Memorandum submitted by RWE npower
BACKGROUND
1. RWE npower, part of the RWE Group, is
one of the UK's largest energy suppliers, with some seven million
electricity and gas customers and a diverse portfolio of some
10 GW of generation capacity in the UK. We also sell our expertise
in power generation in key markets.
2. We welcome the opportunity to contribute
to the BERR Select Committee's inquiry into the UK's energy market.
In our evidence below we concentrate on those areas raised by
the Committee where we feel our comments will be most useful.
WHETHER THE
CURRENT MARKET
STRUCTURE ENCOURAGES
EFFECTIVE COMPETITION
IN THE
RETAIL MARKETS
FOR GAS
AND ELECTRICITY
3. Ofgem stated in January1 that: "Britain's
domestic energy market is highly competitive and remains the most
competitive in Europe. Energy companies continue to compete vigorously
on price, service and the range of products they offer their customers."
We agree with this assessment. The six major companies in the
domestic energy supply market are competing aggressively as reflected
in the changing market shares, the number of customers who choose
to switch supplier, the degree of product innovation, the improvement
in customer service, brand positioning and low margins earned
by retailers. These aspects are discussed further below.
4. In 1996, British Gas had a 100% market
share of residential gas customers as a consequence of its statutory
monopoly in the supply of gas to those customers. That legacy
position has been aggressively unwound through competition from
other suppliers so that in March 2007 it stood at 47%2. Similarly,
the market shares of the 14 regional Public Electricity Suppliers
(PESs), which in 1998 had a 100% market share in the supply of
electricity to residential customers in their regions, have been
aggressively competed away. This significant collapse in the market
shares of the former statutory monopolists is indicative of a
dynamic national market for the retailing of electricity and gas,
and has been defined as such by the Office of Fair Trading3, with
customers free to choose from a number of competing suppliers.
5. The major shifts in market shares we
have observed over the past ten years have been due to the high
level of customer switching that has occurred, and which remains
a feature of the market. As Ofgem has stated4 the level of switching
has increased over time and in October 2007 over 2.8 million households
switched supplier in the first seven months of the year. The European
Commission noted in January 20075 that the UK rates for switching
are among the highest for electricity and exceed all other Member
States for gas. This is facilitated by the range of ways customers
can access products and services, namely: web comparison sites,
company websites, telesales, direct mail and face to face sales
and marketing. A National Consumer Council study6 shows that electricity
and gas have higher switching rates than home insurance, mortgages,
fixed and mobile telephony and current and savings bank accounts.
npower's own aggregate residential customer gains and losses together
over the last three years, ie gross transfers, have amounted to
38%, 44% and 48% of the year-end total number of customers respectively
for 2005-07. In 2007, on the same basis, our customer switching
rates by product type were: Prepayment Meter 81%, Standard Cash
& Cheque 42% and Direct Debit 39%.
6. Product innovation shows a dynamic market
developing to meet customers' needs. As Ofgem commented last July,
there has been an increased take up of dual fuel contracts which
it expects to continue to rise7; around 4.2 million households
are choosing new ways to buy energy ranging from on-line (1.2
million households), fixed and capped rates, green products (nearly
350,000) to low-priced deals for fuel poor customers8. In addition
to providing a range of such innovative products, npower also
has a product which tracks wholesale energy prices and provides
low carbon/energy efficiency products such as microgeneration
along with export tariffs, solar thermal and PV systems and ground
source heat pumps. It also provides associated services of gas
boiler and central heating installation, servicing, repair and
other cover products as well as electrical installation.
7. In this fiercely competitive market,
consumers' expectations of service levels continue to increase
and the industry is having to adapt and evolve to keep ahead of
these expectations. Consumers expect to be able to make contact
outside normal business hours, to be able to handle their accounts
on line and to receive innovation in service (eg graphs on bills
and SMS text for meter reading). The competitive market is further
reflected in the decline of complaints over the last four years
for five of the six largest energy suppliers as Ofgem commented
last year9. Over the period 2004 to 2007 complaints against npower
reported to energywatch have fallen by 9,144 to 3,709.
8. The market participants have taken slightly
different positions on branding and marketing, as would be expected
in a competitive market, with some building more of a national
focus, some more local, some channel specific sub-branding (eg
Atlantic) and some positioning themselves based on, for example,
product innovation and the carbon agenda.
