Examination of Witnesses (Questions 500-519)
PROFESSOR JOHN
CHESSHIRE AND
MR JOHN
CLOUGH
5 JUNE 2008
Q500 Mr Wright: Surely the most cost-effective
way, as you have said, is the benefit checks which flag up £28
a week extra income on average which in itself will draw people
out of the fuel poverty area. The Warm Front scheme quite clearly
reduces the need for energy and conserves the energy and the carbon
neutral as well in many respects. Ultimately is the only way out
of this problem that we have with high energy prices by increasing
the incomes of the individuals, or is this something that we can
do extra?
Professor Chesshire: Incomes is
clearly an important way to go. Whether we can increase incomes
at the rate prices have increased is another matter and with an
economy which OECD projects will grow at 1.7% for the next two
years, by and large it will be very difficult to increase incomes
more than that across the economy and prices are going up, as
we know, between 35-40%. Even incomes have a limit when prices
change at that rate. The only sustainable way is to make our dreadful
housing stock more energy efficient. If one does take the view
that energy prices will rise in real terms, then by definition
they will probably also rise faster than incomes. That again caps
the extent to which you can rely on increases in incomes. The
last thing I would say is that I think looking forward, both for
carbon reasons and for fuel poverty reasons, we have to change
the nature of competition in the energy market and that competition
has been based to date on competition on the price of a kilowatt
unit of energy, whereas the problem facing the fuel poor is the
size of their energy bill. What we have to do is to aim to minimise
the size of the bill and not get quite so exercised about the
size of the unit price. Again, it takes us to energy efficiency
measures, capital programmes and so on.
Q501 Mr Weir: Do you think the energy
companies are making enough progress in reaching the fuel poor
through social tariffs?
Professor Chesshire: No, I do
not, but if I may speak personally because there is a difference
of view amongst our members at FPAG, I really question the weight
government is placing, and possibly Parliament, on the role of
competitive companies to tackle the social problem. Government
has a statutory objective set by Parliament to eradicate fuel
poverty by 2010 for the vulnerable and by 2016 for everybody else.
It is now setting up much vaunted targets to tackle climate change.
When the going gets tough, the tough get going I suppose, and
one looks for a wider range of players to be blamed and hence
this increased focus on the energy companies. I think the energy
companies can do more—we have had examples of that this
afternoon—but they are never going to be the lead players
in tackling UK fuel poverty, let's face it. At best what they
do is tokenistic. What worries me is, with the Ofgem summit and
other initiatives taken recently, our eye goes off the ball onto
the sticking plaster and not onto the gaping wound. That is the
perspective I would come to it as someone advising a group such
as this. Do not get carried away with the marginal increase in
money here on a social programme by an energy company when the
resource requirements are just so much bigger than that, probably
in order of magnitude bigger than that.
Q502 Mr Weir: But they are part of
the solution to tackling fuel poverty from what you have said
yourself. Is part of the problem, and specifically we appreciate
there is a wider context regarding social tariffs, in the way
that they vary so much from company to company?
Professor Chesshire: They do vary
because different companies have a different definition of corporate
social responsibilities (CSR). Some sponsor sport, some sponsor
NEA conferences or whatever it is and they have that difference
of objectives, so I am not surprised that there would be a difference
of approach to the specific issue of fuel poverty as well. As
we have heard, some have claimed to have lower tariff levels than
others and so on and it would not be surprising if those which
have a larger amount of profits to play with might appear more
generous with their social tariff initiative, whereas one might
properly ask them why is the tariff so much higher in the first
place? There is a fog of war out there on the battlefield but
my point is this: can it be more than a sticking plaster? Can
we really expect profit-making companies to address the social
ills such as fuel poverty? Yes, we can, because of corporate social
responsibility—some would be very good at doing it—and
we can also ask them to experiment. I think if we did get six
companies doing more work in this area we might get more knowledge
of best practice. What is the best way of reaching the really
hard to reach customers, for example? Which marketing campaigns
have worked more successfully? Those kinds of issues—engagement
of trusted social partners on the ground, for example, the churches,
the faith and community groups and so on, all those kinds of groups
we could learn a lot from a higher level of social activity by
the companies. I am saying do not rely on this to resolve the
problems that confront Parliament and the Government.
