CORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 1009-i

House of commons

oral EVIDENCE

TAKEN BEFORE THE

Energy and Climate Change Committee

Ofgem Annual Report and Accounts

Tuesday 26 February 2013

Alistair BuchanAN CBE and Andrew Wright

Evidence heard in Public Questions 1 - 103

USE OF THE TRANSCRIPT

1.

This is a corrected transcript of evidence taken in public and reported to the House. The transcript has been placed on the internet on the authority of the Committee, and copies have been made available by the Vote Office for the use of Members and others.

2.

The transcript is an approved formal record of these proceedings. It will be printed in due course.

Oral Evidence

Taken before the Energy and Climate Change Committee

on Tuesday 26 February 2013

Members present:

Mr Tim Yeo (Chair)

Dan Byles

Barry Gardiner

Mr Peter Lilley

Albert Owen

Christopher Pincher

Sir Robert Smith

________________

Examination of Witnesses

Witnesses: Alistair Buchanan CBE, Group Chief Executive, Ofgem, and Andrew Wright, Senior Partner Markets, Ofgem, gave evidence.

Q1 Chair: Good morning. Welcome. Thank you for coming in. I think we are going to be broadcast this morning. First of all I should say, Alistair, congratulations on a massive publicity hit last week. It was quite a successful exercise, I thought, given that, without in any way downplaying what you said, a lot of it was already in the public domain and yet it managed to make a really big news story that lasted all day. Well done on that.

You have asked to make a short opening statement, I think.

Alistair Buchanan: Yes. Two quick comments, one personal and the other professional.

On a personal level, I would like to thank both the Committee and the Chair for delaying this meeting by a few weeks. My father died just before the last meeting and I very much appreciated your offer to postpone to today.

The professional comment is that I have been with this Select Committee since it was created and I would thoroughly commend its work. You have a tremendous impact, which I believe comes from taking a complex and acronym-strewn sector and putting things plainly. As you know I leave Ofgem in a couple of months and I will follow your work with great interest.

Q2 Chair: Thank you very much. We obviously wish you well in the next stage of your career and we value the relationship we have had with you both publicly and, for most of us, also privately.

In the spirit of plain speaking, can you say why you think that the capacity margin assessments that you have made are different from those of DECC and National Grid?

Alistair Buchanan: The capacity margin that was reported with the EMR last year, which was the report commissioned by the Government from both National Grid and ourselves-it was a combined report, so using their numbers-showed, as you will know, a decline on margin from around 15%, 14% down to below 5%. What we then wanted to do and did do was to show a degree of flex around that base case. We felt it was important to show that flex because in a period of tightness we will be turning to our interconnectors. There has always been an assumption that interconnectors per se are a good thing, which they probably are. But what is becoming increasingly clear is that you need to understand what is happening on the other side of the interconnector, whether they have spare capacity, what their approach to that capacity would be, and whether it will in fact come to us when it should. So what we wanted to highlight was that in that period 2015-2016, should indeed the interconnectors be working against us and the flow being away from Britain, you would be down to zero capacity. DECC uses an argument that there will be an 80% inflow, so we also show on that chart a blue dotted line above the base case. You will be familiar with the chart.

Let’s just take a quick look at what is going on around Great Britain and our neighbouring states at the moment. Ireland is a net taker from us and historically that is the flow. There has been a lot of mood music and serious noise about the development of a minimum of 3 GW of wind in the middle of Ireland and that that power will then come to England. Great. It will not be here until 2020, well after the date

Albert Owen: It moves to Wales, actually.

Alistair Buchanan: Pardon me. To Wales. Good comment.

That is the situation in Ireland and indeed the Moyle Interconnector is 50% off this winter for repair. Let’s have a look at near-Europe, something that we have never had to do in any kind of detail before. Belgium is currently structurally in deficit. In a cold winter it would need 14 GW; it can deliver 12 GW at the moment. Two of its nuclear power stations are out. They have been structurally out now for nine months. They are due to come back in three months but if you talk to those in the industry there is great concern about whether those plants have longevity and Belgium anyway is following Germany’s lead to start decommissioning its nukes from 2015. So we have in Belgium a structurally deficient neighbour. If you then go out to the next ring, you have in Bavaria and southern Germany an area that is now barely n-1, the basic technical requirement for security of supply. I spent some time in Germany just before Christmas. The expectation is that south Germany will be around 14 GW to 15 GW short of power by 2022 unless there is vast interconnection built from the north of Germany and/or neighbouring states to bring that in.

