Examination of Witnesses (Questions 140-159)
MR JIM
MCDONALD,
MR ALAN
SMITH AND
MR GEAROID
LANE
10 DECEMBER 2008
Q140 Lynne Jones: Centrica has historically
spent more on this area of poverty measures. Could you comment
on the question? Is it enough and is the money that your companies
are spending on these various schemes coming out of your profits
or is it being re-charged back to the customers?
Mr Lane: The question are we collectively
doing enough to deliver the targets, I think the answer clearly
is no. As an industry, as a government and as a third sector more
needs to be done. The trajectory we are on will not eliminate
fuel poverty by 2016 notwithstanding what might happen to energy
prices and the general state of the economy. Do companies need
to do more? Does it come out of their own profits or does it,
at the end of the day, come from customers? Most of the energy
companies are multifaceted companies who operate in a number of
different sectors and parts of the supply chain in multiple geographies
in different countries. In order to determine whether there is
too much profit in the supply of energy to customers you need
to focus in on the energy retail business, and our energy retail
business has been either marginally profitable or loss making
for many years and has never achieved the kind of profit margins
that are achieved in other retail sectors, for example in groceries.
Therefore, if further demands are put on that then inevitably
over time that will end up being carried by customers.
Q141 Chairman: That is a lovely way
of dancing around the problem.
Mr Lane: I was not trying to.
Q142 Chairman: Let me ask you the
specific question that goes to the heart of what Lynne Jones was
getting at. In terms of the costs you had to bear to meet your
various commitments under EEC1, EEC2 and now CERT, in cash terms
and the expenditures that you made to meet those obligations how
much has been re-charged back to the customer through their bills?
Mr Lane: I am not trying to be
evasive in any way but the price that one charges to customers
in a competitive market is determined by the market conditions
and the market prices but the profitability of our retail division
is extremely low.
Q143 Chairman: That was not the question
I asked. That is a wonderful plea for problems in the retail energy
field but the question I wanted to ask was how much money have
you spent. To meet those obligations it has cost you something
and the question was how much of that expenditure for EEC1, EEC2
and now CERT and other programmes has actually been charged back
within the bill to the consumer? Lynne Jones asked the question:
how much has come out of your profit, in other words off the bottom
line, and that bit is what you have not charged back to the consumer.
Mr Lane: It is by no means as
simple as that. You cannot ask that question.
Q144 Chairman: I can ask the question.
Mr Lane: But I cannot answer the
question because companies do not say "Here is this portion
of cost. I am charging it this way and this that way." Basically
your cost is what it is and your prices are what they are.
Q145 Chairman: No, I would fundamentally
disagree with you. The cost of meeting the obligations which the
government has set energy companies is a cost to your business.
We are agreed on that. If it is a cost to the business, it goes
into your P&L on the same basis as any other cost and you
have to decide, as a corporate entity, how to deal with it. Do
you take it as a cost, of which I presume it is allowable against
tax as a business cost, and thereafter what remains do you charge
it back in the price of the produce to the customer or do you
allow your shareholders' return to be diminished by bearing that
as a cost to the business? What is the strategy?
Mr Lane: Within the retail business
we bear all of our costs as costs, including transmission, distribution
and the cost of these obligations.
Q146 Chairman: But you charge back
in the cost of the product. The transmission and the distribution
go back to the customer as part of the price of the product.
Mr Lane: No, that is not the way
it works at all. The way retail prices are determined is in relation
to the competitive market.
Q147 Lynne Jones: And what prices
you can get away with.
Mr Lane: No, not by any means.
That is the way that companies work: prices are determined by
the market.
Q148 Chairman: There must be an expectation
in terms of your pricing strategy. You, like any other retail
business, have to work in a competitive market-place and the market-place
determines the parameters within which you can set your pricing
for whatever offers you make to your customers. At the end of
the day you earn an income and some of those out of the income
effectively repay the costs of doing business and at the end you
hope you will have a margin which ends up as your gross profit.
Nobody would disagree with that. There may be, and we do know
from what Ofgem have told us, that there is a charge back to the
customer as part of the price the cost of meeting some of these
obligations. I am asking you, straight forwardly in your case,
what is it?
Mr Lane: It is our strategy over
time to ensure that all divisions of our business make some kind
of a profit.
Q149 Chairman: That is a bit vague.
Mr Lane: Within the retail division
itself we will aim to make some kind of reasonable margin within
that business given the competitive pressures and given the cost
base in recent years.
Q150 Lynne Jones: Mr Lane constantly
refers to the retail business. Your companies are also involved
in the wholesale business.
Mr Lane: Yes.