9. Competitive pressures have recently reduced
domestic energy retail margins as E.ON UK10 and Centrica11 have
commented. Since 2002 npower's domestic energy retail margins
have been in single figures and at times negative.
10. In summary, these characteristics confirm
a thriving, dynamic market, with customers free to choose amongst
several retailers all competing aggressively for their business.
WHETHER THERE
IS EFFECTIVE
COMPETITION IN
THE WHOLESALE
MARKETS FOR
GAS AND
ELECTRICITY
11. The GB wholesale electricity market
is widely regarded as being highly competitive. In addition to
BERR12 and Ofgem13, a range of other bodies from the European
Commission14, the Office of Fair Trading15 and the International
Energy Agency16 to Oxera17 have all described the UK wholesale
electricity market as competitive. The DTI's UK Energy Sector
Indicators 200718 illustrates the decline in the HHI for electricity
generation from above 2,000 (which is normally regarded as highly
concentrated) in 1991 to around 1000 (the level below which the
market is conventionally regarded as unconcentrated) in 2006.
We calculate that the HHI for electricity generation in 2007 was
below 1000. This collapse in the level of concentration was due
to new entry in power generation as well as plant divestments
in the late 1990s, both of which have significantly increased
the competitiveness of the sector.
12. Financial performance of generation
plant needs to be assessed over its lifespan of 20 years or more.
The returns need to be such as to provide a basis for future investment.
In fact the returns in the generation market are volatile and
this places a premium on risk management skills. Its difficulties
are highlighted by the financial problems experienced by some
major operators; at the end of 2002 British Energy required support
from the Government and TXU Europe withdrew from the market leading
n 2003 to AES giving Drax up to its creditors—a clear demonstration
of the intensity of competition in the generation market. Profitability
assessment therefore needs to take account of financial performance
over a long period of time.
13. What is important is that the market
provides clear signals for new investment and entry in order to
promote the right level and mix of generation plant to meet the
demands of customers. Hitherto, that has been the case—the
market has delivered the right level of capacity, and delivered
it efficiently.
14. Over the next ten years from 2008 RWE
plans to incur considerable capital expenditure on low-carbon
generation plant in the UK to replace its existing plant. The
generation programme will reduce the amount of CO2 npower emits
(per unit of power generated), compared to 2000 levels, by around
33% by 2015.
15. As a consequence, the npower generation
business is forecast to be substantially cash negative over the
next ten years. RWE's CEO has recently outlined RWE's intent to
invest widely in generation across Europe. As a result our UK
business is effectively in competition for those funds. For example,
the RWE Group has announced its intention to spend €1bn a
year from 2008 on renewable generation and much of this investment
is expected to be made in the UK. It is therefore vital that the
UK generation market remains a stable and credible environment
in which to invest.
THE IMPLICATIONS
OF GROWING
CONSOLIDATION IN
THE ENERGY
MARKET
16. We do not consider that there are significant
barriers to entry to the energy markets. We would suggest that
if there were profitable opportunities, there are a number of
companies that would have the resources to enter the energy retail
supply market such as retailers from other sectors, European energy
companies and energy retailers to non-domestic customers. We note
that there currently are a number of smaller players in the energy
supply markets offering specialised and specific niche products.
17. Ofgem has and is continuing to address some
of the complexities of the energy market such as through its Review
of Energy Supply Licences19 and on the generation side is undertaking
a Review of Industry Code Governance20 to assist distributed energy
providers and micro-generation interests.
THE RELATIONSHIP
BETWEEN THE
WHOLESALE AND
RETAIL MARKETS
FOR ELECTRICITY
AND GAS
18. The link between the wholesale and retail
markets is provided by the trading activity that enables generators
to sell power, and retailers to buy power. This trading creates
contracts between parties that enables them to balance their physical
position in advance of "gate closure", and also enables
them to manage price risk. Whilst most retailers also own generating
plant, the retailers still need to trade, not only with their
own generation business, but also with other generators and traders.
There are a number of reasons for this.
19. First, the wholesale market arrangements
(NETA/BETTA) set up by DTI and Ofgem prohibits the netting off
of generation and retail imbalances forcing both the retail and
generation arms of the same business to trade in the market. Second,
no producer/retailer is in perfect balance either in terms of
the total amount of electricity produced and demanded, or the
time profile of that production and demand over the course of
the day, and therefore needs to buy from the market when it is
short and to sell when it is long.
