House of Commons - Business and Enterprise

Select Committee on Business and Enterprise Written Evidence

Memorandum by the Office of Gas and Electricity Markets (Ofgem)

INTRODUCTION

1. Ofgem is the regulator of the gas and electricity industries in Britain. We welcome the announcement of the Committee's inquiry. Like the Committee, we have noted the increasing public concern at recent events in the energy supply markets. Although we have not seen conclusive evidence that the market is failing, we know that customer confidence is vital in order for a market to function well—and it is clear in this case that customer confidence has been damaged. On 21 February, therefore, we launched an investigation which will look at whether the energy supply markets are working well for all consumers—and not just particular groups such as those who are on the cheapest online deals. The probe will be carried out under Ofgem's Enterprise Act powers which will give us access to detailed company information that is not routinely made available. We expect to report on our initial findings from the investigation in September.

THE ENERGY MARKET IN BRITAIN

2. It is useful to consider the energy market as comprising two elements. In the wholesale markets, electricity generators and gas shippers sell their energy onto suppliers. In the retail markets, suppliers then sell this energy onto business and domestic customers.[302] At the time of privatisation all customers received their gas from British Gas and their electricity from the Public Electricity Supplier for their region. Since the gradual rollout of competition in the late 1990s, customers have been free to switch to different suppliers.

3. There are parts of the supply chain in which competition is very limited. This is true for the energy networks—the pipes and wires that carry the gas and electricity. It would be too expensive for every energy supplier to build its own pipes and wires, so there are monopoly companies which transport gas and electricity from shippers and generators to customers.[303] In order to protect consumers, the revenues that the network monopolies can earn and the structure of their charges (ie the proportion of these revenues they can collect from business and domestic customers) are regulated by Ofgem in five-yearly price controls.

4. This combination of liberalised markets and independent regulation has brought significant benefits to British consumers. Britain's energy market was recently assessed to be the most competitive in Europe.[304] The stable regulatory framework has proved attractive to investors, with £30 billion being invested in the networks since privatisation. Consumers, in turn, have benefited as costs have been driven down by companies, a greater range of tariff offerings has been made available, and service levels and quality of supply have improved.

5. However, there are times when companies do not play by the rules or customers' confidence in the market is damaged. In these cases, the regulator must be prepared to investigate and act where necessary. As recently as February 2008, we imposed a fine of £41.6 million on National Grid for abusing its dominance in the gas metering market—the biggest fine ever imposed for this kind of competition law breach. Now, in response to customer concern at recent events in the energy supply markets, we are conducting a probe to ensure the market is working well for all customers—including the vulnerable. We welcome the insight that the Committee's work will bring.

6. In this memorandum we have addressed all seven of the questions posed by the Committee and we have provided background analysis wherever possible. Since our investigation is at an early stage, there are inevitably some points on which we are not yet able to offer definitive conclusions. Where this is the case we have sought to provide advice to the Committee on the issues it may wish to consider and the information on which it could draw in reaching its own view. In addition, if Members or Staff have any further questions, we would be happy to explore these issues in more detail, either in oral evidence or in a supplementary memorandum.

Q1. Whether the current market structure encourages effective competition in the retail markets for gas and electricity

7. We think a range of indicators should be used to assess the effectiveness of competition in a market. These include changes in prices relative to costs (and hence margins) over time; product innovation and improvements in customer service; customers' responsiveness to suppliers' offerings (measured by switching rates); the resulting changes in suppliers' market shares; and the concentration of the market amongst suppliers. The retail market is increasingly complex with a range of different types of energy contract offered (fixed and capped rate deals, market trackers, standard variable price contracts, green tariffs) and payment methods (direct debit, standard credit and prepayment). In looking at these indicators it is important to look at them in each of the various segments of the retail energy market to assess their competitiveness and also to look at trends in movements of customers between market segments over time.

Pricing and costs

8. There are six big players active in the energy retail market in Britain: British Gas Trading (BGT); E.ON (which until recently traded under the name Powergen); EDF Energy; Npower; Scottish Power; and Scottish and Southern Energy (SSE). Together, these six suppliers account for over 99% of the domestic retail market.

9. Since the beginning of this year all six major suppliers have increased their gas and electricity prices. SSE was the last to increase prices, waiting until the end of March by which time most customers' energy consumption has begun to fall. Customers can still make savings by switching supplier, particularly if they are still with the incumbent gas and electricity suppliers in their region and if they pay on receipt of their bill (ie standard credit) or through a prepayment meter (PPM). Customers who have never switched supplier can make considerable savings on their annual gas and electricity bills. These combined savings are, on average across regions, £125 for a PPM customer, £93 for a standard credit customer and £56 for a direct debit customer. The following graph shows the best savings available in each region by payment method, at the time of writing.[305]

Figure 1

POTENTIAL SAVINGS FOR ENERGY CUSTOMERS WHO HAVE NEVER SWITCHED SUPPLIER—APRIL 2008

Source: Ofgem

10. Further savings are available to customers who switch their payment method or who move to dual fuel (DF) ie taking both gas and electricity from the same supplier. In particular, online tariffs are growing in popularity and are often the cheapest tariff. The chart below shows, region by region, the cheapest deal by payment type for an average dual fuel customer.

Figure 2

LOWEST DUAL FUEL (DF) PRICE PER PAYMENT TYPE BY REGION—APRIL 2008

Source: TheEnergyShop.com and Ofgem

11. Despite the regional savings for customers who have never switched, we have noted that the recent price changes have resulted in the six major suppliers setting their average national dual fuel direct debit prices to within £19 of each other. The following table sets out the range in dual fuel prices (based on national average annual bills) between suppliers and shows how this has changed over the last year. While this level of price convergence could indicate effective competition, we will consider whether there are other reasons for this as part of our probe.

Table 1

DIFFERENCE BETWEEN THE CHEAPEST AND MOST EXPENSIVE SUPPLIERS OVER THE LAST YEAR BY PAYMENT METHOD

Payment method and year	Price range based on each supplier's average annual dual fuel bill
Direct Debit
2007 (Feb)	£118
2007 (July)	£72
2008 (April)	£19
Standard Credit
2007 (Feb)	£158
2007 (July)	£85
2008 (April)	£93
Prepayment
2007 (Feb)	£159
2007 (July)	£92
2008 (April)	£108
Product innovation

12. As well as price competition, suppliers are also innovating to retain and win customers. Innovative products offer more choice to customers and have proved to be very popular. Last year we estimated there were some 9 million gas and electricity accounts on green, fixed price and online deals, accounting for roughly 20% of all energy accounts.

13. When retail prices were rising, suppliers responded by introducing price guarantee deals such as fixed price, capped price and tracker deals. The first price guarantee tariff was introduced in 2003 and by March 2007 all suppliers not only offered the products, but the tariffs had evolved as competition increased. An example of this evolution was the removal of termination charges to allow customers to switch without penalty. Figure 3 shows the increasing popularity of price guarantee tariffs over time. As at March this year around 6 million product accounts (gas and electricity)—or around 13% of the market—were on price guarantee tariffs.