Q151 Lynne Jones: Perhaps the question
should be addressed to the business as a whole. If the retail
is the loss leader but you are making loads of profits in the
wholesale area then it is still the same company. Can you answer
questions about how the wholesale business allocates its prices?
Are you able to make larger profits at the wholesale business
on the basis that you are immune from the kind of questions that
we are asking today?
Q152 Chairman: I guess your wholesale
must sell to the retail business and the wholesale business makes
a margin on its sale to the retail business. Nobody minds people
making margins up and down the chain within the company but somewhere
along the line the cost of meeting these obligations has got to
be met by somebody and it is either being met as part of the price
which the customer pays for the energy. We have had lots of evidence
that talks about the regressive nature of people, particularly
on lower incomes, effectively paying for their own energy efficiency.
I am trying to establish from your standpoint, because you said
we have got to do more, whether "got to do more" means
"we would like to put some money out of either the retail
or the wholesale part of Centrica into the pot and do more over
and above paying our way to meet our EEC, CERT, et cetera, obligations."
Within those two I wanted to know whether it was 100% cost pass
back to the customer of meeting your national obligations over
and above what you might do as a benevolent supplier realising
you have wider social obligations. Could you tell us specifically
what the answer is to those questions?
Mr Lane: There is certainly no
policy of creating a 100% pass through of the costs of CERT, or
any other obligation, to the customer. There is no such policy.
The question as to whether the poorest customers are being asked
to pay for their energy efficiency is a perplexing one given that
customers are on 11 different kinds of qualifying benefits and
now all our customers over 70 get all of those energy efficiency
measures for free and beyond that, in terms of dealing with the
customers in the greatest degree of fuel poverty, our social tariffs,
the essentials tariff, is costing us this year £90 million
which is three times the amount that we voluntarily agreed with
the government. I do not think against that backdrop we can in
any way suggest that there is a policy of passing costs through
100%.
Q153 David Taylor: What proportion
does that £90 million represent of your domestic revenue?
Mr Lane: What do you mean by domestic
revenue?
Q154 David Taylor: The income you
get from domestic customers.
Mr Lane: I do not know the answer
to that.
Q155 Chairman: If this causes you
some pain, let me ask you perhaps you may want to go away and
write to us about it. If I was a shareholder at a meeting and
I stood up and said "One of the costs of the company is meeting
these obligations, could you tell me how it is met? Does the customer
make a contribution to meeting those costs?" Somebody like
the finance director would be able to answer that question and
you are struggling to answer it at the moment.
Mr Lane: I am not because I am
not sure it is a question that can be asked in that kind of simplicity.
Q156 Chairman: We can ask the question
with great simplicity but what I am worrying about is the answer.
Mr Lane: I do not think you can
ask a grocery company whether this specific element of your cost
chain it is your policy to pass through or not to pass through.
The prices are determined by the market, the costs are determined
by what your costs are and on that basis you either make a profit
or a loss.
Q157 Lynne Jones: Could I ask the
other two gentlemen, are your companies involved in the wholesale
market as well and could you comment on this issue as regards
how the expenditure on CERT is actually financed and whether you
pass it on to the customers?
Mr Smith: I would like to make
a comment that we could get into difficulties if we get into too
much detail. We should not forget that apart from the fuel poverty
targets we have, as I said at the start, we have other targets
one of which is an 80% reduction in carbon. In order to deliver
those we are going to have to replace aging fossil fuel and nuclear
plant over the coming years. By 2020 we will need to build at
least 20 new power stations to deliver the low carbon future.
As a company nPower would be spending or investing significantly
more than it earns year on year for the next 10 years. We are
very pleased that our parent company in Germany will bear that
cost. I simply wanted to make that point.
Mr McDonald: I only have retail
responsibility so I could not comment on the wholesale. I apologise
for that.
Q158 Lynne Jones: You are spending
that money in the future but you have made huge profits in the
past. There is a big call for some of those profits to be taxed
in the form of a windfall tax to make sure that it is spent on
relieving fuel poverty. Would you care to comment on that?
Mr Lane: I would comment that
in terms of excess profits arising from the free distribution
of carbon emissions allowances into the market we have been supportive,
probably as a lone voice over a long period of time, for every
tonne of carbon that is emitted by a power station to carry a
cost and for that cost to be borne by the power generator that
emitted that CO2, and the revenue that accrues from the sale or
auctioning of those emission allowances should be used in areas
of fuel poverty or delivering low carbon or zero carbon technology.
Q159 Lynne Jones: What about the
free allowances that the energy companies are going to get under
the next phase, something like £10 billion?
Mr Lane: We believe from phase
3 onwards there should be no more free allowances.
| 