Q503 Mr Weir: I do not think anybody
is relying on it as solving the problem. What we are trying to
get at is, first of all, the Government argue that by not mandating
specific social tariffs it allows the companies to innovate. That
seems to me to be what you are saying as well. Do you accept that
or do you think the Government should have a mandatory clear social
tariff that applies equally to all the companies operating in
the market?
Professor Chesshire: I think FPAG's
judgment will be we want a mandatory minimum floor if we are to
go that way, but not a cap.
Q504 Mr Weir: The other side of the
argument is if we put a mandatory tariff in, the minimum becomes
a maximum because companies will only do what they have to do.
Do you accept that?
Professor Chesshire: In the dynamics
of competition that is the case. In our earlier debate we did
not touch on the dynamics of competition. The issue is that those
customers who are most mobile, most socially adept, most technologically
fluent in the internet and telephoning call centres are the most
mobile and you are left with a rump who are less able to move,
less socially confident, less in possession of the information
and that will be exploited.
Q505 Mr Weir: There is no competition
for these customers.
Professor Chesshire: When I was
advising your predecessor, Chairman, one anticipated this very
point that the mobile part of the customer base would become mobile
and the margins for them would be competed away. When I first
switched I saved £142 as a direct debit customer to direct
debit. We are now talking about £30. There is no competition
in the pre-payment end of the market.
Q506 Mr Weir: To get a meaningful
social tariff, accepting all that you say about it, it does not
tackle the whole problem. There is going to have to be action
by the Government to set a mandatory minimum. Would you accept
that?
Professor Chesshire: I think it
needs to be examined. We have not formally at FPAG taken the view
that that is the way to go because we want to see what the offer
is. We want to see some evidence, but it may well be that if capital
programmes cannot increase and for the reasons I have given incomes
cannot increase at the rate that price increases in this area,
then we might need to consider this. The problem is some groups—this
is my own personal view—will want the net spread as wide
as possible. If you have say eight million households receiving
a social tariff being supported in total by 25 million customers,
there is an awful lot of cross-subsidy. The nearly fuel poor suddenly
find themselves subsidising the fuel poor and become fuel poor
as a result. This is why FPAG as yet has not taken a decision
yes, that is what we want. We want to see what the offers are.
Clearly the wider the number of social groups entitled to this
tariff, the bigger the challenge is in its sustainability over
time, but it is an option which we need to bring onto the table.
Q507 Mr Weir: Taking it slightly
wider, I did raise earlier with the other witnesses those who
are off grid and not on the gas supply, for example, have you
thought of any way in which they could be helped with the rising
prices of fuel oil or bottled gas and suchlike which are not covered
apparently by Ofgem's recent fuel summit or any other regulation?
Professor Chesshire: I think all
of us have paid insufficient attention to the non-reticulated
customers—not the wires, not the pipes in other words. The
amount of research time focused on households using coal, oil
or LPG has really been quite small. There was a Competition Commission
inquiry some two years ago about LPG and so on and who pays for
the tanks and whether customers are locked in, but by and large
outside Northern Ireland, I think, the amount of policy attention
focused on customers using coal or oil has been quite small. Those
numbers are quite small and, as Mick Clapham will tell you, Chairman,
a number of those are still in receipt of concessionary coal and
so on.
Q508 Mr Weir: It is estimated at
one and a half million households.
Professor Chesshire: There is
a problem there because as you are moving solid or liquid fuels
into rural areas the transportation costs are very high as well
because the amount you are dropping off at each point is comparatively
small compared with a dense urban area. Even if one moves to renewable
sources of supply like biomass, unless one can get clusters, rural
areas are always going to be disadvantaged because you are moving
a low density fuel around quite large distances using oil as the
fuel to transport it by and large, so that is a problem. I think
programmes such as Warm Front over time, and certainly CERT over
time, need to look at a range of renewable micro-generation technologies,
for example, both at individual household level and, where applicable,
because of scale at an integrated level, maybe a local dairy and
a farm with a school and houses and so on. Not much field trial
data exists on those—it is being accumulated—but we
have not spent enough money in my view on soundly-based field
trial data to inform public policy and scheme design, but that
will be a feature I have no doubt of policy programmes in the
next five years or so.
