Memorandum submitted by Ofgem|
This memorandum is intended to provide the Committee
with information regarding areas of interest to Ofgem ahead of
our session on 18 January. It is divided into four sections covering
energy supply, energy networks, energy generation and Ofgem's
role and performance.
1. ENERGY SUPPLY
In November 2010 Ofgem announced that it would be
reviewing the effectiveness of the retail energy market to see
if further action was needed to protect consumers. The review,
which we aim to finish by March this year will comprise of the
assessment of the current state of the effectiveness of the retail
of progress energy companies have made on implementing Ofgem's
next quarterly Electricity and Gas Supply Market Report into retail
and wholesale energy prices
There were a number of reasons why Ofgem instigated
the review, one of which was our last quarterly report (November
2010) into retail and wholesale energy prices. This analysis (see
graph below) showed that retail net margins had increased from
£65 in September 2010 to £90 in November 2010 following
price rises from some of the "Big 6" energy suppliers.
The analysis incorporated the new, higher prices
of the three Big 6 energy supply companies that had already detailed
price rises for this winter at the time of Ofgem's announcement.
Only one Big 6 supplier, EDF Energy, has promised to freeze prices
between now and March 2011.
Whilst Ofgem would expect efficient firms to make
a profit, the increasing margins concerned us. Correspondingly,
we have sought to undertake deeper analysis to provide clarity
on behalf of consumers that the market is transparent and is working
as effectively as possible.
However, there were other supporting reasons why
we felt a review was needed. Since the Retail Market Probe in
October 2008, Ofgem has secured a series of important reforms
for customers to improve transparency and ensure fair play. These
are displayed in the table on the following page.
In addition to licence changes, we also published
Standards of Conduct that we expected the companies to adhere
to. As part of our current review Ofgem will be looking at how
effectively energy companies have implemented all of these reforms
as we have observed differing supplier performance to date. For
example, some of the companies responses to providing consumption
data to customers has been poor and we have also been concerned
with suppliers' doorstep activity, announcing in September investigations
into four suppliers over potential mis-selling to customers.
Other relevant retail market work
Following on from our 2008 Retail Probe and measures
to empower consumers with more information about how much they
are paying for their energy, Ofgem has announced its intention
to ensure companies provide advanced notification to customers
of any price rises.
Currently, companies have up to 65 working days in
which to notify consumers after they have put up energy prices.
Consumers then have 20 working days to switch supplier if they
wish to avoid paying the price increase. Under our proposals the
position would be reversed, with companies required to give 30
calendar days notice before they increase prices. We support this
approach in order to allow consumers more time, once informed
of a price rise, to either switch supplier or take action to reduce
In addition to our work regulating the retail market,
Ofgem continues to specifically assist vulnerable and fuel poor
customers in a variety of ways, including through the below.
This helps contribute towards Government's fuel poverty goals.
Action undertaken through our previous energy supply
probe, in particular relating to the banning of unfair price differentials,
has particularly benefited customers who pay by pre-payment meter
or who are not connected to the gas grid and have an electricity
only tariff - the latter of whom suffer some of the highest levels
of fuel poverty in Britain.
In our work through setting the current gas distribution
price control we have created conditions to enable gas distribution
companies to extend the gas network to non gas, fuel poor communities.
We continue to shine a light on suppliers' voluntary
social measures through annual reports designed to share and recognise
good practice and help inform consumer advisers about the range
of help available. Collectively suppliers spent £153m on
social programmes in 2009-10, exceeding the Government's target
of £125 million. Of this spend £128 million was on
rebates or discounted tariffs with almost 1.6 million customer
accounts benefitting from some form of rebate or discounted tariff.
Ofgem will monitor compliance for one more year before the voluntary
scheme ends and the Government's mandated scheme begins.
(c) Debt and disconnection
We have a long and successful track record in promoting
best practice among suppliers in the way they approach debt prevention,
debt management and avoid energy disconnections. Energy disconnections
overall have decreased substantially since 2004, from around 16,000
in 2003 to just over 4,000 in 2009.
We have strengthened licence obligations on suppliers
to see more proactive identification of vulnerable consumers who
may be in debt and at risk of disconnection and our ongoing work
has seen two companies (Scottish Power and EDF Energy) take action
to address their relatively high disconnections. EDF Energy has
suspended electricity disconnections for the winter where it has
been unable to install an electricity pre-payment meter and Scottish
Power is undertaking a pilot scheme from October which it is forecasting
will cut its disconnection by 44 per cent. It will also suspend
disconnections if it is a particularly harsh winter this year.