So then we start to look at where the constraints sit. There are massive constraints between Holland and Belgium, which is one of the reasons why Holland can’t currently resolve a lot of Belgium’s issues. There are massive constraints between Germany and Belgium and they need to build a new line. If we look to our colleagues in France-of course there is just one 2 GW wire to France-France starts to be very interesting play. If you look at the assumed flows and if you are speaking to Germans they are assuming that the flow from France to southern Germany will increase by 25% over the next 10 years, so the Germans are assuming that the flow is going to go from France to Germany. The Belgians desperately need power, frankly from anywhere, and of course we are building a wire to Belgium, which is a rather interesting concept right now. So what we are looking at here is saying, "Right, the concept of interconnection is an easy one to say and everybody generally tends to agree with it. Yes. Isn’t interconnection good?" Well, yes, but you have to know what you are interconnecting to and you have to understand what the pressures are on them, what their technical constraints are.

It is a long answer but to me this interconnector debate, and it is true of gas as well, is one that has possibly not had the focus that it should have had. Coming back to the comments that you opened with, one of the reasons why I wanted to make quite a big play on it last week is that I think we are going to have to understand our neighbours’ power policies, which is your side, and our neighbours’ power flows, which is more our side, more than we ever have done before.

Q3 Chair: Just to be quite clear on the interconnector point, the interconnectors are commercial enterprises in their own right and they make their money out of the difference in the price between one market and another, and so the flow is determined entirely by whether the price is higher on one side or the other. So if there was a situation where we faced a capacity crisis here but the prices of electricity were even higher in the other markets, the interconnection flow would be away from the UK to the other markets.

Alistair Buchanan: That is correct, and there are two additional things that one has to bear in mind here. The first is the way technical constraints can block what would appear to be a logical pricing flow, so you just can’t technically achieve that. The other issue is contracts. We have seen this in the gas market. If somebody has signed a long-term contract then it will flow as per the contract rather than going to get the best spot price available at the time. If we look at the gas market, the great concern, which we flagged up in our report to Brussels in 2005-06, was that when gas left Britain the gas did not come back to Britain when the price was higher in Britain. Although it was very difficult to get any evidence at the time-the transparency of information is better now than it was then-we believe that certain member states imposed their public supply obligation and stopped gas from flowing from their country for fear that they would be short, so they did not allow that gas to flow back to Britain. As you know, we are now doing another investigation with the Dutch and the Belgians looking at gas flows to ensure that the movements appear to align with what the market would suggest rather than any other behaviour.

Q4 Chair: Do you think the Government is doing enough about maintaining capacity?

Alistair Buchanan: Through its two packages, the electricity package and the gas generation package, I think the Government is clearly flagging up that it is taking gas generation seriously. It has to, to a certain extent. It most definitely has recognised that. Its own words are, "We face a serious security of supply challenge". They are not mine; they are their own words. So they are obviously looking at addressing that. This is a short to medium-term issue. Short term, do you have a capacity mechanism that you can kick in in time? Tucked away in the "Gas Generation Strategy" report in December, on page 32, is a very important paragraph where both the Government and the civil servants have given themselves the ability to use the capacity mechanism in a very quick and dirty way. I think it is paragraph 3.28. They recognise this by saying, "It would not be ideal to have to go down this route" because you would probably not be able to entice new generation in, because you are solving an immediate problem, and you are probably not going to be able to have a really detailed and worked through auction mechanism, which again is obviously something you would rather have. So, on the very short term, if there really is a problem, the Government has given themselves the ability to act.