14. Online tariffs are another growing product area, often offering additional cost savings to customers. These offer customers savings for managing their accounts online. We estimate there are about 2.5 million online accounts with the biggest six suppliers.

15. Green tariffs have grown in popularity as customer concern for the environment has risen. This interest has allowed small suppliers specialising in green energy to enter the market, and large suppliers have introduced more green products to their tariff offerings to attract climate conscious customers.

16. More recent developments in the market have shown signs that suppliers are beginning to compete in the provision of services aimed at reducing energy consumption. For example, one supplier offers cash credits to match the reduction in energy use.

Figure 3

Source: Ofgem

Changes in suppliers' costs

17.Table 2 below provides an illustrative estimate of the increase in costs that suppliers face in 2008. Various costs that suppliers need to recover from domestic customers are increasing, including network charges and measures to tackle climate change.[306] However, such has been the increase in wholesale costs, we think this is the dominant area of higher cost for a number of suppliers, particularly for gas. In the table, the "energy, supply costs and margin" is a residual figure, based on an annual bill minus the known costs to suppliers.

Table 2

ESTIMATED AVERAGE DOMESTIC ENERGY BILL COMPOSITION

2007-08 to 2008-09	2007-08		2008-09		YoY % Change		Share of total bill 2008-09
Bill Composition	Gas	Elec	Gas	Elec	Gas	Elec	Gas	Elec
Energy, supply costs and margin	£404	£254	£454	£283	12%	11%	71%	69%
Distribution	92	62	115	62	25%	0%	18%	15%
Transmission	12	13	10	13	-17%	0%	2%	3%
VAT	28	18	31	20	11%	11%	5%	5%
Environmental	9	16	19	30	111%	88%	3%	7%
Meter provision	12	4	14	4.5	17%	13%	2%	1%
Average current bill	£557	£367	£643	£412	15%	12%	100%	100%
Source: Ofgem

18. The Renewables Obligation (included above in environmental costs) obliges electricity suppliers to source an increasing share of their power generation from renewable sources. Where a power supplier is unable to meet their obligation from their own generation they must buy renewable energy from accredited suppliers or pay a buyout price to meet the obligation. The share of energy that suppliers are obliged to source from renewable increases on 1 April 2008 from 7.9% to 9.1%.

Switching

19. In response to competition on price and the introduction of new products, there has been a steady increase in the level of switching between gas and electricity suppliers, with the level in 2007 exceeding that seen in 2006. Figure 4 and Table 3 below show the number of monthly and annual transfers of domestic gas and electricity customers.[307]

Figure 4

MONTHLY CUSTOMER TRANSFERS IN GAS AND ELECTRICITY

Source: Ofgem

Table 3

TOTAL ANNUAL TRANSFERS IN GAS AND ELECTRICITY

Total transfers	Jan to Dec 2004	Jan to Dec 2005	Jan to Dec 2006	Jan to Dec 2007
Electricity	4,229,023	4,316,401	4,820,756	5,157,028
Gas	3,588,634	3,510,976	3,915,480	3,982,207
Source: Ofgem

20. There are approximately 26 million domestic electricity and 21 million domestic gas customers in Great Britain. Based on a consumer survey undertaken by Ipsos Mori in early 2007, around 22% and 19% of these electricity and gas customers respectively switched their supplier in 2006.[308]

21. Datamonitor has estimated that of the 21.5 million customers taking both gas and electricity, 80% have switched either their gas or electricity since the market opened to competition. Taking the market as a whole, and including electricity only customers, Datamonitor estimates that 70% of households have engaged in the energy market by switching either their gas or electricity supplier.[309]

22. However, there is evidence that within some groups of customers, the percentage who have never switched supplier is higher eg amongst those who pay by standard credit. We will be doing more work to understand the reasons for this and what action can be taken as part of the probe.

Cross-sector switching comparison

23. Evidence from Ofcom research in 2006 provides a benchmark with which to compare switching rates and the ease of switching in the gas and electricity markets. The first chart in Figure 5 indicates that relative to sectors with similar characteristics (eg network characteristics and the presence of an incumbent in the case of telecoms) the number of customers who have switched is broadly similar. The second chart in Figure 5 indicates that when compared to the telecoms industry the relative ease of switching is deemed to be similar.

Figure 5

COMPARISON BETWEEN SECTORS OF THE PERCENTAGE OF SWITCHERS AND EASE OF SWITCHING

Sources: Accent 2005 for gas and electricity (commissioned by Ofgem) and Ofcom's Consumer Experience Report 2006 for telecoms and car insurance. *Datamonitor Report "The true state of the market—an analysis of dual fuel switching in the UK energy market" January 2008.

Market shares

24. Customers are still leaving their incumbent suppliers and the market shares of the incumbents continue to fall. British Gas' market share for gas has continued to decline (in December 2007 it was 46%), while the electricity market incumbents have less than half the customers in 8 of the 14 regions.

25. Nationally, in electricity and gas, SSE has seen the biggest increase in its share of customers. It has gained four million extra customers in Britain in the last three years and has moved to the second biggest supplier behind British Gas. During this period SSE has consistently been one of the most competitive suppliers on price and has been rated the highest supplier for customer service. British Gas has seen the biggest fall in market share in gas, while E.On has seen the biggest fall in electricity.

Table 4

NATIONAL MARKET SHARES IN GAS

Group	Dec 2002	Dec 2003	Dec 2004	Dec 2005	Dec 2006	Dec 2007	Change in market share 2002-07
British Gas	63	61	57	52	48	46	-17
E.On	12	12	13	13	13	13	1
EDF Energy	5	5	5	5	7	7	2
npower	9	9	9	10	11	12	3
Scottish Power	5	6	8	9	9	9	4
SSE	6	7	8	10	12	14	8
Others	0.2	0.6	0.3	0.4	0.0	0.0	0.2

Source: Ofgem analysis

Table 5

NATIONAL MARKET SHARES IN ELECTRICITY

Group	Dec 2002	Dec 2003	Dec 2004	Dec 2005	Dec 2006	Dec 2007	Change in market share 2002-07
British Gas	22	24	23	22	22	22	0
E.On	22	22	21	20	19	18	-4
EDF Energy	15	14	13	13	14	13	-2
npower	17	15	15	15	16	15	-2
Scottish Power	10	11	12	13	12	12	2
SSE	13	14	15	16	17	18	5
Others	0.3	0.7	0.4	0.6	0.2	0.3	0

Source: Ofgem analysis

26. To understand in more detail the change in electricity market share it is necessary to consider the market shares of the incumbent electricity suppliers in each of the old Public Electricity Supply regions. This is because there was originally a monopoly electricity supplier in each of these 14 regions.

27. In December 2007 the market shares of the electricity incumbents was below 50% in 8 out of the 14 regions. Figure 6 shows the regional market share of the incumbent electricity supplier in each region. The incumbent supply group is identified in brackets alongside the name of the region.

