Examination of Witnesses (Questions 720-739)
MR KEITH
MUNDAY, MR
PETER BENNELL
AND MR
GRAHAM PAUL
24 JUNE 2008
Q720 Chairman: Not necessarily from
the `Big 6' of course. The `Big 6' hint at the need to increase
liquidity in the wholesale liquidity market, to be fair, but Centrica
say, "What is the problem? There is 40% generated by independents
with no supply base and no contracts so what is the issue?"
What is the issue if 40% is independently generated by British
Energy—and we could discuss who might own British Energy
in the future—by Drax, by others?
Mr Bennell: Drax, for example,
will only sell to a rated counter party. That is a counter party
with an investment grade credit rating. We are miles off that.
Welsh Power Group are miles off that.
Q721 Chairman: So that is a commercial
decision by Drax?
Mr Bennell: It is a commercial
decision, yes, and it follows waves of problems in the early part
of the 2000s where lots of people went out of business, I guess.
The fact of the matter is that it is very, very difficult to find
people that are prepared to trade with you and to supply you and,
when you do, it is very difficult to find any sort of liquidity
in the things that you are trying to buy. As far as price reference
is concerned, it can go on a transaction that happened yesterday
or possibly even the day before. It might be a very different
transaction, it might be much smaller, or it might be much bigger.
Mr Paul: I feel quite confused
by that statement that has been read out because the preliminary
results in 2007 presented by Centrica gave four key objectives
that they had as a business and the third one was to reduce risk
through increased integration, so perhaps you may want to—
Q722 Chairman: They do actually refer
to integration and Mr Oaten is going to ask about integration
next because there is a very interesting quote from Centrica on
vertical integration.
Mr Munday: There is an aspect
of liquidity that is worth touching on and that is the granularity
of trade. Peter touched on it with respect to Drax. The wholesale
market tends to trade in quite large chunks of power. Small suppliers
find that these chunks of power are actually far too big for them
to handle and what we want to trade in is one or two megawatts
of power rather than what happens where Drax probably wants to
sell 20 or 20 megawatts at a time because that is efficient. They
have got 4,000 megawatts to sell in total so why are they going
to mess around with people like us who just want to buy the odd
one or two megawatts? It is not necessarily an efficient transaction
for them to trade with us. There is a big issue here not just
about the product but about the granularity of the product and
the timeliness of when it is available. As a supplier what we
need is to be able to sell to a customer and buy from the market
or buy from the market and sell to a customer. It is a hand-to-mouth
existence. A generator, on the other hand, will decide periodically,
"I want to go to market and sell a load of power". That
will be an independent generator. The difference for me with the
`Big 6' is that every day they are selling and competing against
us with the same customers, so they are actually transferring
power internally within their businesses through some mechanism
to actually feed it. For me all we want to do is to be able to
access the power on non-discriminatory terms so that we can compete
with them in terms of cost to serve, innovation, and the things
that we are good at; retailing.
Q723 Mr Weir: How are you going to
do that? In theory it sounds fine but how are you going to do
that. You are talking about Drax selling large amounts and presumably
that is where the broker comes in and they will buy the large
amounts and split it up into smaller amounts. Is that how it works?
I am struggling to understand how you work this market and how
you are suggesting you get this energy from the `Big 6' in the
way you suggest.
Mr Bennell: We would like to see
some fundamental changes in the market. A requirement to sell
your output into the market would be very helpful.
Chairman: We are going to get to Mark's
question so I had better bring Mark in because you are itching
to talk about vertical integration. Before I come to that, can
I just ask you a question which is that some of the `Big 6' have
said to me, "These guys are just whingers, they could invest
in their own generating capacity". In fact, Welsh Power is
doing that so why do you not just build a few biomass plants and
a few CHP plants and get on with it?
Q724 Mr Hoyle: A couple of nuclear
plants!
Mr Munday: There is one in my
back pocket.
Q725 Chairman: There is a serious
point here. One of you does but the other two do not.
Mr Munday: When the market was
originally designed, it promised a level playing field in generation
and supply. It also promised that you would not have to enter
both markets. If you think of the characteristics of entering
both markets, they are indeed quite different. For a retailer
you need to be good on customer service, computing systems, all
that sort of thing. To be a generator you have got to be good
at heavy engineering and you need big finance. You can start a
supplier with a relatively small amount of money, £1 or £2
million something like that gets you up and running as a supplier.
For a generator if you want to build a nuclear plant you can all
see the price, it is a completely different type of operation.
Under the original market design (which we are still working to
because nobody has refuted it) it promised separation of this
because that was thought to be to the best value of the consumer.