They have given themselves the ability to act on the short to medium term in the electricity security of supply report by discussing a capacity mechanism that will kick in in four years’ time. They are still working through the nuts and bolts of that. Andrew has more detail there. But here they are talking about demand side being able to get hold of the capacity mechanisms as much as supply side. Is it going to be for all generators? Will those getting a ROC get it? All those things are still to be decided. But to answer your question, fundamentally I think the Government has responded with these two mechanisms. They have provided for a quick and dirty if they need it and then they have provided for a more thoughtful, mechanistic capacity mechanism to kick in, in their terms, around 2017-2018.

Q5 Sir Robert Smith: I should remind the Committee of my entries in the Register of Members’ Interests to do with the oil and gas industry, in particular a shareholding in Shell.

Your analysis shows there will be a lot of pressure on gas generation. Of course gas generation uses gas as a fuel from another network that is also becoming more open and changing in its structure. Obviously it is crucial to keep the gas pipes full of gas otherwise you get into a serious problem. Have you done any modelling?

Alistair Buchanan: We are doing gas price controls at the moment, and that is both the local distribution companies and the supergrid. So we will ensure that certainly as far as the network is concerned, that is a highly functional proposition in order to maintain gas. I think that is what you are driving towards. I am not sure.

Q6 Sir Robert Smith: That maintains the pipes but does it maintain the molecules?

Alistair Buchanan: In terms of-?

Sir Robert Smith: Gas flowing into the country.

Alistair Buchanan: Around that period 2015 to 2020, the routes to market for us are not going to be UK shale, are not going to be European/Polish shale and almost certainly are not going to be American shale either. We can discuss all of those in turn. Russia will have increased its gas into the EU, and of course there is the North European pipeline being developed from Germany across to the coast in Holland. There will be an increase but nothing like the increase we were expecting. So, Russian gas is going to go up from something like 150, 160 bcms now to 185. We were expecting 220. But there is no Shtokman Field. Some of the fields in western Siberia are a bit later than we thought. Turkmenistan is delivering quite a lot less than we thought. It is not coming from there either. So where is it going to come from? It is going to come from LNG. We have great facilities for LNG, as you know: Milford Haven, Isle of Grain, Teesside. Without going in detail into the presentation, when you look at the LNG market there is a tightness in that market around the period 2014 to 2018 and 2020. That is because these huge physical projects are not coming on but the demand for LNG continues to grow, both from us and around the world. So you have that tightness in gas at a time when we have tightness on our power supply and it is really uncomfortable.

Q7 Sir Robert Smith: Tightness on the power supply is uncomfortable to the point where you are concerned about meeting the needs but obviously also it will put up prices. Is the gas tightness a price concern?

Alistair Buchanan: It is a good question, a very good question. Personally I think it is more about price. I think you will be able to get the gas but it is more about price. If you look at BG, GDF Suez, Total, they can all see it. In Australia most of the fields are coming on well delayed from where they were meant to be; East Africa is taking its course. So you know where the major new fields are coming on. There is an expectation that you will get the gas but there is going to be a squeeze on the price. That is the uncomfortable issue there.

Q8 Dan Byles: Mr Buchanan, last week you made some very interesting comments about the possibility of the UK reneging on our LCPD commitments and keeping existing coal plants open. I know you made those comments with some heavy caveats. Do you really see that as a distinct possibility? Would that not be open to some quite strong legal challenge from other operators?

Alistair Buchanan: There is a very clear page in my presentation where I say it is very difficult to renege, rather than a suggestion that the Government could and/or should renege. I have to be very clear about that. Irrespective of your side of the fence, international reputation management, judicial review, I think you then have some very interesting issues within the sector.

Q9 Dan Byles: And the interests of operators who have already invested.