Figure 6

ELECTRICITY REGIONAL MARKET SHARES (DECEMBER 2007)

Source: Ofgem analysis

Retail market concentration

28. In some markets there may be many buyers and sellers. In others, the market may be concentrated in the hands of a very small number of participants. In extreme cases there may be only one seller (a monopolist) or one buyer (a monopsonist). The level of market concentration can, therefore, provide further clues as to the nature of competition. Very generally, the more concentrated the market, the weaker the competitive influence firms are likely to have.

29. The Herfindahl-Hirschman Index (HHI) is one method of measuring the level of concentration and is part of the conventional toolkit used by competition authorities as part merger assessments. The HHI takes account of the differences in market participants' size and it is calculated by summing the squares of the market shares of all the firms engaged in the market. The maximum that an HHI can be is 10,000. The OFT consider that a market with a HHI score of above 1,000 would be regarded as concentrated and a score above 1,800 would be regarded as highly concentrated. That said, care should be taken in interpreting HHI scores. For instance, in comparing HHIs in different markets, account should be taken of the different cost structures in operation.

30. Tables 6 and 7 show the HHI in the national gas market and the average HHI across the 14 regions in electricity respectively. These tables illustrate that both sets of HHIs have been declining steadily over the past five years.

Table 6

MEASURE OF CONCENTRATION (HHI) IN THE GAS MARKETS

	Dec 2002	Dec 2003	Dec 2004	Dec 2005	Dec 2006	Dec 2007
National	4,301	4,049	3,610	3,206	2,841	2,722

Table 7

MEASURE OF CONCENTRATION (HHI) IN THE ELECTRICITY REGIONAL MARKETS

	Dec 2002	Dec 2003	Dec 2004	Dec 2005	Dec 2006	Dec 2007
Average across Regions	4,892	4,557	4,236	4,002	3,724	3,461

Source: Ofgem analysis

Small new entrants

31. As well as the "big six" domestic suppliers, there are six active small suppliers licensed in the energy market. In a number of cases, these suppliers offer products in niche markets. For example, Ecotricity and Good Energy offer "green" products or tariffs. One newer supplier, First Utility, is offering a smart meter to its customers, complete with a home display unit, and Utilita is offering competitive pricing focused at PPM customers. In the small and medium enterprise (SME) market three new entrants are Opus, Corona and Bizz Energy.

32. There are also other active small suppliers who are not licensed but have ongoing arrangements with more established suppliers. These companies may provide specialised social offerings such as EBICo. EBICo is a not-for-profit energy company that offers PPM customers the same unit price as customers paying by other payment methods. This company obtains energy from one of the larger suppliers, but has separate pricing arrangements.

33. While these suppliers have been gaining customers, they have less than 0.5% of the market. As part of the probe we will be looking to understand the reasons why small new entrants have not been able to enter the market more effectively.

Q2. Whether there is effective competition in the wholesale markets for gas and electricity

34. In wholesale markets, as in retail markets, a range of information is used in assessing the nature of competition. Below we consider evidence on price movements, market shares, liquidity in the market and also the interaction between the UK and continental markets.

Price movements

35. Understanding price developments is key to understanding whether competition is operating effectively. In particular, we need to understand whether price levels and changes in prices are driven by changes in demand or supply (ie cost) conditions or whether firms are exploiting market power and raising prices above competitive levels. Below we present evidence on the factors we view as having contributed to recent increases in wholesale price levels. The evidence suggests that recent wholesale gas and electricity price increases appear to be largely driven by the main cost drivers.

Wholesale energy price increases

36. To understand the determinants of electricity prices, it is helpful to note that a significant share of GB electricity generation is gas and coal fired (around 75%) as shown in Figure 7 below, this is important since these sources of generation are usually the ones called on when an extra unit of electricity is needed—ie they are the marginal source of supply. Both these energy sources are exposed to the international markets and can consequently be affected by price movements in these markets.

Figure 7

GB ELECTRICITY GENERATION CAPACITY (2007)

Source: National Grid

37. High world oil prices are reflected in gas prices, particularly since the GB market is now increasingly exposed to the European markets where oil and gas prices are closely linked as a result of the market's structure.[310] The price of all four main energy sources (coal, oil, gas and electricity) have increased significantly between August 2007 and now. Global Liquefied Natural Gas (LNG) markets were also much tighter than winter 2006-07 due to unexpected higher global LNG demand, particularly from Asian markets such as Japan. Charts 8b and 8c show that prices are expected to remain high for next winter and summer 2009.

Figure 8a UK ENERGY PRICES MAY 2005—MARCH 2008 (30 DAY MOVING AVERAGE)

Source: Bloomberg

Figure 8b FORWARD CONTRACT PRICE WINTER 2008-09 FOR ELECTRICITY, COAL, OIL (BRENT CRUDE) AND GAS

Source: Bloomberg

Figure 8c

FORWARD CONTRACT PRICE Summer 2009 FOR ELECTRICITY, COAL, OIL (BRENT CRUDE) AND GAS

Source: Bloomberg

Environmental costs

38. In addition to upward pressure from global oil, coal and gas prices, GB prices have also risen as a result of programmes introduced by the government to tackle climate change ie Phase II of the EU Emissions Trading Scheme (ETS) and the renewable obligation for GB power generation.

39. Phase II of the ETS started in January 2008. As a result, the price of carbon has increased from virtually zero before the turn of the year to around €23/t (euros per tonne) today. Generators will seek to recover the costs of these permits through the price at which they sell their generation, either in the wholesale market or to their own supply business. Even though they receive some of the permits for free they will still seek to recover the value of the permit, since otherwise it would be more profitable not to generate and to sell the permit in the EU ETS market. The impact of this increase in the carbon price accounts for about an extra £9/MWh (pounds per Megawatt hour) in wholesale electricity prices. Under the UK's National Allocation Plan, large electricity generators receive slightly less than half of their emission allowances free of charge, so the resulting increase in the price of power represents a windfall gain for these generators. Based on today's carbon prices, these free emission allowances represent a windfall of emission allowances of around £9 billion pre-tax over the five year compliance period.

Figure 9

ETS CARBON PRICE

Source: Bloomberg

Possible infrastructure constraints

40. Constraints on gas supply infrastructure can cause peaks in prices, choking off consumer demand when the market believes supply capacity constraints are significant. While the UK gas infrastructure position is significantly better in 2007-08 with more import and storage capability than in winter 2005-06, some of the expected capacity is now coming on later than planned. However, compared to winter 2006/07, last winter was very mild both here and on the continent which helped to keep GB gas prices lower than this winter to date.

41. Overall, evidence points to a combination of energy price increases driven by price increases in global energy markets, as well as, environmental policy levies. However, it is useful to consider other indicators commonly used to assess the potential effectiveness of competition in a market. The next section considers evidence on market shares in the wholesale gas and electricity markets.