In this area we work with Citizens Advice,
Money Advice Trust and Consumer Focus.
(d) Advice and research
We have a three year partnership with Citizens Advice
on the "Energy Best Deal" campaign which provides vulnerable
consumers with tariff and energy efficiency information and advice.
Over 64,000 consumers have received help as a result of this campaign.
We also regularly undertake consumer research on issues relating
to vulnerable customers, such as their ability to switch and take
advantage of the market.
(e) Forward look
A priority focus in this area of our work at the
moment is updating the licence obligations to ensure they provide
fit for purpose protection for consumers with smart meters, including
vulnerable consumers. We will be publishing a consultation on
our proposals at the end of January.
Ofgem continues to use its full range of powers to
enforce the rules within the energy retail market and the other
markets that we regulate. Below are examples of recent work.
Last summer, Ofgem successfully fined National Grid
£15 million concerning anti competitive agreements struck
with suppliers at the time the metering market was opened to competition
in 2002. The terms of these stifled new entry to the nascent
gas metering market and ultimately limited the benefits to consumers
from more competitive metering costs and innovative services.
Our landmark case attracted the largest penalty in any abuse of
dominance case to date.
Earlier this month, we announced our intention to
impose a penalty of £8 million and to fine National Grid
Gas in breach of obligations to provide us with accurate information
over the reporting period 2005-06 to 2007-08. Ofgem takes failures
by regulated companies to meet reporting obligations very seriously
as this is an important part of ensuring that the "regulatory
contract" is met and consumers receive value for money.
In 2010 Ofgem issued First Utility with a Provisional
Order, instructing them to change their practises in too readily
disconnecting consumers who had opted for their early smart meter
packages. The consumer experience around smart meters is critical
for the success of the programme and our early interventions in
this area have set a benchmark for consumer protection to tackle
issues emerging from the early rollout of the technology.
Other investigations underway include the afore mentioned
investigations into four of the Big 6 on mis-selling, all of the
Big 6 on complaints handling and three electricity distribution
companies are being investigated on connections standards.
In addition, as well as our general enforcement work,
we are also examining the conditions in which domestic customers
are being automatically rolled over onto new contracts when their
existing contract expires, as well as exploring suppliers' practises
in using deemed contracts when people move house.
Ofgem recently announced a comprehensive and open
review of the charging regime and associated connection arrangements
for using Britain's high voltage electricity network and high
pressure gas grid.
The electricity and gas grid transmission charging
regimes have served customers well, for example, by encouraging
power generators to locate close to where electricity is used.
However, Britain is facing an unprecedented challenge as it moves
to a low-carbon energy system and low carbon technologies such
as wind and wave power stations have less flexibility on where
they are sited than conventional power sources.
We are reviewing transmission charging arrangements
for gas as well as electricity to ensure that a consistent approach
is adopted for both. We are committed to undertaking an open,
comprehensive and objective review drawing on a wide range of
stakeholder input, including independent academic reports, international
experience and alternative viable models.
TransmiT does not re-open the Government's recent
proposals for reforms to the electricity grid access arrangements
but focuses on charging arrangements and other practical and commercial
difficulties experienced by new generators which fall outside
the scope of the Government's work. Such difficulties to be examined
include the significant financial commitments a generator has
to sign up to before National Grid will begin work on their connection
and the process by which the grid companies prioritise the engineering
work required to physically connect generators to the electricity
RIIO and the network price control process
Of the estimated £200 billion of energy related
investment needed by 2020, as highlighted by Ofgem's Project
Discovery, about £32 billion needs to be in the energy networks.
However, the new grid will have to be far smarter than the existing
network in order to accommodate more low carbon sources of generation
such as wind and decentralised energy, as well as to enable the
infrastructure to deal with increased electrification of heat
and transport. The way energy networks are designed, operated
and priced is likely to need to change.
In order to deliver a smart grid, while ensuring
security of supply, Ofgem has fundamentally changed its regulatory
framework by reforming the old RPI-x regime. RPI-x had provided
the framework that set each of the regional network companies'
regulated performance over each five year "price control"
period. While RPI-x was successful in securing £35 billion
of investment over its lifetime, Ofgem did not think it provided
the required flexibility necessary for delivering the grid needed
in the future.