Q509 Mr Weir: There is nothing that
gives any immediate solution.
Professor Chesshire: There is
no silver bullet I regret to say.
Q510 Chairman: You have heard what
I said in response to the last session to the lack of joined up
energy regulation. From the Office of Fair Trading letter it is
quite clear that they can only do this by launching a full scale
inquiry and they say that they must prioritise their work given
its limited resources. There is no-one going oversight here in
the way there is with gas and electricity.
Professor Chesshire: If I could
challenge you, Chairman, there is no ongoing oversight in respect
of the gas market. The reason you are having your inquiry and
the reason why so many of us are getting rather vexatious is that
those who believe in the much vaunted market do not want to evaluate
its successes or its failures. FPAG has always argued, and it
should be evidence-based—I think Sir John Mogg takes the
same view—let's do this, but let's do it regularly, annually
and report frankly and let's have it peer-reviewed as well, I
would suggest, not just done by the agency responsible for the
regulation. That is a personal view but peer review is quite important.
Q511 Chairman: Our next witnesses
are Ofgem so I am sure these issues will be put to them. I would
like to engage in the philosophical discussion about why—I
am intrigued by this debate about social tariffs—it is right
for energy companies to offer cheaper prices to some of their
customers but not for food supply companies like Tesco's or Sainsbury's.
We will not go into that debate now.
Professor Chesshire: That is my
next session tomorrow, Chairman!
Q512 Chairman: Let's look at the
differential between different forms of payment. Why is the average
differential between direct debit customers and prepayment and
standard credit customers so large? Why do they increase these
differentials?
Professor Chesshire: I do not
think we wholly answered the question, Chairman, going back to
your colleague. I think lack of competition in some parts of the
market—competition for mobile customers on direct debit
was intense early on. They were seen to be lucrative customers,
they were seen to be trouble-free customers, they paid up on time
and did not cause debt or disconnection problems and they were
seen as the obvious target market for suppliers operating outside
their historic catchment geographical area. No one found competition
for the fuel poor or those on prepayment meters, which are not
quite the same, as attractive; in fact, obstacles were often put
in their place where they had accumulated debt to prevent them
switching suppliers and so differentials widened for that reason—market
dynamics. Why they have widened in the last year or two defeats
us, Chairman. We have drawn attention in the FPAG annual report
now for the last three years to the evidence of this widening
differential which cannot be explained by novelty of a newly liberalised
market. We have had the liberalised market going for a long time
now, so opportunistic companies did take, in my judgment, opportunity
to raise margins where they could in the least competitive part
of their business. We have argued, and Ofgem knows this, that
Ofgem is the only body really fully qualified with access to all
the information up and down the energy supply chain to take a
look at this. We have said that two or three years running.
Q513 Chairman: You have partially
answered all the other questions I wanted to ask you in that helpful
answer. If prepayment meter customers who are not identical with
fuel poor customers—many fuel poor customers are standard
credit—but if they are being ripped off by the energy companies
with making more money out of prepayment meter customers, then
there should be enhanced competition for them logically. If they
are paying they should be attractive customers.
Professor Chesshire: I am an economist
and at some point you must be right. The margins get sufficiently
fat, as it were, for some innovator to come in and say we will
specialise in that part of the market, what others might have
regarded as the awkward corner of the market. If that does not
happen then there is yet another solution of course which is technological
change and we will I hope before too long see the roll out of
smart meters and this will squeeze those price differentials.
That will take a somewhat longer time.
Q514 Chairman: We have had this discussion
before in this Committee and smart metering is often raised as
a solution to carbon dioxide emissions. My own personal view is
that it is much more likely to help competition in the energy
market by highlighting prices and encourage switching.
Professor Chesshire: Yes.
Q515 Chairman: As a direct debit
customer myself who feels his energy supplier always overestimates
what I owe the company and therefore I think is taking too much
money off of me too regularly, is there any prospect that direct
debit customers are being ripped off by excessive upfront charges?