Alistair Buchanan: If you are an operator and you have invested a billion quid to clean up your plant and your thermal efficiency-how much output you are getting for the input-falls typically by, what, 5%, I don’t think you are going to be thrilled that some of the dirtiest coal plants, maybe oil plants, get some money from us and then can run at a higher thermal efficiency. That is a concern. There is another legitimate concern about a lot of this plant. The example I used last week is if any of us has a really old car and we know that we can’t even get a resale value on it, we are not going to spend any money on it at all probably, we are just going to run it into the ground. If we were running any of these businesses, why would we spend any money on keeping a plant going that we know has to close. So part of the issue here is that the plant has not had a lot of love and attention because it is being wound down. Some of the plant may already be cannibalised. Certainly, for example, on a gas-fired plant that has closed early, not coal, they have withdrawn the nitrogen and that means it is starting to rust in parts. I asked an engineer on that plant about regenerating it and he said, "Well, you can’t". It is going to be very, very difficult to do that.

Q10 Dan Byles: Just to be clear, in your comments last week you were not really raising that as a possibility? You were discounting it as a possibility and giving the reasons why?

Alistair Buchanan: Yes. It is a very fair question. It is one of the most frequently asked questions I get. What I wanted to say was, "Look at all the issues you are going to have to resolve in order to get to that point".

The second question that then comes, because we all very focused on 2015-2016, is that bear in mind we have 28 GW of coal today. Only 8GW have gone. You have another 20 GW behind that that are going to have to meet the Industrial Emissions Directive, another very expensive moment in the life of a company that owns a coal-fired plant. To the best of my knowledge, only six of that 20 so far have signed up to clean up. So you are going to have another wodge of plant closing, and it is not just going to be coal this time, it is going to be gas. So the question that again is legitimately asked of me is, "We can’t do the LCPD, that one has gone. Is there any way that we can go back and have a look at the IED, which is meant to kick in around 2022-23?" That may be a legitimate area for debate but it is one that I suspect both Andrew and I feel is on the edge of where we should be making a comment. We can observe and hand it back to you.

Q11 Albert Owen: Before I go on to consumer protection, can I pick up one point you said about gas and the tight market? In your statement last week did you talk about gas storage at all? We seem to have been talking just about building new plant, increasing production, where we could be storing and maybe the price would be affected by that.

Alistair Buchanan: We did, and I did, talk about gas storage because it is one of the areas that the Government is now looking at and will be making a further statement in May, following its gas strategy report in December. We were hired as a consultant to the Government to give them advice on gas storage and/or public supplier obligations and/or cash-outs. In other words, the Government is looking holistically at what it might want to do in the light of the gas report that we gave them, which they then published in December. So it is being looked at. It is probably best asking them as to where they have got to on that.

Albert Owen: We are asking everyone that, don’t worry. We will get round to them.

Alistair Buchanan: We are providing them with the inputs.

Q12 Albert Owen: Can I move on to consumer protection? Are you confident that you have the public trust in this? A lot of the public opinion polls say you do not protect the consumer interests. Prices have gone up, you are making statements, the prices are still going up and consumers are being hurt by it because they have tight incomes and families. My question to you is do you have enough teeth to do the job and how are you going restore consumer confidence in you?

Alistair Buchanan: This is absolutely to the heart of what we have been concerned about for a couple of years. As you know, our concerns about the security of supply were raised in the autumn of 2009 with Project Discovery. The Retail Market Review was kicked off a year later but we already had the retail probe in place. We are very conscious that in a period of rising prices or pressures on prices that the consumers must have confidence that companies are not taking advantage of them. But more than that, they must have confidence that they are getting high quality information, that there is transparency in the marketplace. As you know, both you and we had a major run-in with the industry two years ago. They have sought to recognise that, doorstep selling, 65-day rule. They have come forward to us and basically said, "We will pay the fines. We will settle. We have made mistakes." As you know, we have a number of very high profile cases still going on. All of that suggests that the industry-and this is really important-has gone through the moment of denial and anger and is trying to resolve their relationship with the consumer. I suspect you have a much better feel for that than I do and I suspect they have a long way to travel.

Q13 Albert Owen: I agree with you that we both put pressure on them, but it was in your original remit that you protect the consumer. Why did you wait this long before you started coming out about complicated tariffs and everything like that?