RIIO (Revenue=Incentives+Innovation+Outputs) is the
successor to RPI-x and is Ofgem's performance-based solution to
the challenge. The RIIO model takes the best from RPI-x, but places
far more emphasis on the delivery of specific outputs (eg network
reliability) through a framework which heavily encourages innovation.
It will essentially protect consumers by rewarding those companies
that innovate and invest efficiently, meeting their outputs, but
will penalise those companies which perform badly for consumers
with lower returns on their investment.
Key features of the RIIO model include setting longer
eight-year price controls, offering incentives focused on delivering
results, and expanding the £500 million Low Carbon Network
Fund to fund innovative smart grid project trials (more below).
Ofgem estimates the RIIO model could cut the cost of investment
to consumers by £1 billion compared to the previous regulatory
framework in the next ten years.
We are now consulting on our initial views on the
specific outputs and other aspects of the first price control
frameworks under RIIO for the gas and electricity transmission
companies (RIIO-T1) and for the gas distribution companies (RIIO-GD1).
Low Carbon Networks Fund
Ofgem announced the Low Carbon Networks Fund (LCN
Fund) in August 2009 as a fundamental part of the current price
control regime for Electricity Distribution Network Companies
that runs from April 2010 to March 2015. The fund will allow up
to £500 million over five years, encouraging and enabling
the companies to trial new technology, operating and commercial
arrangements which can aid the transition to a low carbon energy
There are strict criteria for winning projects and
the lessons learnt from these ground-breaking initiatives will
be shared with all network companies and interested parties, potentially
benefitting millions of GB energy consumers.
In November 2010, Ofgem announced £62 million
for the first year's funding towards the following projects:
Electric: Customer-led network revolution (£26.8 million)
- A project in the north east exploring how a combination of smart
technologies and changes in customer behaviour can reduce the
costs associated with low carbon technologies.
Power Networks: Low carbon London - a learning journey (£24.3
million) - A "smart city" initiative for London that
will explore how to best use new technologies and active network
management. The project will also seek to understand when, how
and why consumers use energy and how this can be influenced.
Networks: Low carbon hub (£2.8 million) - A project in East
Lincolnshire to investigate ways of increasing the amount of electricity
generation - mainly wind - that can connect directly to the local
Power Distribution: Low voltage Network Templates for a low-carbon
future (£7.8 million) - A project in South Wales to examine
the effect that low carbon technologies have on the network.
Investment in the offshore grid
The offshore regulatory regime for licensing offshore
electricity transmission, introduced in 2009 by DECC and Ofgem,
uses competitive tendering to ensure the offshore cable connections
are delivered on time and at reasonable cost. Essentially, any
company with the appropriate experience can bid for the right
to own and operate offshore transmission links in return for a
20-year regulated revenue stream. The aim is to use competition
to keep these revenue bids as low as possible by providing opportunities
for new entrants to compete with existing players (National Grid,
Scottish Power and Scottish & Southern are the existing onshore
The early signs are positive with the first round
of tenders attracting high quality bids worth almost £4 billion
of investment appetite for all nine transmission links (worth
around £1.1 billion), connecting 2GW of offshore wind. It
has resulted in overall forecast savings of £350 million
for offshore wind farms and ultimately consumers, and attracted
some new firms and investment capital to the sector.
In November 2010, Ofgem commenced a second transitional
round of tenders for six wind farm assets for around 2.8GW of
capacity, with a potential asset value of around £1.9 billion.
Overall around £20 billion of investment could be needed
for offshore transmission links in the next decade.
Electricity Market Reform
Ofgem's Project Discovery used scenario analysis
to test the current energy market arrangements to see if they
could cope with the unprecedented combination of the global financial
crisis, tough environmental targets, increasing gas import dependency
and the closure of aging power stations. It concluded that all
these factors combined to cast reasonable doubt over whether the
current energy arrangements will deliver secure and sustainable
The five key factors affecting the market that emerged
from Discovery were as follows:
levels of investment (up to £200 billion before 2020) need
to be sustained in difficult financial conditions and against
a background of increased risk and uncertainty.
in future carbon prices could delay or deter investment in low
carbon technology and lead to greater decarbonisation costs in
market price signals at times of system stress do not fully reflect
the value that customers place on supply security (for both electricity
and gas) - which could result in insufficient incentives to invest
in peaking capacity.
with international markets exposes GB to a range of additional
risks that may undermine GB security of supply.
energy costs may mean that increasing numbers of consumers are
unable to afford adequate levels of energy to meet their requirements,
affecting the competitiveness of industry and business.
