Energy and Climate Change Committee - Draft Energy Bill: Pre-legislitive ScrutinyWritten evidence submitted by Which?

1. Introduction

1.1 Which? is an independent, not-for-profit consumer organisation with around one million members and is the largest consumer organisation in Europe. Which? is independent of Government and industry, and is funded through the sale of Which? consumer magazines, online services and books. Which?’s mission is to make individuals as powerful as the organisations they have to deal with in their daily lives by empowering them to make informed decisions and by campaigning to make people’s lives fairer, simpler and safer.

1.2 The UK’s energy system needs to be renewed and at the same time decarbonised. Which? is not an environmental organisation, nevertheless we recognise the scientific consensus on the risks climate change presents and the importance of reducing CO2 from electricity and heat. Which? accepts that investment in new generation is needed to replace power plants and to meet climate change targets. Steps are required to lay the foundations for and bring on this investment.

1.3 Since consumers are effectively underwriting this significant investment through their energy bills, affordability must be at the heart of all of the Government’s considerations. The increasing cost of electricity bills is the number one financial concern of consumers,1 so it is crucial that this investment comes at the lowest possible cost.

1.4 The Government’s recognition of the importance of affordability is welcome. However its statements on the impact on consumers are dependent on a series of high level assumptions that might not be realised. In particular, assumptions are made about future gas prices, which are inherently volatile, and the cost of capital reductions associated with introducing Contracts for Difference (CfDs). We are concerned that the Government’s pronouncements seem over confident when uncertainty remains about the structure of the CfDs and the interim investment instruments.

1.5 The Energy Bill must ensure that external judgements can be made about whether consumers are getting value for money for the contracts negotiated with generators. This means that information about the contracts and negotiations must be put into the public domain, clarity must be given about how contracts will be scrutinised and processes must be put into place to ensure that the Government is held accountable. Further detail is needed in the draft Energy Bill to ensure that this process is transparent.

1.6 Without this, consumers are likely to question whether investment really is cost effective. The Government previously set far too generous support levels under the Renewables Obligation and the Solar PV FiTs regime. There has been a failure to put in effective scrutiny and control mechanisms for the smart meter roll-out and the Energy Company Obligation (ECO). A much more robust approach to protect consumers is therefore needed.

1.7 The lack of a rigorous approach to keeping costs under control could further undermine trust in the energy market. This in turn could magnify the already high levels of consumer disengagement with the energy system, energy efficiency and energy use. Should this result in a consumer backlash, it could create political and policy uncertainty, which may deter investment.

1.8 Recommendations

Further detail is needed in the Energy Bill about how contract negotiations will be made transparent, how the CfD process and the interim arrangements will be monitored and scrutinised and how the Government and the national system operator will be held accountable.

The draft Energy Bill states that the Secretary of State must have regard for “the likely cost to consumers”. Further detail is needed on how this will be interpreted and scrutinised.

The cost of CfDs must be passed through to consumers on a per unit basis to ensure that it has a less regressive impact on household energy bills. Further analysis is needed on the impact of this legislation on vulnerable consumers.

The most important detail about CfDs will be in secondary legislation. The Select Committee should have a role in scrutinising this detail before Parliament’s final consideration of statutory instruments.

The Carbon Price Support (CPS) is an unnecessary measure that increases costs for consumers, is unlikely to provide long-term certainty for investors and as a result of the draft Energy Bill represents policy duplication. It should therefore be abolished.

The impact of Electricity Market Reform (EMR) on consumers’ bills means that the Government must ensure that people can take steps to reduce their energy costs. In particular, comprehensive reform of the retail market is needed so that it works for consumers and an effective energy efficiency strategy is needed to help people to cut their energy usage.

The Government should use the Bill as an opportunity to reform energy tariffs. Ofgem’s Retail Market Review (RMR) proposals do not go far enough and could institutionalise the existing “two-tier” market. The Government should legislate for a simple, standardised format for all tariffs from all suppliers, so that consumers can work out at a glance which tariff is the cheapest.