20. npower operates its generation and supply
businesses independently, each transacting all its volumes through
RWE Supply & Trading (RWEST). Generation volumes are sold
in a manner determined by the RWE Group's hedge policy. This hedge
policy is subject to liquidity available in the wholesale power,
fuel and carbon markets. Encouragement of liquidity is therefore
a key focus of the RWE Group, and much of the RWEST business is
focussed at encouraging liquidity in the markets in which we operate
(as reflected by the Market Design Project sponsored by the Futures
and Options Association).
21. npower's retail business has a separate
hedge policy determined by its management team. npower retail's
hedging model applies its hedging policy and npower retail operates
within strict position limits. This ensures that npower retail
has little room to speculate on commodity prices, but is incentivised
to concentrate on cost, service, pricing and brand as its value
drivers.
22. RWEST is a separate company from RWE
npower and operates in the energy wholesale markets as the RWE
Group's sole face to the wholesale markets. All transactions with
both the generation and retail business units of npower are made
at arms length and are subject to stringent and routine "fair
value" testing by an independent team within the RWE Group.
During 2006 and 2007 of about 140 TWh transacted by RWE npower
through RWEST only around 11% were netted trades. Netted trades
occur when one npower business unit effects trades "simultaneously"
with another, where "simultaneously" roughly approximates
to the same day.
23. It is clear from the discussion above
that retail prices are fundamentally driven by wholesale prices,
which for electricity are in turn fundamentally driven by the
prices of gas and other fuels. npower's domestic electricity and
gas price increases in early 2008 were necessitated by the rising
forward electricity and gas wholesale commodity costs for 2008
which increased by 66% and 60% respectively since mid-February
2007 as well as increases in network charges, social obligations
and environmental costs, the last of which will inevitably continue
to rise.
24. Our customers, however, have been protected
from the full impact of wholesale prices increases over recent
years as a result of our effective hedging policy. A view of the
movement in costs (on a rolling forward 12 month wholesale commodity
costs basis for electricity and gas, plus transport, EEC and metering
costs) and of npower's Dual Fuel Quarterly Cash and Cheque annual
bill size from 2004 to 2008 shows that the difference in prices
and costs is now less than in 2004 and that the retail price changes
significantly lag changes in costs (mainly increases) (see Appendix
A).
25. Whilst all companies are subject to
similar increases in energy commodity costs as well as network
charges and the Energy Efficiency Commitment/Carbon Emissions
Reduction Target (EEC/CERT) at the same time, there is in fact
a significant variation in the timing of price movements for domestic
customers. This variation in the timing and scale of price changes
may be due to differences between suppliers in hedging or business
strategies.
THE INTERACTION
BETWEEN THE
UK AND EUROPEAN
ENERGY MARKETS
26. The UK has moved from being an exporter
to an importer of gas. Consequently, and as a result of improved
infrastructure links to European and world markets, it has become
more exposed to international prices. Continental gas prices have
been pushed up by the rise in oil prices as most are indexed to
oil and LNG prices have increased as a result of demand from Asia
notably Japan. With regard to Europe, RWE supports measures that
strengthen competition in the EU (and contribute to an economically
and ecologically sensible climate protection strategy).
27. We note that, as Ofgem showed in January21,
Britain's domestic electricity bills are competitive with most
other EU countries being on a par with the EU average and that
its domestic gas bills are amongst the cheapest in Europe being
considerably below the EU average.
THE EFFECTIVENESS
OF REGULATORY
OVERSIGHT OF
THE ENERGY
MARKET
28. Ofgem has clearly successfully created
competitive generation and retail energy supply markets. Ofgem
has continually monitored the development of the wholesale and
retail energy supply markets to make sure that competition remains
effective and periodically publishes information, for example
through at least annual Domestic Retail Market Reports. In addition,
Ofgem has successfully embarked on delivering on its "better
regulation" duty as illustrated by the recent Supply Licence
Review, where it sought to protect the interests of consumers
with an appropriate balance of sectoral regulation and a blend
of self-governance, competition and consumer law.
29. Historically, Ofgem has focussed on
promoting effective markets and cost reflectivity in charges.
However, this approach is coming under increasing pressure as
Ofgem appears to become a vehicle for the pursuit of social and
environmental goals rather than as a pure economic regulator.