Alistair Buchanan: I think it is a very good question. In 2008 we issued the retail market probe, which was focused on three broad areas. One was pre-payment meters, where the companies were abusing their relationship, and off-gas grid, where they were as well. We got £0.5 billion back from the companies and they stopped those practices. We also set out a voluntary way ahead, still within the grain of the market. I am afraid in that period 2008 to 2010 the companies did not take that seriously. In looking back, did we make enough noise? Did we get enough powers? Those are legitimate questions for you to ask. But by the middle to end of 2010 we all knew that something was going very wrong. They were mis-selling, they were mis-marketing, they were mispricing, which was the thing that really got-

Q14 Albert Owen: I am not going to let you get away with skirting over that, "Did we have enough powers?" I have asked you this question before and I have asked the Government. I have said to them, "Do you need more powers?" and you are saying that is a matter for the Government. I can remember two Secretaries of State now; I have asked them the same question. "That is up to the regulator to ask for them". So I am going to pin you down now. You are making these statements. You are off somewhere else. Can you tell us honestly whether you have enough powers or whether you have not even asked for those powers but you should have?

Alistair Buchanan: Personally I think we have enough powers currently.

Q15 Albert Owen: You do?

Alistair Buchanan: Yes, I do.

Q16 Albert Owen: Can I ask you then about the off-grid. You mentioned it again so I am responding to your comments. Do you think you should have some powers to help consumers who are off-grid as well as on-grid, because it is the gas market? I know it is a different one under the setting up and privatisation but I think it is an important one. Could you comment on it? I do not think the OFT has the right remit to protect consumers.

Alistair Buchanan: This has been brought up in virtually every session that I have come to here.

Albert Owen: By me, usually.

Alistair Buchanan: It clearly is a great concern for Parliament. As you rightly identify, this area is with the OFT and not with Ofgem. Whether this an area that needs the policymakers to revisit, because you are uncomfortable about that, it seems to me that it just comes up every time we talk.

Q17 Albert Owen: Sure. I need your comment really, because we are putting it to Government. They are setting up OFT inquiries. There is some fiddling around after we had those inquiries; it is not conclusive. What I am saying is the people who are on-grid, the people with electricity, have you as a body, a regulator, to protect their interests. Off-grid they do not. That is unfair and it is unfair to a big swathe of the population. I am asking you, as the head of the regulator, whether you feel you should extend your remit to off-grid.

Alistair Buchanan: It is very dangerous for a statutory body to ask for more powers and you will be the first to say that. What I will say, though-possibly because I am leaving in a couple of months’ time-is that if Parliament were to give us those powers, we would do it the very best way that we could.

Q18 Albert Owen: So it lies with DECC and the Government?

Alistair Buchanan: Yes.

Q19 Albert Owen: I will move on to a couple of other things. The number of complaints has increased considerably. Again, do you think you have the resource to deal with it? The figure that we have obtained is that you have had 56 extra staff, a 47% increase, working on the consumer side and yet complaints are going up and people do not feel confident in it. Would you like to comment?

Alistair Buchanan: Yes. I do not know if you have a breakdown of that staff headcount number, but the majority of the increase there was not on consumer and social policy, which may upset you. It was on enforcement staff because our enforcement cases have ballooned. In the last three years we have had five cases, five cases a year; we are now on 11. Potentially you could add another nine to that, which are at informal review stage. So that consumer engagement has been much more on the enforcement side where we felt we needed to really beef that up.

On the consumer side, we have refocused on that. The deputy head of Consumer Focus joined us. We were really pleased that he joined us. He has provided new focus. The new approach to customer complaints is one of the issues that he is driving through. It is a confused landscape, as you are well aware. There is a degree-I am going to use this word but I may regret it because people will ring me up-of hiatus here because you have the handover from Consumer Focus to Citizens Advice and you have the Regulated Industries Unit sitting somewhere between the two of them. So there has been a concern that maybe issues might fall through the cracks.

Q20 Albert Owen: I will come on to that but a number of energy companies are having increased complaints. What can you, as the regulator, do to say to them, "Get your house in order. Get this sorted."?