2. Decarbonisation and Low Carbon Investment Must be Delivered Cost Effectively

2.1 The impact of policies to support low carbon electricity on consumers’ bills has thus far been fairly small, although by no means insignificant. The Committee on Climate Change (CCC) suggests policies added around £33 to the average annual domestic electricity bill in 2010 and this figure is likely to be similar in 2011.2 As low carbon generation makes up a larger share of electricity and the carbon price increases, the impact on prices will grow.3 However, the actual impact will be significantly affected by what happens to the wholesale price of gas. The higher the gas price, the less low carbon support costs will increase electricity prices bills.

2.2 Which? does not favour particular low carbon technologies over others. Fundamentally, there are two reasons for this. First, deliberative research indicates that consumers’ views on different forms of electricity generation vary significantly.4 Second, there is significant uncertainty at this stage around the relative future costs of the different low carbon alternatives.

2.3 The Government’s ultimate goal for low carbon generation should be grid parity with other generating technologies. As the costs of deployment fall when technologies mature and the EU ETS becomes a more effective price signal, no subsidy premium for low carbon power should be required. However, we recognise that in the interim, the Government needs to put in place policies to provide financial support to encourage investment in low carbon electricity.

2.4 Although we recognise that the Carbon Price Support (CPS) is not under consideration in the Draft Energy Bill, it remains a key part of Electricity Market Reform. We remain unconvinced about the likelihood of the CPS providing the long-term certainty and confidence for investors. The annual CPS rate is only set two years in advance—far shorter than the timescale that low carbon investment decisions are based upon. While the CPS may reduce the level of subsidy required to support low carbon generation with CfDs, this is an unnecessarily complicated approach and represents policy duplication. Simplicity should be seen a positive feature of the electricity market, and one that the Government should actively encourage.

2.5 We are not setting out specific recommendations with regard to the Capacity Mechanism, however it adds a further layer of complexity. We have concerns that some of the more CO2 intensive fossil fuel plants, which the CPS and EU ETS deliberately seeks to disincentivise, are at the same time supported financially through the capacity mechanism. Effectively, consumers could end up paying twice—once through the higher electricity prices resulting from the CPS and EU ETS, and then again through payments to keep flexible fossil fuel plants available.

2.6 The Capacity Mechanism’s final design should be compatible with promoting demand shifting as well as demand reduction and new generation. We note that this is not explicitly stated in the Bill. More broadly, the overall reform package should help to support the development of interconnection. This should help to keep down the cost of managing a higher proportion of renewables on the system.

3. Contracts for Difference and Investment Instruments

3.1 There is no perfect mechanism for supporting low carbon generation. CfDs could prove a cost-effective way of doing this. The existing Renewables Obligation (RO) has been expensive for consumers. It was particularly generous for landfill gas and onshore wind before the introduction of “banding”, and more recently, in its support for biomass.

3.2 Affordability was one of the key reasons the Government opted for CfDs. Modelling for DECC suggested that continuing with the RO, or moving to a more straightforward Premium Feed In Tariff, would be more expensive than the “two-way” CfD.5 Generators will have to pay back money to consumers if the market reference price ever rises above the contract strike price.

3.3 Nevertheless, the “two-way” CfD model will make it impossible to predict how much subsidy consumers will give to low carbon generators in any year. This is because the level of support will depend on the market reference price, which is uncertain. As the model develops, the Government must provide further analysis about why the financial benefits associated with CfDs outweigh the uncertainty. The Government must also demonstrate how they are keeping a firm handle on costs.

3.4 CfD strike prices will not be determined until the second half of 2013 and setting these at appropriate levels will clearly be difficult. Developers naturally have the greatest understanding of the costs of these electricity projects. This gives these companies advantages over the Government and other stakeholders, including consumer groups, during any consultative process. Lessons must be learned from the initial rates of support under the RO and the Feed-in Tariff for Solar PV, since both of these proved generous to the benefit of electricity generators and not electricity bill payers.

3.5 Negotiating fair and appropriate strike prices for nuclear will be a particular challenge, given the uncertainty around construction costs. Unlike most CfDs for renewables projects, nuclear contracts will be bespoke. Only a few companies are considering investing in nuclear in the UK and this will undoubtedly give these firms a strong bargaining position during contract negotiations.

3.6 CfD contracts must be designed in such a way that they provide robust information on costs. Which? wants transparency around costs and competition between the different low carbon generating technologies in order to drive down costs.