Wholesale gas market shares

42. For market definition purposes here we consider the relevant gas market to encompass those companies involved in supplying gas on to the GB National Transmission System (NTS). There are around 120 companies that were active in supplying gas onto the NTS in 2007. Due to the large number of companies active in the gas market we provide an overview of gas supply by broad supply source, below.

43. The gas supply shares for the four main gas delivery sources in calendar year 2007 were: 70% from Beach (a combination of more mature UK continental shelf (UKCS) and Norwegian fields); 12% Langeled (a pipeline carrying gas from Norwegian fields); 7% Bacton Balgzand Line (the new gas import pipeline from the Netherlands, known as BBL); and the remainder from LNG, storage and the gas interconnector (a two way gas pipeline, known as IUK, connecting the UK with Belgium). Within each of these key sources of supply a varying number of companies operate.

Figure 10

WHOLESALE GAS MARKET SUPPLY SHARES, BY SUPPLY SOURCE 2007

Source: National Grid

Gas market concentration

44. The level of market concentration can provide clues as to the nature of competition. Generally, the more concentrated the market, the weaker the competitive influences are likely to be. As in the retail markets, the concentration of the gas and electricity wholesale markets can be considered using estimates of Herfindahl-Hirschman Indices (HHI).[311]

45. One way of defining the market share for calculating concentration ratios in the gas supply market would be the share of gas deliverability in gigawatt hours per day[312] (GWh/day). On this basis, the overall gas wholesale supply market's HHI is estimated to be 430, indicating a relatively low concentration.

46. As well as looking at the overall market it is also useful to look at market concentration with respect to the source of gas delivery. This is because different gas sources will be marginal at different times, depending on the level of demand, as illustrated in Figure 10. When a gas source is marginal it is possible that operators have relatively more market power—enabling them to influence prices to a greater extent. While the overall HHI score indicates that there are a relatively diverse number of players, some of the UK's individual gas supply sources are relatively more concentrated.

Table 8

ESTIMATED MARKET CONCENTRATION BY SUPPLY SOURCE

	Estimated HHI
UKCS	704
Norway	2023
Storage[313]	708
IUK	1,164
BBL	4,400
LNG	3,342
Overall wholesale gas market	430

Source: Ofgem analysis

47. UKCS and storage are the sources with the lowest market concentration, while BBL, LNG and Norway have relatively higher concentrations.

48. Figure 11 shows daily gas supply for each supply source. Gas supply has been ranked by gas demand, so day 1 on the chart represents the highest gas demand during the period, and shows the sources used to meet demand.[314] As demand increases more expensive sources of gas bid into the market. While we do not know exactly what the costs of each supply source are, the chart makes conventional assumptions about the merit order of each source.

Figure 11

ESTIMATED GAS SUPPLY BY DEMAND ORDER, OCTOBER 2007 TO MARCH 2008

Source: Ofgem analysis, National Grid data. (SRS is mostly controlled by National Grid for balancing, although some capacity is auctioned)

49. Overall, Figure 11 gives an indication of the number of days each supply source is at the margin. A concentrated marginal source may have the ability to influence prices temporarily, bidding them above a competitive level. Combining the gas load stack with its components concentration ratios enables us to see which source is at the margin and the sources concentration.

50. Table 9 below, shows the volume of gas delivered per day during Winter 2007-08, as a share of the estimated total volume each gas source can deliver per day (one way of measuring capacity). The data showing the maximum volume of gas delivered over the Winter 2007-08 period indicates that, even on these maximum delivery days, each source is still likely to be capable of delivering more gas. This provides evidence that it is unlikely that more concentrated supply sources are able to influence the price of gas at the margin, since other supply sources still have remaining supply capacity to compete.

Table 9

WINTER 2007-08 GAS DELIVERED AS SHARE OF ESTIMATED TOTAL DELIVERABILITY (A MEASURE OF CAPACITY)

	Ave delivered gas	Max delivered gas	Min delivered gas
UKCS	73%	84%	54%
Norway	62%	95%	22%
BBL	70%	88%	17%
IUK	22%	58%	0%
Storage	23%	72%	0%
LNG	16%	74%	0%
SRS	1%	28%	0%
Total	53%	68%	38%

Sources: Ofgem analysis

51. While some of the more concentrated gas sources are at the margin during periods of peak demand, the following should be noted: (i) there are very few days during which these sources are the marginal source supplying peak demand, (ii) the supply market overall has a relatively low concentration, (iii) total supply capacity is in excess of peak demand, (iv) the total deliverability of each source is in excess of maximum gas delivered (each source has some additional margin which they can supply to the market), and (v) wholesale energy buyers have the ability to hedge in advance of the gas delivery day. Hence, on the basis of this evidence, there are limited signs of one source being able to influence market price to a significant extent.

52. In addition to examining the competitiveness of the gas supply market it is also noteworthy that at certain price levels a demand side response occurs. This can act as an additional break on potential market power. The demand side response seen in winter 2005-06 when gas supply capacity was tighter than normal saw examples of this response.

Wholesale electricity market shares and concentration

53. Similar to the market definition for gas, we define the wholesale electricity market as those players who supply electricity to the National Grid. This definition hence overstates the case for some electricity users since 12.7 gigawatts of generation is embedded and not supplied to National Grid. This volume of generating capacity is four times the output of the very large Drax power station. Figure 12 below shows the market shares of generators in Great Britain.

Figure 12

GENERATION OUTPUT SHARES, 2007

Source: National Grid

54. As for the gas market, we present HHI measures for the electricity market. The HHI of the wholesale electricity market (based on output) is estimated to be around 986, indicating a relatively low concentration.

55. Looking ahead to the ownership of the generation capacity anticipated to be entering commission, the concentration outlook continues to be one of a relatively low HHI. Proposed new generating capacity is being commissioned by the "big six" as well as smaller independents. Figure 13 below shows the forecast HHI and new generation capacity coming on stream between 2008-09 and 2013-14.[315]

Figure 13

CAPACITY IN MWh (LHS) AND CONCENTRATION OUTLOOK (RHS) IN HHI

Source: HHI from Ofgem analysis, Capacity from National Grid.

Vertical integration

56. Evidence suggests the six majors are becoming increasingly vertically integrated. Vertical integration is often an efficient response by firms aiming to minimise their transaction costs and optimise their risk management strategies. For instance, since the depth[316] of the day ahead electricity market is limited (due in part to the innate inflexibility of certain types of generation plant), suppliers can gain greater control of their potential supply liabilities by owning generation capacity. In particular where they own flexible plants, enabling a quick response to prices and demand.

57. However, vertical integration, can, in some instances raise competitive concerns. In the energy market, a high concentration of generation capacity in the hands of a small number of electricity suppliers could preclude other players from gaining competitive access electricity supply. Figure 14 below shows the estimated supply—generation balance across the power market, and we can see that the main six retail suppliers are able to cover their own domestic and SME supply liabilities with their own generation.