Ofgem therefore welcomes DECC's Electricity Market
Reform (EMR) consultation and looks forward to working with the
Department to help change the electricity market to meet consumers'
long-term interests for reliable and low carbon energy supplies.
Ofgem also believes that by starting the reform process promptly
this should help to keep investment costs and energy prices as
low as possible for consumers.
However, as the consultation itself points out, market
reform alone is not necessarily sufficient for meeting Government
objectives if other parts of energy policy are not aligned. Correspondingly,
the work which Ofgem is undertaking to improve electricity market
liquidity (more below), RIIO, TransmiT and other areas such as
planning are crucial for delivering UK energy policy goals.
Over the last 18 months we have been monitoring and
investigating the liquidity of wholesale electricity in Great
Britain and have concerns that the wholesale market might not
be delivering the products and signals that all market participants
need to operate their businesses effectively. In particular, independent
suppliers and generators have expressed concerns that they find
it difficult to manage risk with the wholesale products currently
available. This could be having a negative impact on the outcomes
for consumers in the supply market, especially if it means that
there is no viable threat to existing suppliers.
In 2010, we published possible options for intervention
and a further assessment of the market, and stated our commitment
to take action in the event that we do not see sufficient improvement.
While we have seen some positive signs, such as through
a new trading platform (N2EX) and through efforts of one of the
Big 6 to publish its commitment to selling energy "clips"
in sizes more suitable for smaller suppliers, it is in the best
interests of the market to have greater liquidity. Additionally
some markets in Europe have achieved greater liquidity in electricity
than we have in the UK. However, interventions in this area can
have unintended consequences and with the EMR process going on
in parallel it is important that interventions are beneficial
over the long term. Correspondingly, we have decided to:
our work on liquidity with wider market developments
to develop the detailed design of our options for intervention
to monitor the market, with a view to publishing our next assessment
in Spring 2011
Security of Supply Outlook
DECC and Ofgem's recent Statutory Security of Supply
Report covered the outlook for electricity and gas going forward.
In terms of electricity, current capacity is sufficient
and National Grid's central case projection for peak electricity
demand is for this to remain relatively stable, but the Large
Combustion Plants Directive will lead to closure of significant
quantities of coal and oil-fired fleet by 2016 at the latest.
The Industrial Emissions Directive could also lead to further
closures by 2023. Together these could lead to up to 37 thermal
plants closing, which represents almost a quarter of GB's 2009
generation capacity. In addition, significant existing nuclear
generating capacity is reaching the end of its operational life
with only one existing nuclear power station likely to be operating
The Government has initiated EMR which is intended
to tackle some of the issues on the electricity side and ensure
that future capacity is forthcoming. In addition, the current
Energy Bill contains additional work in this area with Ofgem potentially
having a role in advising the Government on capacity margins.
The outlook for security of gas supply is broadly
manageable in the near term. This does not mean that it is risk-free;
there are risks, both in the short term, and towards the second
half of the decade, when some uncertainties remain. UK annual
gas demand is projected to trend downwards slightly in DECC and
National Grid's central case. There are however sensitivities
around this leading to a wider potential range of outcomes, depending
on factors such as relative fuel prices of gas and coal, the amount
of gas fired generation in the electricity generation mix, and
economic growth. Projections for peak demand show this remaining
at current levels in the Central case or trending downwards to
around 450 mcm/d in other scenarios over the period 2010 to 2025.
While production from the United Kingdom Coastal
Shelf is projected to continue to decline, GB has an increasingly
large and diverse range of import sources on which to draw. New
import and storage capacity is at various stages of development
and delivery. Should this come forward, the UK would continue
to be well-served. In practice, it is noted, however, that projects
might slip, and not all of this capacity might come forward.
Looking ahead, Ofgem has announced that it will be
undertaking a "Significant Code Review" into gas security
of supply. This will look at producing incentives to ensure that
price signals continue to pull in gas supplies from around the
world, particularly in times of system stress. This process is
also referred to in the Energy Bill, which allows for it to be
Ofgem has also recently consulted on other mechanisms
for decreasing uncertainty around building new gas storage facilities.