3.7 Which? is therefore concerned about the level of transparency that there will be in this process. The draft Bill has little detail about how the CfD process will be made public and the role of Parliament, Ofgem and other external stakeholders in monitoring these new arrangements. While it is encouraging that the Secretary of State must give regard to “the likely cost to consumers” when making CfD regulations, it is unclear how this will be interpreted.

3.8 The most important detail about CfDs will be in secondary legislation. We would therefore like to see the Select Committee play a similar scrutiny role in advance of Parliament’s final consideration of statutory instruments.

3.9 For example, significant questions still remain about how the CfD repayment model will work and the overall cost of capital reduction; whether CfDs are the most appropriate support for both nuclear and renewables; and how to ensure that there is a clear reference price for each wholesale power market against which CfD strike prices are struck.

3.10 With regard to the interim powers for the Secretary of State to introduce investment instruments, Which? is encouraged by the parliamentary scrutiny that will be required. However, there is also a lack of detail about the precise way that the cost to consumers of these contracts will be made public and scrutinised.

4. Clear Communication About Impact on Energy Bills

4.1 Estimating and clearly presenting the likely future cost impacts of policies to support low carbon energy is incredibly difficult. However, DECC’s presentation of its modelled data is often unclear and at times disingenuous—for example, by conflating the costs and savings of policies.

4.2 While Government modelling suggests policies to encourage generation and energy efficiency will in total lead to a 27% increase in the electricity price by 2020 and a 28% rise by 2030, it states that overall policy will lead to lower bills due to policies encouraging energy efficiency.6 Yet, while all consumers feel price increases, their ability to benefit from energy efficiency varies significantly. This depends on a range of factors including property type, tenure and income.

4.3 Messages that suggest that overall policies will not add to bills undermine the case for action on energy efficiency. If such savings do not materialise, it is likely to increase consumer distrust towards energy companies and the Government’s low carbon policy agenda.

4.4 Despite the fact that DECC has looked at the impact of the EMR across income deciles, further analysis is needed on the full impact of these proposals on vulnerable consumers. For example, analysis should be undertaken about the impact for vulnerable consumers who use electric rather than gas heating.

4.5 Which? understands that the cost of the CfDs will be passed through to consumers on a per unit basis. This is welcome and will have a less regressive impact on households than passing costs through on a per household basis or leaving it to the discretion of energy companies how they do this, as is currently the case with CERT and the ECO.

5. Reforming Energy Tariffs

5.1 Which? recognises that this legislation is focused on reform of the electricity market, rather than the retail market. We have been engaging with Ofgem’s Retail Market Review (RMR).

5.2 However, since Ofgem confirmed its proposal for the reform of energy tariffs in December 2011, Which? has been calling for the Government to intervene and ensure that all energy tariffs are simple and fair. With Ofgem now stating that their revised RMR proposals will not be published until later this year, we believe that the Energy Bill provides an opportunity to do so.

5.3 Which? previously set out the case for reforming energy tariffs in our written evidence to the Energy & Climate Change Select Committee’s inquiry into “Consumer Engagement with Energy Markets”. Which? believes that a simple format should be mandated for all tariffs. This would enable people to only look at unit rates to work out which energy tariff is cheapest.

5.4 Our recent experience through running the Big Switch with 38 Degrees has further strengthened the case for reform. Almost 290,000 people signed up for the Big Switch, the UK’s first nationwide collective switch. Co-operative Energy won the Big Switch auction, resulting in average savings of £123 a year for around 200,000 people and a possible collective saving of £25 million on household energy bills.

5.5 The Big Switch confirmed that the vast majority of consumers struggle to get the best from the energy market. People that signed up for the Big Switch were on a total of 1,435 existing tariffs. Furthermore, at present, it is impossible to compare tariffs “at a glance” with a minimum of 98 prices per dual fuel tariff. Most people who switch do so to save money, yet indications are that around 40% do not achieve a saving.7 This is no wonder when switching sites are the only source of a “whole of market” comparison, yet few use or switch via them.

5.6 Collective switching by trusted intermediaries provides an opportunity for consumers to navigate this unnecessarily complex market. However, Which? remains convinced that a more radical solution would be to extend Ofgem’s proposed simple format for standard tariffs to all tariffs for standard energy meters.

June 2012