58. Around 55% of generation capacity is owned by the six main domestic suppliers (see Figure 12), and the remaining share would seem sufficiently large and flexible enough for potential new entrant to contract to supply energy for their customers.[317]

Figure 14

ESTIMATED SUPPLY—GENERATION BALANCE BY SUPPLIER 2006

Sources: Generation data: BERR and Elexon. Domestic supply data: Ofgem data and analysis. I&C: Datamonitor Report "Q4 2006 B2B Market Share Monitor", 18 January 2007.

Liquidity

59. Liquidity refers to the ability to quickly buy or sell a particular item without causing a significant movement in the price. A liquid market will feature a large number of buyers and sellers ready and willing to participate in the market at all times. Liquid markets are important in ensuring that price signals to participants are accurate and to allow participants to adjust contractual positions without materially altering the prevailing price. Short term exchange liquidity might also lower barriers to entry for new suppliers.[318] It is important to note that a high level of liquidity is not an end in itself, and is merely one indicator of a healthy market as it makes new entry relatively easy.

60. It is worth noting that there may be a number of benign explanations for falls in liquidity, for example improvements in initial contracting, supply-demand balancing and forecasting may cause liquidity to fall. In addition, more sophisticated products (eg options) are a substitute for direct trading in physical products. However, at very low levels of liquidity, confidence in traded prices can be undermined.

61. There are a wide range of measures of liquidity, including number of market participants, number of trades, volumes traded and churn (the number of times a single unit is traded).

Gas

62. The majority of total volume traded in the UK is traded over-the-counter (OTC), with most activity observed close to real time and close to the delivery of the product, ie volumes are highest for near term products (day-ahead, week-ahead, month-ahead).

63. The Financial Services Authority (FSA) conducts an annual survey of energy brokers in the UK to determine total OTC traded volumes, these are reported below.

Table 10

ESTIMATED VALUE OF UK GAS MARKET

	Volume traded (billion therms)	Est value of market (£billion)
2006-07	437	134
2005-06	209	108
Increase on 2005-06	226 (109%)	26 (24%)

Source: Financial Services Authority

64. According to the FSA, the total volume of forward traded gas through electronic or voice brokered services year from 1 August 2006 to 31 July 2007 was 437 billion therms, an increase of 109% on the previous year.[319]

Electricity

65. As with gas, the majority of trades in electricity take place OTC, so that the share of trades over exchanges (usually the APX or ICE) is very small as a share of total trades.

66. As in the gas market, parties trading gas in the UK can utilise a wide range of trading platforms. The FSA annual survey is reported in the table below.

Table 11

UK ELECTRICITY OTC TRADING VOLUMES

	Vol traded (TWh)	YoY growth	Est value of the market (£m)	YoY growth
2006-07	985	337 (52%)	31	1 (3%)
2005-06	648		30

Source: FSA

67. The relative lack of depth to the exchange traded power market relative to the gas market in the UK is likely, in part, to be a function vertical integration. That is, power suppliers own a sizable portion of their own generation capacity, when compared to the UK gas market. In addition, the UK power market is less well connected in infrastructure terms than some European power markets. For instance, Germany and France are well connected, allowing greater scope for trading power across borders.

Investment

Gas

68. The increased diversity of gas supply sources goes towards strengthening competition in the wholesale market as well as ensuring security of supply. Over the last few years the market has delivered several new import infrastructure projects, including the Langeled pipeline, the BBL interconnector, expanded capacity of the IUK interconnector and LNG import facilities at Teeside, Isle of Grain and Milford Haven. In addition to this a number of new storage facilities have also been constructed by market participants and others are in various stages of the planning process. These have the potential to double the GB storage capacity; if these projects gain planning permission the extra storage capacity will assist the market in managing peak winter demand as North Sea production continues to decline. Figure 15 shows the outlook for LNG infrastructure capacity between 2007-08 and 2012-13.

Figure 15

NEW LNG INFRASTRUCTURE

Source: Ofgem estimates. National Grid data

Electricity

69. We would expect a properly functioning market to send price signals to investors encouraging them to build the generation capacity to meet required future demand. Below we assess some of the evidence on market signals for investment.

70. A standard industry measure of profitability in electricity generation is to consider the "spark and dark" spreads.[320] These provide an indication of the expected return from investment in new generating capacity over the short term. There is much debate about the levels required to encourage new investment in generation capacity, particularly in the context of current pressure on new plant capital costs. Some of these capital costs may be attributed to current high commodity prices. Forward spreads for winter 2008-09 can be found below in Table 12. Different efficiency factors can be used to calculate spreads, and it is noteworthy that new gas plants are able to achieve efficiency rates of around 58%, where 49% to 54% might be more normal for existing plants.

Table 12

WINTER 2008-09 FORWARD SPREADS (13/3/2008)

	Winter 2008-09 (£/MWh)
Spark	17.56
Dark	34.60
Clean Spark	12.11
Clean Dark	22.10
Clean Spark (+O&M +Transportation[321])	11.71
Clean Dark (+O&M +Transportation)	16.21

Source: Ofgem analysis, Bloomberg data. Efficiency factors (heat rate) taken to be: Spark 54% and Dark 37%.

71. Long lead times for building plant, combined with large fixed costs and long payback periods mean that market uncertainty can lead to higher discount factors and risk coefficients being used in making investment decisions. A variety of factors can affect these investment payback calculations, not least of which is confidence in the market.

72. Rates of proposed investment in new generation capacity provide some evidence that the wholesale market is encouraging the private investment needed to meet future UK energy demand. For each of the years in Figure 16 below, the first bar shows the amount of generation capacity which is already in existence or under construction; the second bar adds to this the generation capacity not yet built but which has consent under section 32 or section 36 of the Electricity Act 1989; and the third bar adds in all possible capacity from generation that has a connection agreement with National Grid.

Figure 16

NEW GENERATION CAPACITY OUTLOOK

Source: Ofgem analysis. National Grid data.

73. The extent of investment in new generation capacity we have seen over the last 10 years, as well as planned capacity, suggest the market is functioning well and encouraging investment.

European interaction

74. GB—European energy market interaction has increased significantly over the last few years, and short term prices on the GB, Zeebrugge (Belgium), and TTF (the Netherlands) markets are becoming increasingly correlated. That said European market liberalisation is crucial to increase price transparency and increase European and GB market efficiency. We cover the GB markets interaction with European markets in response to question 5, below.

Q3. The implications of growing consolidation in the energy market

75. A discussion of the impact that consolidation may have had on energy market competition is covered in response to questions 1 (on the retail market) and 2 (on the wholesale market). Ofgem's market probe will examine the nature of competition in the gas and electricity retail markets.