Andrew Wright: First of all, there are arrangements in place for handling individual complaints to make sure that the consumers have routes to satisfy themselves if they can’t get satisfied by dealing with the companies, and that is not involving us.

We have a lot of regulations to ensure that companies have appropriate complaints handling procedures in place and have appropriate reporting requirements so that the sort of information that you are talking about is available for people and clearly consumers can see which companies are doing better than others. If they fail to meet appropriate standards, both in terms of complaints handling and in certain areas in terms of customer service, then we do have the option of enforcement against them. Fundamentally it is down to the companies to improve the quality of their service to their customers and to handle these issues. They will potentially lose customers if they consistently disappoint them on the levels of their customer service. But we do have a range of levers to try to improve.

I think one other aspect that is worth pointing out is we are bringing in new, enforceable standards of conduct as part of the Retail Market Review, which talk about dealing with customers fairly and also about dealing with their problems promptly. That will give us additional power to be able to address issues around consumer complaints

Alistair Buchanan: These are published. It is a slightly dark art but I suspect it is one that you would support. Scottish Power stands out in my memory. We will name and shame companies and they will get a lot of publicity from that and they do not like that. That is not good for their competitive position in the marketplace. I think it is very important that their performance is published and that everybody is alive to how well or how badly a particular company is doing.

Q21 Albert Owen: You mentioned Citizens Advice and its new role of advocacy. How do you think that will impact on consumer protection over the coming years? I think I heard you right saying there was a bit of a gap but the CAB is now or will be up and running. Do you think it will improve consumer protection, or do you have concerns that the CAB is not properly resourced to deal with that? It is a first port of call for many individuals but it does not have the expertise, I would argue. I have been an adviser in the past myself. It can deal with simple issues and signpost them in the right direction. Do you think Citizens Advice Bureau has the proper resources, has the expertise, to deal with what you have described as quite complex arrangements?

Alistair Buchanan: I agree. I think Citizens Advice do a fantastic job and we worked with them on the Energy Best Deal. It is absolutely fantastic. The funding is there because we get it through the licence fee, so they will have the money. The proof of the cake is going to be in the eating. They are a very able and very well led unit. I think the issue here is going to be how comfortable they feel-and it might take a few years to work this out-in this much more public advocacy role. It may take a time.

Q22 Albert Owen: Do you think they could lose their independence? Is that what you are suggesting?

Alistair Buchanan: It is quite a unique skill, public advocacy, and it is quite a bruising thing to do. In order to maintain a relationship of a very high level of professional trust with the consumer, when you are advocating as well you have to make sure that you are not in any way going to undermine that. That can be done and if anybody can do it it is probably them, but it is a big challenge.

Q23 Albert Owen: So it is a vote of confidence in them from you?

Alistair Buchanan: Not from me. It is a vote of confidence in them from the Government and I am sure it is very well placed. But as this Committee in particular will remember, had the last Government won the election they were going to look at the concept of a consumer advocate. In some other jurisdictions around the world they do have a consumer advocate and the consumer advocate can be quite an interesting challenge to a regulator. I don’t mean that in a bad way either.

Q24 Albert Owen: How will measure their success? How will we monitor their success in the future? You said about the proof of the pudding is in the eating. As a Committee, how will we be able to say the CAB has done a good job in advocacy?

Alistair Buchanan: That is a very good question. I think you will be looking at the traditional markers on customer complaints, how much is going to the Ombudsman, so you will have all of that data criteria. My guess is you will take a judgment call on how they are leading the consumer’s interest and the consumer’s voice in the debate. I would be very interested to see how you and they have that interaction going forward.

Q25 Albert Owen: I do have one final final, and I should have said it before. With consumer protection, how do you respond to the comments that some are making that you failed to protect the consumer? The Prime Minister had to come to your rescue at Prime Minister’s Questions and say that he was going to single-handedly change the law to protect consumers. Slightly tongue-in-cheek, but I would like a response.

