supplier
or payment method and if the support available from Government
and suppliers is better targeted. There are now differences of
around £100 per household between suppliers' prices, and
the biggest savings available are to prepayment meter (PPM) customers.
18. Ofgem, along with other agencies, works
to help improve consumer awareness of these choices and to help
vulnerable customers access the benefits of the competitive energy
market. For example, we are calling an energy summit this Spring
to look at the specific issue of how to improve switching levels
among vulnerable customers, including lower income customers,
the frail, the elderly and those with low literacy and numeracy
skills. We are also working with Citizens Advice Bureaux to develop
a pilot programme to help educate low income and hard to reach
customers in how to make better choices in the energy market.
We also work to tackle any barriers that unreasonably prevent
customers switching supplier. For example, this year we will be
reviewing suppliers' policies on blocking customers who are in
debt from switching.
19. Government can keep up the "Winter
Initiative": a practical way to improve targeting, using
Department of Work and Pensions data, of suppliers' social measures
as well as the energy efficiency help available from Government
under the Warm Front scheme and the Carbon Emissions Reduction
Target. Ofgem led the first such initiative in winter 2006-07,
and BERR are repeating this in January with the active involvement
of energy suppliers and Ofgem. Consideration could also be given
to extending the remit of the Warm Front scheme. For example,
customers could be referred to their supplier for tariff advice
or to go onto their social tariff, where applicable.
How does Britain's energy market compare with
that on the continent?
20. Competition in the supply market, effective
regulation by Ofgem of the energy networks, and lower taxes mean
Britain's electricity bills are still competitive compared with
most other European countries. Britain's gas bills are also still
among the cheapest in Europe. For example, the German media have
been reporting likely price increases in their retail market of
25% in electricity and 15% in gas.
21. Britain's wholesale gas markets are
closely linked to European prices, due to the interconnector pipelines
connecting us with the continent and declining supplies from the
North Sea. Thanks in large part to Ofgem's efforts through the
European regulators' groups CEER (Council of European Energy Regulators)
and ERGEG (European Regulators' Group for Electricity and Gas),
currently chaired by Sir John Mogg, we have made significant strides
in improving transparency in European power and gas markets. We
now have access to important information on the levels of gas
in store in all the major European markets and can see how much
gas is taken out of store each week. Through the ERGEG "Regional
Initiative", which seeks to make practical progress at the
regional level so as to facilitate cross-border trade, we can
now see daily gas flows on major pipelines in France, Belgium
and the Netherlands and we will have an even wider range of information
available to us by the end of the year. Germany remains a problem
and less progress has been made there. There is also limited transparency
on production from the Norwegian gas fields. It remains impossible
to understand total Norwegian gas supply and this adds uncertainty
and volatility in the GB and north-west European regional market.
The picture is much better in the power market with most countries,
including Germany, now publishing regular and detailed information
on the availability of their generating stations, maintenance
plans etc.
22. However, a longer term solution to the
structural problems in the European market will require changes
to the legal and regulatory framework in the EU. The European
Commission (EC) adopted legislative proposals in September 2007
with a view to establishing such a legal and regulatory framework
at national and EU level—the "third package".
The proposals aim to complete integrated EU energy markets, achieve
security of supply and allow the markets to deliver on sustainability
(when combined with the EU Emissions Trading Scheme). The proposals
have now been passed to the European Parliament and Member States
for full legislative scrutiny. This co-decision process usually
lasts two to three years, although the EC have set a target of
reaching agreement by the next European Parliament elections in
June 2009. Ofgem is providing advice to the Government on the
proposals and continues to play a lead role within ERGEG. In particular,
we strongly support the work of the EC to end the large multinational
companies' domination of the European energy market, as fair access
to EU gas supplies would bring significant benefits to UK consumers.
Ofgem has been instrumental in assisting in that work, including
during the 2006 Sector Inquiry.
23. Ofgem would be happy to provide any
further information to the Committee on any of these issues.
January 2008
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