Q4. The relationship between the wholesale and retail markets for electricity and gas

76. The volatility in energy prices means that the cost of the gas and electricity is the largest and most difficult component of energy supply cost to estimate. While network and environmental cost will be subject to the same influences for all suppliers, a supplier's actual energy costs depend on its own forward purchasing strategy—how much gas and electricity it has bought to cover customer requirements at different times. In the more volatile gas market we have witnessed, with wholesale gas prices rising by around 40% to 60% over the last year (depending on the time period measured), forward purchasing strategies are likely to be an important determinant of cost.

77. A key decision a supplier makes in energy procurement is what proportion of the energy should be bought ahead (hedged) on the forward markets. If they don't buy all of their customer's energy requirements in advance they must buy them at day ahead or spot prices. Hedging reduces suppliers' exposure to the volatility of day ahead and spot prices. But it also leaves suppliers in a less flexible position, and more reliant on their forecasts for their customer numbers and their customer demand being accurate. The balance between hedging and buying at spot can impact heavily on the wholesale costs faced by a supplier.

78. Britain has faced increased exposure to global markets (from increased supplies being sourced through new infrastructure connections with Norway and the Netherlands) at a time when wholesale energy prices have increased significantly. The rise in energy prices means that the spread of different wholesale energy prices faced by a supplier also increases. Some suppliers are, therefore likely to be more effective at buying low cost than others.

79. Figure 17 shows the correlation between the average annual dual fuel standard credit tariff (the red line) and the wholesale day-ahead energy price for an average domestic consumer's annual consumption[322] (the green line). Wholesale energy costs are only one part of the costs faced by suppliers, but do represent around 70% of the total cost in the average 2007 domestic customer bill.

Figure 17

WHOLESALE AND RETAIL ENERGY PRICES, CONSTANT Q1 2008 PRICES

Source: Ofgem analysis, Heren and TheEnergyshop.com data

80. Wholesale prices rose between q2 2005 and q1 2006 and subsequently fell between q1 2006 and q2 2006. However, retail prices did not fall to the same extent as wholesale prices between q1 2006 and q2 2007. It is possible that this relationship results from a combination of factors affecting suppliers. These factors might include: (i) increases in environmental costs, (ii) increases in charges to maintain the network, and (iii) heightened price uncertainty in the European and global energy markets going forward—such uncertainty could be manifesting itself in an aversion, on the part of retail suppliers, to pass through price falls in the short term, because the risk of short term prices increasing again might be deemed to be high.[323]

Q5. The interaction between the GB and European energy markets

81. The interaction between GB and European markets has increased significantly in the last few of years. The declining production of the UK continental shelf, the advent of new supply infrastructure from Norwegian fields, and a new import pipeline from the Netherlands[324] mean that the UK is becoming increasingly exposed to European energy markets.

82. In this section, we examine the behaviour of GB gas and electricity prices and infrastructure connections with Europe, as well as providing an overview of the European energy market.

Gas: price differentials and infrastructure flows

83. GB gas supply infrastructure with the continent consists of two major interconnectors, BBL[325] (flowing from the Netherlands to GB) and IUK[326] (flowing in both directions, to and from Belgium to GB). In addition to this there are a number of pipelines supplying gas from UK and Norwegian gas fields.

84. Figure 18 shows the correlation between day ahead gas prices in Britain, Zeebrugge in Belgium and the Title Transfer Facility (TTF), a gas trading hub based in the Netherlands. It is clear that apart from a relatively short period around January 2006, there is a strong price correlation. This is likely to be due in part to the commissioning of the BBL pipeline in late 2006.

Figure 18

GB, ZEE AND TTF DAY AHEAD PRICES

Source: Bloomberg

85. On examination of Figure 19 (showing IUK exports from GB to Belgium and BBL flows from the Netherlands to GB) there is some evidence that IUK flows respond to price differentials between GB and Belgium. Broadly, where the Belgian price is higher, flows to Belgium increase, and where the GB price is higher, flows switch to GB. This is consistent with the reasonable price correlation observed (particularly from January 2007 onwards) between GB, Belgium and the Netherlands in Figure 18.

86. BBL is a one way pipeline between the Netherlands and GB, and is generally used by UK suppliers for sourcing gas under longer term contract. Since, flows are only one way it is not possible for the BBL pipeline to respond in the same way as the IUK interconnector, although some price driven behaviour may be observed—for instance a drop off of flows between September and October 2007.

Figure 19

IUK AND BBL FLOWS AND PRICES

IUK EXPORTS FROM GB

BBL FLOWS

Sources: Bloomberg, National Grid.

87. It is noteworthy, however, that the depth of the short term markets in the Netherlands and Belgium is very limited in comparison with the GB market. The vast majority of European gas is traded on long term (oil indexed) contracts. Consequently, only a small share of European supply is sourced from the Belgian and Dutch markets, meaning the large GB wholesale market heavily influences day-ahead Belgian and Dutch prices. The prices European energy suppliers actually face are relatively opaque.

88. In relation to flows from Norwegian gas fields, we initially observe a reduction in flows to the UK in winter 2007 compared to the previous winter, while at the same time flows to the continent increased. Although GB gas supplies have been adequate this winter, this fall may initially seem of concern.

89. One possible explanation for this drop in early winter is that the GB market is receiving this gas via BBL instead. It is clear from Figure 20 below that GB received around 10-15 million cubic metres (mcm) per day more through BBL this winter (November and December 2007) than last winter. It is also clear that the significant fall off in Norwegian flows to GB in the last week of October 2007 coincides closely with the ramp up of BBL (approx 25 mcm/day). In addition to Norwegian gas the BBL pipeline can be used to source flows from and through Germany and Belgium.

90. Another explanation for the drop off in flow to GB in October/November could be a combination of production outages at Norwegian fields, (eg Njord, Kviteebjorn, Ormen Lange) and continental buyers exercising flexible terms in their contracts to increase their supplies. For instance, figure 20 shows a year on year fall in flows to GB and an increase in flows to Germany, France and Belgium from October/November onwards.

Figure 20

NORWEGIAN, IUK AND BBL IMPORTS

Source: Bloomberg, National Grid

Figure 21

AVERAGE MONTHLY PIPELINE UTILISATION

Source: Ofgem analysis. NPD, Fluxys, GRTgaz, and National Grid data

UK-European gas liquidity

91. Trading in the UK gas market is significantly higher when compared to European markets in recent years, the open market for wholesale gas in GB is the most mature energy market in Europe, both in terms of traded volume and value. Greater market liquidity is generally thought to increase market efficiency, and as such is generally accepted as a feature of a well functioning market. As shown in Table 10, the volume trade on the GB gas market has increased rapidly, year-on-year (YoY) between 2005/06 and 2006-07 the volume of trade rose 109%, and the value of trade on market increased by 24%.

92. Figure 22 showing GB and European gas trading statistics from the FSA illustrate that the volume of gas traded on the open market in GB is significantly greater than that traded on the European open market.