Alistair Buchanan: No, I think it is a perfectly legitimate question. As many of you know, and of course you put in your own report, on the one hand-I didn’t like the expression but it is your expression-"we went like a snail", on the other hand we were incredibly careful and we ticked all the boxes so that nobody could undermine us. You gave us both a hit and a pat at the same time in your report, and I think that is probably true. We were ready to go and everybody knew we were on 19 October. There was no secret about what we were going with. Everybody knew where we had got to because we had consulted until we were red in the face, but we have to because if we don’t the package will get undermined by a process challenge and there is nothing more irritating than that. That is where we were. The Prime Minister went with his package, or his quite a narrow package, on 17 October.

Q26 Albert Owen: It is a bit of a compliment that it almost duplicates what you were doing already, inserting it in the Energy Bill.

Alistair Buchanan: Those were his views, compliment or not, that is-

Q27 Albert Owen: No, I am saying the Government has taken much of what you came up with forward into the Energy Bill.

Andrew Wright: On our recent announcement about the decisions of the authority to proceed with the package we certainly had very supportive statements, both from the Prime Minister and from the Secretary of State.

Q28 Chair: Nevertheless, with all the benefit of someone who is about to leave their job, perhaps you could confirm that the Prime Minister’s announcement on that day in Prime Minister’s Questions was as much a bolt from the blue as far as Ofgem was concerned as it was for DECC?

Alistair Buchanan: Yes, I was not alive to the fact that there was going to be that statement. I was in front of the Public Accounts Committee that day and it was of interest to them in a sideline to the meeting as to whether I knew or not. But we did know that No. 10 were reviewing their options. There was no surprise in that, there was no secret in that; they had been talking to Andrew and his team. We just didn’t know exactly what it was and when they were going to land it.

Chair: I should also remind the Committee of my interests in a number of energy-related businesses.

Q29 Mr Lilley: You mentioned 100,000 complaints. There is a complaint that is much more widespread than that by most households and that is that their energy bills have gone up. Are you in a position to tell us and them what proportion of the rise in household electricity and gas bills in recent times is the result of an underlying increase in the cost of fuel, to what extent is it an increase in other costs, including costs imposed by Government but costs that they bear, and, thirdly, an increase in their margins? A lot of people we met in Scotland-admittedly they were not representative of ordinary people but they may have represented ordinary people’s views-think that the companies’ margins have shot up and that is the reason. Could you enlighten us on those?

Alistair Buchanan: Yes, I will try to break it down and put a bit of history in as well. Let’s start with the network charge. That is my core business. If somebody said, "What is your widget?" it is a price control; that is what Ofgem is responsible for. It is 25% of the bill. Those bills had been dramatically cut for-

Q30 Mr Lilley: Could you just spell that out in English?

Alistair Buchanan: Yes, that is pipes and wires. The pipes and wires-

Mr Lilley: The cost of the pipes and wires, not the-

Alistair Buchanan: The cost of the pipes and wires is 25% of your bill.

Mr Lilley: Yes, and that does not change from year to year?

Alistair Buchanan: It does and this is something that is not good news for the price but is very important for the integrity of the network. From 1993 to the 2004 price review prices were cut aggressively, mainly because the companies had been deeply inefficient. What then became very clear was that a lot of the kit that had been put up after the Second World War needed replacing.

Q31 Mr Lilley: Would it be that costs were cut across the-

Alistair Buchanan: Yes, costs were cut. Everything was cut in fact. The companies were squeezed. If you think of it like a lemon, under RPI minus X we just squeezed. It was great price control for its time but not any good any more, which is why we got rid of that price control and moved to RIIO. The reason I say all this is that the network charge-

Q32 Mr Lilley: RIIO being-?

Alistair Buchanan: RIIO is the new methodology. This is a methodology that basically is rewarding companies for-

Q33 Mr Lilley: Is that RIO? What does it stand for?

Alistair Buchanan: RIIO, yes. Your revenues are going to be derived from incentives that we set, innovation money and how innovative the company is, but critically-and I think the Committee will like this one, it goes back to what Mr Owen was asking-is that you will be valued on your outputs. Annually your outputs will be published; we will see what you are doing as a company. Why this is so important on the network charge is that network charges are going up. They are going up because we are having to reconfigure the network. If you think of gas, it now comes in through Wales and through the Thames, not so much through Scotland. You are having to reconfigure the gas network, totally reconfigure the electricity network. You are connecting wind farms, generally in remote places, and maybe nuclear stations, generally in remote places, so you are having to reconfigure.