Professor Chesshire: This is a
periodic one, Chairman, and that is the amount of idle balances
carried forward each quarter by the energy companies. Certainly
at a time when energy prices were falling that was a problem and
people were accumulating large amounts. I think some quarters
I had over £100 sitting there idly during the summer months
which the companies explained in their covering letter would be
used to pay off my higher consumption in the winter and by and
large that is true. In a rising energy price market of course
that is much less likely to be true. In fact, I would think, and
we do not have an FPAG position, the majority of customers were
rather glad to find that they did have a bit of a carry forward
to soften the blow when it came. Ofgem needs to take a look at
that but I think it is not quite the issue it was because we are
on a rising price curve, not on a falling price curve.
Q516 Mr Weir: The amount taken by
direct debit is rising every time prices go up.
Professor Chesshire: That is true.
Chairman: Speaking from my personal experience,
I did have large carry-overs when prices were falling and I think
on the whole I am doing rather well now when prices are rising.
Q517 Mr Bailey: Energy companies'
profits—I gather from your submission that you broadly agree
with the figures given by the NRFC in terms of companies' profitability?
Professor Chesshire: Yes. We do
not have a big research budget. We do rely on the resources of
officials in BERR and Defra and sometimes from Ofgem. Where we
placed our own weight in the last two or three years is looking
at the resources required for fuel poverty so we have not tracked
this area so our submission relies fairly heavily on the work
of others, particularly the National Right to Fuel Campaign.
Q518 Mr Bailey: Why do you think
energy companies have sought to increase their profit margins
and, secondly, who do you think has been the biggest beneficiaries
of these increased profit margins?
Professor Chesshire: We argue
in our memorandum that the difficulty is arguing what is a reasonable
level of profit in this rather complex energy supply chain. Undoubtedly
there was a time probably five years ago, maybe a little longer,
when margins were being squeezed quite severely and there was
concern about a mounting backlog of power station replacement
building up over time. If this was likely to be low carbon technology
it was possibly at a higher capital cost than combined cycle gas
turbines, for example, so there was some public policy concern
of the profit margins being made by the industries. I do not want
to sound an apologist for them, but clearly they were being squeezed
very hard at that time. I think most reasonable analysts would
have expected some return to normal profits. The difficulty is
defining what that normal profit might be. Clearly the pendulum
has gone the other way for various reasons and they are now making
very significant profits in view of the National Right to Fuel
Campaign and the data we present here, profits which are very
high indeed, probably not sustainable again in the long term but
they will be nibbled away by pressures. You ask who is benefiting
from this and I am scrambling around in the notes I have here
to identify who that is and let me try and be as specific as I
can in response to your question. Our judgment is that the bulk
will be electricity generators; that would include the independents
but certainly the `Big 6' integrated generators are likely to
be the beneficiaries. The difficulty there is they can pass costs
and profits up and down the supply chain and they can gain from
some transfer pricing. The other beneficiaries in that process
will clearly be the traders, the transporters, the shippers, the
movers of electrons and gas, and also the storage and distribution
networks. Some will have gone upstream to the gas producers themselves
who are also the integrated oil companies in some cases. I think
there has been quite a lot of crumbs on the table for quite a
lot of players is the answer to your question, Mr Bailey.
Mr Bailey: Earlier you seemed slightly
unenthusiastic about the role of the industry in alleviating fuel
poverty, which seemed slightly at odds from the general thrust.
Chairman: Through social tariffs.
Q519 Mr Bailey: Yes. Do you think
that the independent generator as in the gas companies should
be included in any scheme to contribute to alleviating fuel poverty?
Professor Chesshire: We do not
formally have a view at FPAG on that point. If Ofgem is looking
at this market and if the Committee is looking at the market it
is something worth looking into. Clearly there are huge transactional
costs. There are a lot of players involved who are not familiar
with the fuel poverty type of issues, a lot of transformation
of information to lots of different places. My judgment is that
the share of the market you are going to be capturing, the incremental
share of the market is really quite small and I am not briefed
on that. If it was an awful lot of effort for 5% more of the market
is it worth the candle? I would not want to rule it out if we
are going to have a root and branch review, let's have a root
and branch review, but do not be carried away that there are lots
of riches somewhere out there which are not being captured by
the `Big 6' integrated energy suppliers in the domestic sector.
We are talking about the domestic sector in FPAG.
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