Figure 22

GB-EUROPEAN ANNUAL GAS TRADING VOLUMES (OVER-THE-COUNTER)

Source: FSA

Lack of liberalisation and transparency in euro market

93. The lack of effective gas market liberalisation on the continent means that the GB market is unlikely to get the full benefits of gas producers and suppliers seeking out the most attractive destination for their gas and supplying gas to GB at times when our market has relatively high prices. Related to this point is the fact that European gas markets are far less transparent than the GB market. This can make it difficult for market participants to assess where Norwegian flows are going and to track movements in customer demand on a daily basis. This uncertainty is likely to add to the daily and within day volatility of GB spot prices, increasing prices and the risk premium that customers need to pay to fix prices.

Euro gas contracts oil indexed

94. A feature of the less liberalised continental gas market is that contract gas prices are generally linked to oil prices through pricing formulas meaning that contract gas prices adjust to oil prices with a lag. Oil prices have increased over the last year to over $100/barrel. This means that European buyers can take the opportunity to arbitrage their long term contract gas price against the spot gas price using the flexibility they have to vary the volumes they take under contract. It also means that European gas prices rise to higher levels than gas supply and demand fundamentals might suggest they should, which in turn means that GB prices have to be higher to attract marginal gas supplies for domestic consumption.

95. European long term contract prices move with changes in the oil prices with a lag of around six to nine months. Therefore, we expect the high sustained oil price to continue to be a factor behind high UK and European gas prices looking forward.

Electricity

96. The GB electricity market is heavily influenced by international coal and gas prices, as shown in Figure 6, 38% and 37% respectively, of GB power generation is fuelled from these fuel sources. In addition to a 2 gigawatt interconnector with France,[327] the remainder of GB generation is from nuclear, oil, and renewable sources.

GB-France power price correlation

97. Figure 23 below shows the correlation between GB and French electricity prices. Detailed Ofgem and National Grid analysis suggest there is strong evidence that the interconnector is functioning well, and responding as expected to price differentials.

98. Taking into account the limited 2GW capacity, the GB and French power prices show a strong correlation. More recently the spike in prices in December 2007 saw French power reach above £200[328] and GB prices peak at around £93.

Figure 23

GB AND FRENCH ELECTRICITY PRICES

Source: Bloomberg

99. Overall, GB and French prices show a correlation, which has increased more recently as gas infrastructure and supply sources have become more interlinked.

Q6. The effectiveness of regulatory oversight of the energy market

100. Strong independent regulation has a key part to play in maintaining a well-functioning market. Companies want to know that the investment climate will remain stable and that they will not face unacceptable burdens—otherwise they may invest their money elsewhere. Customers want to know that if their supplier does not play by the rules, firm action will be taken and consumers will be protected. It is important to consider whether these challenges are being met.

101. Let us consider the customer perspective first. Markets are never perfect. Sometimes customers are treated unfairly and sometimes companies behave in an anti-competitive way. We have a range of powers at our disposal to deal with this activity and these can be considered across four main areas: our ongoing monitoring of the markets; the informal influence we can exercise through encouraging best practice and "naming and shaming" companies; the rules we place on suppliers in their licences; and the formal powers we can exercise under the Gas and Electricity Acts and competition law.

102. Monitoring the market: We conduct surveillance into the retail and the wholesale energy markets, analysing prices, supply, demand and market activity, plus more specialised analysis of individual areas eg quantitative analysis of the relationship between wholesale and retail prices. This constant market monitoring can bring problems to light and lead to action under our powers below.

103. Naming and shaming: In 2007 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. In June 2007, we singled out Npower and British Gas for their prepayment meter (PPM) tariffs relative to other suppliers urging customers on these tariffs to consider switching away. In February 2008, we named and shamed Npower for not doing as much as other suppliers to help customers in debt.

104. Placing obligations in suppliers' licences: In our 2007 supply licence review we lifted certain conditions which were either redundant or no longer required given other protections, to help promote new entry and the development of new tariffs and services. For vulnerable customers however we strengthened the range of protections. For example, we have extended a ban on gas suppliers from disconnecting older customers over the winter to electricity suppliers. New obligations now require the timely recalibration of prepayment meters after a price change, following earlier intervention by Ofgem and guidelines to bring three suppliers into line. We have maintained requirements in the licence on suppliers to provide a full range of payment options to suit customers' needs. We have broadened the requirements on suppliers to provide information to customers on the dangers of carbon monoxide poisoning and the benefits of fitting carbon monoxide alarms. This is in addition to the existing requirement to provide free gas safety checks for pensioners in receipt of certain benefits.

105. Using powers under energy and competition legislation: Ofgem has a range of powers under the Gas and Electricity Acts and under the Competition and Enterprise Acts. We have used these to good effect to help make the market work better for customers. We have in the past taken action against suppliers for mis-selling and for blocking customer transfers, including the imposition of a £2 million fine. More recently we have used the Competition Act to tackle anti-competitive behaviour by National Grid in the gas metering market which has harmed competition and consumers. Our investigation resulted, in February 2008, in the imposition of a £41.6 million fine—the biggest ever fine for this type of competition law breach. The Enterprise Act gives us powers to refer the market to the Competition Commission, and to gather detailed financial information from the companies we regulate. It also gives the Office of Fair Trading (OFT) the power to prosecute individuals who engage in cartels. We have drawn on some of these powers in the past, during the wide-ranging wholesale market probe in 2004-05, and we are currently making use of them again as part of our investigation into the energy supply markets.

106. Although we have not seen conclusive evidence that the market is failing, we know that customer confidence is vital in order for a market to function well—and it is clear in this case that customer confidence has been damaged. Our investigation into the energy supply markets, announced on 21 February, will look at whether the market is working well for all consumers—and not just particular groups such as those who are on the cheapest online deals.

107. We expect to publish our initial findings before the end of September. If we conclude that further action is required, this could take several forms. For example, we could refer the market to the Competition Commission for another investigation or we could take more immediate action under our existing powers eg investigating and imposing penalties on companies that have broken competition law; changing the licences under which all companies in the energy market have to operate; recommending legislative changes to the government; or campaigning to promote customer awareness and participation in the market.

108. If anyone has any evidence of anti-competitive behaviour, we urge them to bring it to us. We will not hesitate to use our powers to investigate and, if necessary, impose penalties on any energy company that has been found to have broken competition law.

109. From the companies' perspective, Britain's stable regulatory regime has proved attractive to investors. Between privatisation and 2006 over £80 billion has been invested in new oil and gas production from the North Sea; over £30 billion in the gas and electricity networks; and £14 billion in new electricity generation stations and in refurbishing coal fired stations to create a more diverse generating mix. This is clearly good for energy companies—and it is good for consumers too. Britain's domestic gas supplies are declining faster than expected and we have ambitious targets for renewable energy. In order to secure our energy supplies and protect the environment, therefore, unprecedented levels of investment are required. In addition, where new players enter the market, competition increases and customers benefit from greater choice.