Mr Paul: This is a very important
question. The wish is to have a competitive market but with the
structure of the market the way it is at the moment, to enter
it you have got to not only build a generation business you have
also got to build a retail business. Is that what we mean by a
competitive market? Or do we mean something similar to the telecoms
market as we have seen with British Telecom where you can have
retailers entering the business without having to lay new wiring.
Chairman: In other words, you do want
to become vertically integrated. We cannot hold you back any longer;
vertical integration, Mark Oaten.
Q726 Mr Oaten: Obviously there are
a number of barriers that you have outlined in terms of being
able to compete and to buy from the `Big 6' and to get into the
market and one of the key ones that comes across time and time
again is the so-called transparency issue and not actually understanding
the breakdown of what is going on. One of the difficulties is
with the `Big 6' having these integrated European accounts. You
cannot, as I understand it, break down where they are making profit
in relation to generation and where they are making profit in
relation to supply. I still do not get this, I do not get why
that transparency is going to help you guys. What is it you are
after and how is it going to help if that was split out and you
could see exactly what was going on?
Mr Munday: Transparency itself
is only part of the solution. What we are interested in is getting
good value to the consumers. In order to do that, we are sitting
here today feeling that there is cross-subsidy going on between
generation and supply. We do not have the tools to prove that.
We cannot indicate that that is going on because there is no information
available in the public domain to support that. For me the first
step on understanding what is going on in the market is to get
some transparency. If there is cross-subsidy going on then there
is European legislation that prohibits cross-subsidy between generation
and supply. Presumably the regulator or the Government will actually
enforce that legislation and level the playing field so that we
can contest the market.
Q727 Mr Oaten: Pause there for a
moment. What gives you the sense and suspicion that there could
be cross-subsidy taking place then?
Mr Munday: It is our daily lives.
We are losing customers left, right and centre to the `Big 6'
at prices which are demonstrably below the current wholesale market
prices. This causes us a great deal of concern but coupled to
that there is a number of events which give us even greater anxiety.
Earlier this year Centrica announced profits of £545 million
in their supply business. That is absolutely fine although it
caused a bit of a furore. A few weeks later Paul Golby of E.ON
stood up and said, "I am losing money in supply and I expect
to lose money for the next 12 months". So at the same time
as he is losing money in supply he is taking customers off of
us, some of whom we have had for years, at below wholesale market
prices. That just leaves a very, very nasty taste in my mouth.
If you go to the latest news, we strongly believe E.ON now are
growing their business very aggressively. They have put on many
hundreds of thousands of customers (some of them ours) in the
last few months and again we are sensing, because of the feedback
we get from brokers every day, that these are prices which are
below the current wholesale market price. Tie this in with an
admission that he is losing money; what conclusion does it lead
you to?
Q728 Mr Oaten: Do you think this
is all of the `Big 6' who are doing this? Do you think to some
extent there is an agreement and understanding between the `Big
6' that this can take place?
Mr Munday: I do not think I have
got any evidence to say that there is any degree of collusion
going on between the `Big 6'. At the moment it happens to be E.ON
who are doing it. Next month it could be any of the other `Big
6'. It is not always the same person. It depends on whether they
want to grow their market share and what they want to do. They
all go through periods where the transactions that we see and
we face appear to be demonstrably below the wholesale market.
Q729 Mr Oaten: So the cross-subsidy
is not taking place on a steady level, it peaks and troughs where
there is a need and a demand and the `Big 6' move around?
Mr Munday: They do move around.
The E.ON one has been particularly sustained for about two years/two
and a half years.
Q730 Mr Oaten: So transparency would
help expose that and then regulation would come in, in your judgment?
Mr Munday: Yes.
Q731 Mr Oaten: How would you like
to see that happen? What are you proposing?
Mr Munday: What I would like to
see is clear accounting separation of generation and supply and
the enforcement of the non-cross-subsidy regulations on those.
I would also like to see that the accounts of these businesses
are predicated against open and transparent transactions through
the market so that we have got something substantive to underpin
the accounts. Unless you have an open market to underpin the accounts,
you could make up any prices you want to put in them, so you need
the market to make it work.
Q732 Mr Oaten: So just in summary,
in part, you see two advantages to this: the first is that it
would expose any potential illegal behaviour; the second, picking
up a point that Graham Paul made earlier on, it would help you
understand when you are trying to enter the market at what price
and where it is happening
Mr Paul: What is the true cost
of wholesale electricity is a fundamental requirement for us when
we are trying to negotiate a contract.