Experience shows that there are increasing tensions between the
objectives set for Ofgem as illustrated by the following example.
30. Ofgem's Proposed Corporate Strategy
and Plan for 2008-1322 suggests that the retail energy market
may become increasingly like a normal service industry market.
In practice, recent developments show the reverse is the case.
These include:
— Ofgem's two CSR reports in 2007.23
— Ofgem's debt and disconnection "best
practice" report in January 2008.24
— The doubling of CERT from April 2008
compared to EEC2.26
31. All the evidence that has been adduced
by a large number of studies indicates that the market does work
well. If there are policy objectives which will not naturally
be delivered by the market, it would be better to be clear about
what those are and to seek to identify appropriate interventions
which introduce the least distortions. This would improve regulatory
certainty, both for Ofgem as to its role, and for market participants.
32. Ofgem has also explained in its Proposed
Corporate Strategy and Plan 2008-1327 that: "investors will
require a stable political and regulatory environment before making
investment in new generation capacity". However, it is difficult
to see how this reconciles with its recent proposals for a windfall
tax on energy companies28, particularly at a time when additional
generation investment of some 20—25GW is required by 2020,
in order to replace capacity that will have to be taken out of
service.
PROGRESS IN
REDUCING FUEL
POVERTY AND
THE APPROPRIATE
POLICY INSTRUMENTS
FOR DOING
SO
33. npower's mandatory expenditure on fuel
poverty through energy efficiency programmes is increasing markedly.
The Government recognises the benefit of the Energy Efficiency
Commitment/Carbon Emission Reduction Target (EEC/CERT) for priority
group customers (those in receipt of income/disability based benefits,
tax/pension credit or those aged 70 or over), announcing the combination
of its expenditure on Warm Front and increasing expenditure on
CERT as together increasing the spending on fuel poverty, but
energy suppliers receive little credit. Of its expenditure on
energy efficiency under EEC1 (April 2002-March 2005) £48m
and EEC2 (April 2005-March 2008) £147.7m, 50% of the savings
were targeted at priority group customers. Expenditure under CERT
(April 2008-March 2011) group customers is estimated at around
£400m of which 40% of the energy savings will be targeted
at the priority group. In all cases, the proportion of expenditure
on the priority group exceeds 50% of the total because of the
increasing difficulty of identifying and implementing measures
for this group of customers.
34. In addition, npower already has an extensive
range of measures available to support vulnerable customers which
include:
(a) npower's Health Through Warmth Scheme
(HTW) which benefits the vulnerable (not necessarily npower customers)
by using its working in partnership with local authorities and
the health sector to identify people living in cold or damp conditions
whose health is adversely affected by these conditions and facilitating
access to statutory national grant schemes and local funds. If
clients are not eligible for statutory or charitable funding,
HTW offers a crisis fund and facilitates installation of energy
efficiency measures. It has had 36,000 referrals that delivered
practical help to the value of £30m and the HTW crisis fund
has contributed £3m. npower has agreed a further commitment
of £4.5m to HTW.
(b) The First Steps Programme targeted at
those most in need. This includes social tariffs, debt relief,
one to one account management, energy advice & measures and
benefit entitlement checks
(c) First Steps is just part of our Spreading
Warmth Programme which offers assistance to a wider group of vulnerable
npower customers through products and services such as large print
bills, free gas safety checks, energy measurement devices and
energy efficiency advice. Specific elements include: the Warm
Response Helpline, an energy efficiency helpline and a network
of in-home advisors.
(d) A detailed 14 point programme to ensure
that we would never knowingly disconnect the electricity or gas
supply of a vulnerable customer.
(e) Working with other major energy suppliers,
EAGA and BERR to inform 250,000 people in GB who are eligible
for pension credit by letter of free insulation, central heating
grants and other services.
(f) A commitment to fund the Home Heat Helpline:
an impartial, single-point of advice for vulnerable customers
set up by the ERA in conjunction with energy suppliers.
(g) In relation to npower's January price
increase we provided additional protection for the vulnerable
by:
(i) Not increasing prices for thousands of
customers on our first step tariff
(ii) Committing to rebates of up to £100
for 50,000 of npower's most vulnerable customers
(iii) Mitigation of the cost increase for
pre-payment customers by halving the average electricity differential
and reducing the differential for gas
(iv) A delayed price increase for many token
pre-payment customers.