110. We must therefore maintain a stable regulatory regime which gives investors confidence and removes unnecessary administrative burdens, whilst being prepared to boost consumer protection where it is necessary and proportionate. In the energy supply markets, Ofgem is working to tackle barriers to entry and give more choice to customers. In 2007 we cut the energy supply licence from 160 pages to 60 pages, removing barriers to entry like the "28 day rule" which many saw as preventing suppliers from offering long term energy services such as the installation of household electricity generation or measures to improve energy efficiency. We also amended the rules to make it easier for suppliers to install smart meters which have the potential to help cut emissions and improve the accuracy of customer bills. All these steps help to encourage investment in the market.

111. Overall we believe that our work is helping to support the operation of the market whilst providing customer protection where necessary.

Q7. Progress in reducing fuel poverty and the appropriate policy instruments for doing so

112. A household is considered to be in fuel poverty when it spends more than 10% of its income on gas and electricity. Three main factors are responsible: high energy prices, low incomes and poor housing.

113. The number of customers living in fuel poverty declined steadily between 1996 and 2003, with little movement in overall figures in 2004. These reductions resulted from a combination of improvements to income (such as the new pension credit arrangements), improved energy efficiency (primarily through the Energy Efficiency Commitment and Government funded fuel poverty schemes such as the Warm Front and its counterparts in Scotland and Wales) and reductions in energy prices. The Government estimates that nearly three quarters of the reduction in fuel poverty numbers in England between 1996 and 2005 was as a result of improvements to incomes, 20% was due to improving energy efficiency and only 5% was due to falling fuel prices.[329] In Scotland, half of the reduction in fuel poverty between 1996 and 2002 was attributed to rising incomes, 35% to falling fuel prices and 15% to improvements in energy efficiency.[330]

114. However, the number of households in fuel poverty has risen in the last three years as a result of electricity and gas price increases. Current estimates suggest that there were over 4 million households in fuel poverty in the UK in 2006.[331] Ofgem is committed to doing all it can to ensure prices are no higher than they need to be. However, prices are unlikely to return to the lower levels of the 1990s because of rising global energy demand and higher commodity prices. An enduring and sustainable solution to fuel poverty will, therefore, need to focus on the issues of housing and incomes which are principally for Government to address.

Housing

115. 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.[332]

116. We encourage Government to take a "find and fix" approach, to ensure that when someone is identified as being in fuel poverty a comprehensive solution is provided to help lift them out. Joined-up action across Government is therefore essential. For example, we would encourage data sharing between the Department for Work and Pensions, the EAGA Partnership and energy suppliers to improve the targeting of the help available. In addition, consideration could be given to extending Warm Front so that customers are also referred to their supplier for tariff advice or to go onto their social tariff, where applicable.

Incomes

117. In addition, Government should stay 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) 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.

Prices

118. 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. Customers who have never switched supplier can make big savings by switching. On average, across all regions, switching savings amount to £125 for a PPM customer, £93 for a standard credit customer and £56 for a direct debit customer.

119. As well as savings available from switching payment method and supplier, a number of suppliers offer special discounted tariffs and packages to vulnerable customers that meet certain criteria (such as those in receipt of government benefits). Ofgem published two reports in 2007 in order to "shine a light" on suppliers' social measures, encourage best practice and inform consumer agencies of the range of assistance available.

120. 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, Sir John Mogg chairs Ofgem's Social Action Strategy Review Group and will host an Ofgem Fuel Poverty summit in April. This Summit will focus on identifying ways to ensure that vulnerable customers are able to take full advantage of the savings available by switching supplier. Where switching is difficult or not possible, we will look at what other help may be available to reduce the amount customers have to pay for their fuel.

121. We are also working with Citizens Advice to develop and launch a pilot programme to help educate low income and hard to reach customers on how to make better choices in the energy market. If the evaluation of this pilot proves successful, we are hoping that the Government will consider funding a national rollout of this programme.

122. As part of Ofgem's energy supply markets probe, referred to above, we are focussing in particular on whether competition is benefiting all customers. This includes those who pay by PPM and Standard Credit, given the concern about the differentials between these tariffs and Direct Debit. In addition, we will look at whether there are any immediate actions we can take in this area to improve consumer awareness of the options available. Furthermore, we are looking to tackle any barriers that unreasonably prevent customers switching supplier. This work includes a review of suppliers' policies on blocking customers who are in debt from switching.

123. Given the challenge of targeting help, we would recommend that the Government keeps up the "Winter Initiative": a practical way to improve targeting, using Department of Work and Pensions (DWP) data, of suppliers' social measures as well as the energy efficiency help available from the Government under the Warm Front scheme and the suppliers through the Carbon Emissions Reduction Target. Ofgem led the first such initiative in winter 2006-07. The Government should also consider how it could facilitate data sharing between the DWP, HM Revenue and Customs and energy suppliers to improve the targeting of their social programmes to assist those who need them most.

124. I hope that this information and analysis is useful to the Committee. If Members have any further questions, my colleagues and I would be happy to explore these issues in more detail, either in oral evidence or in a supplementary memorandum.

1 April 2008

302 The retail markets are often also referred to as the supply markets. Back

303 Independent Gas Transporters and Independent Distribution Network Operators represent a very small exception to this. These operators sometimes install systems on new housing developments. Back

304 "Energy market competition in the EU and G7: preliminary 2006 rankings", prepared by Oxera for BERR, October 2007. Back

305 The savings shown in these tables do not include additional savings available through online deals or switching to dual fuel. They sum the savings from moving from the incumbent gas supplier to the best gas offer, and moving away from the incumbent electricity supplier to the best electricity offer. Back

306 The Renewable Obligation increases from 7.9% to 9.1% on 1 April 2008. The RO currently adds around £10 to an electricity bill per year and is set to rise to around £20 a year by 2015. The Carbon Emission Reduction Target (CERT) replaces the Energy Efficiency Commitment in April 2008 and it is estimated that the cost will increase from £18 to £38 for the average customer bill in 2008. The cost of the European Emissions Trading Scheme (EU ETS) is estimated at £31 per customer for 2008 and this is already reflected in the wholesale electricity cost. Network charges to pay for upgrades to invest in Britain's pipes and wires increased on average by around £11.37 for gas and £1.37 for electricity in 2007-08; and in 2008-09 they will rise on average by around £2 in gas and £1 for electricity for a typical domestic customer. Back

307 The figures show the number of meter points that are transferred from one supplier to another. Therefore, customers who switch more than once will be counted more than once in the annual switching figures. Back

308 The Ipsos Mori consumer omnibus survey is available from our website at http://www.ofgem.gov.uk/Sustainability/SocAction/Publications/Documents1/Switching%20Rates%20for%20Vulnerable %20Customers%20Report.pdf Back

309 Datamonitor's report is available from www.datamonitor.com. Back

310 Specifically, it is because gas prices are linked to oil prices through formulae in long term contracts. Back

311 For more information on HHIs see paragraph 28. Back

312 This analysis combines a number of data sources, reflecting Ofgem's best HHI estimate at the time of writing. Examining each source of gas delivery on an individual basis can provide a more rounded picture. Back