Mr Munday: It would also mean
that when we are buying in the market to sell to customers we
are buying at the same price as the other players and we can actually
compete on the things that we are good at which is the innovation,
cost to serve and consumer services.
Q733 Mr Oaten: I have got one final
question. The brokers are giving you this anecdotal evidence that
this is taking place?
Mr Munday: Brokers and some direct.
Q734 Mr Oaten: There are never any
audit trails, never anything that is written down, never any proof
that this is happening? There is nothing where tangibly you can
say to this Committee, "Here is the evidence"?
Mr Munday: We are in the process
of collating the evidence to support this for the Ofgem price
probe and to the extent we are comfortable that the evidence we
have got is reliable it will be submitted to them, and we can
copy it to yourselves.
Q735 Mr Oaten: Can it be submitted
to us as well?
Mr Munday: Yes.
Q736 Chairman: The comments you have
just made are about the SME sector of course. Scottish Power in
their evidence to us said "We judge that domestic supply
remains a loss-making activity".
Mr Munday: I would absolutely
agree with that. BizzEnergy is, as I said earlier, keen to get
into the domestic market. We are sitting there ready to go and
at the moment prices are some 30% below where we can actually
buy. That is good for the consumer, so we are not going to knock
that, but it makes it very difficult for a new entrant to come
in and compete.
Mr Bennell: It would depend on
when the question is asked of course because wholesale prices
have risen 30% or 40% since March.
Q737 Mr Weir: It is a devil's advocate
question perhaps. I presume from what you are saying that the
cross-subsidy in generation subsidising prices to the consumer
business or whatever. If you got your transparency, if this was
outlawed, if you like, would it lead to a rise in energy prices,
especially as I am sure if we ask the `Big 6' they will say they
are absorbing much of the rising cost and not passing it on to
consumers?
Mr Munday: I do not think so.
The proposals do nothing to interfere with generation costs. The
proposals do nothing to interfere with customer income. It just
provides a degree of transparency in the middle and it is part
of the judgment as to whether the industry is working well.
Q738 Mr Weir: If I understand it
correctly, what you want to do is to stop cross-subsidisation
between the two, in your view, to give you equal access into that
market at the same price, but that effectively would end the cross-subsidisation
surely or would not work, and therefore would lead to some rise
in energy prices, would it not?
Mr Munday: I do not think it will
lead to a rise in energy prices at all because you are not interfering
with generation costs. Why would prices go up?
Mr Bennell: If you stand back
from this, you have got a range of prices and the ones at the
bottom tend to be supported by the ones at the top, as we have
said. What we have got to drive to and what we have got to fix
is this broken market. The transparency will be helpful there
but an actively trading market where people have to sell what
they are producing is likely to lead to lower prices, particularly
if there is some prohibition on self-supply put with this as well.
Go back to the 1990s, there was a lot of concern about concentration
of ownership of generation. Generators wanted to buy suppliers
and the regulator at the time put safeguards in place before he
would allow that, and there were disposals of plant and there
were prohibitions on self supply and that led up to the better
situation that we had around the opening of the NETA market in
2002. What we have seen since then is a concentration of that
ownership and liquidity and everything else in that market going
away. I would struggle to see how a more liquid, a more efficient
and a better market would lead to higher prices. It might lead
to higher prices for the very small number that are benefitting
from this, but for a lot of people it would—and certainly
for us—open the competitive opportunities that just are
not there at the moment.
Q739 Mr Weir: Again being the devil's
advocate, the `Big 6' will argue, I am sure, that they are keeping
down prices to consumers and absorbing some of the cost of the
rise in wholesale price. In a fully liquid market are you arguing
that competition for that energy will push down prices? Might
it not have the opposite effect?
Mr Bennell: If you are a supplier
to the domestic market you are unlikely to buy on the market today
for today or for next week. I think you are going to have a portfolio
of purchases that would take you through because of the nature
of that business. If you have got a properly liquid market I believe
the average level of those costs is likely to be lower and that
will lead to lower over time average prices. What we have got
at the moment is a situation where we have seen a very steep rise
in wholesale costs, particularly since the end of March this year
on this wholesale market, and I think that is the position that
you are referring to where people are saying that this increase
is not being passed on. Absolutely that has not been passed on
yet, but this is not a six-month business. If you win a domestic
customer you hope to service them for some years, you are going
to have customers coming and going and you will build up your
purchases accordingly.
Mr Weir: That is fair enough but at the
same time I do not know anybody who is suggesting that prices
are going to come down in the near future on the wholesale market.
Chairman: Take that as a comment and
I will bring in Adrian Bailey who has a supplementary to ask.
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