This has focussed on clearing up issues relating to third party
Ofgem was established in its current form in 2000
and operates under the direction and governance of the Gas and
Electricity Markets Authority ("the Authority"). The
Authority is responsible for the economic regulation of the electricity
and gas industries in Great Britain and has a primary regulatory
duty to protect the interests of existing and future consumers
wherever appropriate by promoting effective competition in electricity
and gas markets. The interests of gas and electricity consumers
are their interests taken as a whole, including their interests
in the reduction of greenhouse gases and in the security of the
supply of gas and electricity to them. Ofgem is responsible for
carrying out the Authority's regulatory duties on its behalf.
The main statutory powers that Ofgem has to support
our duties are to:
modify, enforce and revoke licences. All energy generation, transmission,
distribution and supply companies in Great Britain are regulated
through these licences;
and issue fines of up to 10% of licensees' turnover, where they
have been found to breach licence conditions; and
price controls over the prices charged by monopoly network operators
Ofgem also has powers under the Competition and Enterprise
Acts to carry out investigations into companies suspected of breaching
these rules and engaging in anti-competitive behaviour.
In addition to remit amendments in recent Energy
Bills, Ofgem's role has widened to include the administration
of government programmes on behalf of DECC. Correspondingly Ofgem,
in 2009, split its business into two separate units: "Ofgem
E-serve" administers environmental programmes on behalf of
the Government generally by using GEMA's regulatory powers, while
"Ofgem" is responsible for statutory regulation.
Ofgem is independent of Government, and accountable
to Parliament, for all its statutory functions, which include
the programmes delivered by E-serve.
Costs and Accountability
Ofgem's operating costs in 2009-10 were £51.1
million, an increase of £9.1 million (22%) on the previous
year. The increase reflects Ofgem's involvement in new activities
such as managing the tendering process for offshore transmission
networks and administering E-serve programmes. As an indication
of the rapidly expanding scale of Ofgem's work, in 2001/02 Ofgem
administered government environmental programmes worth £150
million - with 12 members of staff. At the end of the last financial
year it was delivering £4 billion worth of programmes with
a staff of 54 at a cost of £8 million.
Since 2005, we have controlled our own operating
costs by limiting cost increases to the Retail Prices Index less
a set percentage, currently 3 per cent. This has delivered £11.9
million savings over the past five years, and is expected to deliver
savings of £12.5 million over the next five years.
Our core regulatory activities are funded by mandatory
fees collected from gas and electricity licence holders, which
are adjusted each year to cover planned expenditure and totalled
£35.2 million in 2009-10. We also received £5.2 million
from DECC to cover the costs of administering environmental programmes,
with the remainder funding from the schemes themselves. The fines
we impose for infringement of industry rules - over £50 million
since 2002 - go to HM Treasury and are not used to fund Ofgem.
Ofgem's Treasury-agreed estimates of its annual costs
are presented to Parliament for approval and subsequently voted
on. The Authority has a statutory duty under the Utilities Act
2000 to report to Parliament on its activities and progress during
From 2010, we will judge performance on how we contribute
towards our four key themes:
to the achievement of a low carbon energy sector;
to maintain the security of Britain's energy supplies;
consumer choice and value and protect vulnerable customers; and
Ofgem E-Serve, ensuring the timely and efficient delivery of Government
programmes for a sustainable energy sector.
Remit changes and Ofgem's future
The Energy Acts of 2008 and 2010 have further empowered
Ofgem in our work to promote sustainable energy and take account
of the interests of future as well as existing consumers. Across
our work we can point to decisions that are impacted by these
new statutory duties, and lay to rest the idea that an economic
regulator cannot handle matters such as sustainability. In our
networks businesses, our rulings on interim connect and manage
(to get early renewable projects plugged into the system) or our
new RIIO model reflect these changes. In energy supply, our rulings
on 30 days advanced notification of price changes and our retail
probe remedies also show Ofgem responding to its remit changes.
We are participating fully with DECC's current review
into Ofgem and are focussing on our current set of duties until
the Government decides if it wishes to make any changes to our
role and remit.
Meanwhile we are reviewing the responses to the DECC
consultation process and are looking at a number of issues raised
by the respondents to see whether we can improve our ways of working.
We are also assisting DECC with their delivery landscape review
insofar as it relates to Ofgem E-serve.