35. As a result of the announcement in the
Budget, we are presently in discussions with government on a possible
way forward. We hope that this might lead to a long-term sustainable
approach to tackling poverty. We would like to see all parts of
government as well as other relevant industries working collectively
on this important issue.
36. Other measures that could alleviate
fuel poverty include:
— More help through data sharing with
suppliers required to enable them to identify and so more effectively
target vulnerable customers.
— Increased use of Fuel Direct by extending
its availability to those on benefits and not just those in debt.
This would help us offer more attractive tariffs.
— A universal roll-out of Smart Metering.
NOTES
1. Ofgem (14 January 2008) Proposed Strategy
and Plan 2008-13, para 1.6
2. Ofgem (4 July 2007) Domestic Retail Market
Report June 2007, p 22
3. Office of Fair Trading (11 March 2006) Anticipated
acquisition by Npower Ltd of the electricity and gas business
of Telecom Plus plc, p 2.
4. Ofgem (17 October 2007) Press Release OVER
2.8 MILLION HOUSEHOLDS SWITCH SUPPLIER.
5. European Commission (January 2007), UNITED
KINGDOM—Internal Market Factsheet, p 1.
6. National Consumer Council (November 2005),
switched on to switching? A survey of consumer attitudes and behaviour,
2000-2005, p 3.
7. Ofgem (4 July 2007) Domestic Retail Market
Report June 2007, p 4.
8. Ofgem (4 July 2007) Factsheet 69 Britain's
competitive energy market, p 2.
9. Ofgem (4 July 2007) Factsheet 69 Britain's
competitive energy market, p 2.
10. FT.com (6 March 2008) Eon chief hits out
at "myths" on profits www.ft.com/cms/s/0/d24843e4-ebb6-11dc-9493-0000779fd2ac.html
11. Centrica (14 December 2007) Full Year 2007
Trading Update.
12. BERR website www.berr.gov.uk/energy/markets/competitiveness/page28432.html
13. Ofgem website www.ofgem.gov.uk/Markets/WhlMkts/Pages/WhMrkts.aspx
14. DG Energy and Transport's Country by Country
Review for Great Britain, issued as part of the 10 January 2007
Energy Package, comments: "for electricity, there would appear
to be a sufficient range of companies to suggest that the market
is both competitive as well as being open to new entrants".
15. Office of Fair Trading (20 February 2006)
Completed Acquisition of Great Yarmouth Power Limited by RWE Npower
plc.
16. International Energy Agency (2007) Energy
Policies of IEA Countries The United Kingdom 2006 Review states
(p 117): "Overall the UK electricity market appears to be
competitive and there are numerous market players ready to respond
by investing in new generating capacity according to the needs
of the market—eg in mid-2006 two CCGTs, Langage (885 MW)
and Marchwood (859 MW), were constructed".
17. Oxera (October 2007) Energy market competition
in the EU and G7: preliminary 2006 rankings (prepared for BERR)
places the UK first with a score of 8.3 for the electricity market
with the UK electricity wholesale market among the leading markets.
18. DTI (26 July 2007) UK Energy Sector Indicators
2007 Background Indicators Annex p 67.
19. Ofgem (1 June 2007) Supply Licence Review—Final
Proposals (128/07).
20. Ofgem (28 November 2007) Open letter announcing
review of industry code governance (284/07).
21. Ofgem (15 January 2007) Factsheet 66 Updated
Household energy bills explained, p 3.
22. Ofgem (14 January 2008) Proposed Strategy
and Plan 2008-13, para 1.17.
23. Ofgem (8 October 2007) Review of suppliers
voluntary initiatives update (235/07) and (6 October 2007) Review
of suppliers voluntary initiatives to help vulnerable customers
(203/07).
24. Ofgem (25 January 2008) Debt and Disconnection
Best Practice Review (07/08).
25. HM Treasury (12 March 2008) Budget 2008 Economic
Fiscal and Strategy Report p 66.
26. Defra (June 2007) UK Energy Efficiency Action
Plan 2007 Table 3 Energy Savings associated with UK energy efficiency
policies and measures, p 14.
27. Ofgem (14 January 2008) Proposed Strategy
and Plan 2008-13, para 3.6.
28. Ofgem (16 January 2008) Press Release MARKET
IS SOUND—OFGEM ASSURES CHANCELLOR.
APPENDIX A
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