The network cost, unfortunately, is going up. It is about £250 and let us take £1,000 as the bill price-it is a little bit higher than that at the moment-so £250 in network. That is going to go up towards £300 over the next eight years. I am afraid the network side is going up. What about the e-charge? The e-charge for an electricity bill at the moment is 11% and rising and that’s basically all the environmental schemes that the Government has put in place. It is a little bit less than that for a gas customer, but broadly it is about 10% of your bill and that will be rising to about 15% of your bill within the next five years. These are all the Renewable Obligation Certificates, your energy efficiency schemes and so on, so that is going up as well and in fact it is taking quite a big step. If you talk to any of the companies they will-and don’t take any enjoyment out of it-confirm that you are sort of jumping from about £100 to £150 on your e-charges, so that is that.

On your wholesale price, when we look forward at the moment-if I look at Platts but it’s not a great indicator-if you go two years out on electricity, the winter forward price is 10% higher than where it is today. But that is not a hugely liquid market two years out when I come back and talk about liquidity, but nevertheless the forward curve is up. Where does that leave your margins? The latest information that we have on margins for the retail customers, where most of the focus goes-what is my supply company earning-in the last full year the retail companies saw their margins fall from 3.8% to 3.1%. We are just about to start another results round, in fact starting this week with British Gas Centrica, so we will be able to redo these numbers to see where they are in terms of the financial margins that they are taking. But in the last financial year they fell and so the margin for the customer was £33 for a supply company, so that is where we are.

The generation companies made a bigger margin, particularly nuclear and coal. On the gas side it is virtually impossible to make any money at all if you own a gas-fired power station. It is very tilted in generation towards if you are a nuke because, of course, you are base load so you are getting all the price above base load, and coal because coal has benefited from the collapse in coal prices from $120 to $85, therefore your dark spread is very generous. This is exactly why we have this problem with capacity that we were talking about earlier because the coal-fired plant that was meant to run to the end of 2015 has used all their hours up. It is so economically beneficial for them to run now that they are just burning themselves out of existence. I hope that has given you a flavour of where the pressures are on the price. It is not comfortable.

Q34 Mr Lilley: I was not so much asking about the future, although it was extremely helpful, as the past year or two. Certainly the people in Scotland thought it was primarily the energy companies that had increased their profits and that was why their bills had gone up by 25% or whatever it is. But if you are saying the margin at the distribution end is somewhere between 3.3% and 3.8% that would astonish them.

Alistair Buchanan: That is on the supply side. On the network side we set the allowed return. So, regulated is networks, we set the return, which has been for the distribution companies about 4.7% post-tax cost of capital. It is very competitive in terms of return. Then on your retail side I have given you the margin figures and on your generation side there is a very big difference. It depends what you run. If you are running-

Q35 Mr Lilley: Could you average it over the grid as whole?

Alistair Buchanan: The average generation figure net margin is about 24%.

Q36 Mr Lilley: 24% of what?

Alistair Buchanan: That is your operating profit margin of sales.

Q37 Mr Lilley: That would be 24% part of the total household budget.

Alistair Buchanan: Indeed, but we try to separate them so that we can give confidence.

Q38 Mr Lilley: I am thinking of the chap who is paying £1,000 a year. How much of that is going in profit?

Andrew Wright: In terms of the supply business’s profit, as Alistair said, it is between 3% and 4%, and in terms of-

Alistair Buchanan: It depends what generation you run.

Andrew Wright: It depends what generation you run.

Alistair Buchanan: If you are a nuclear operator you will make a profit, if you are a gas operator you won’t.

Q39 Mr Lilley: I buy electricity; I do not buy nuclear electricity. It all comes out; it is all electrons as far as I am concerned. I want to know what the average profit is as a percentage of my bill.

Andrew Wright: Right, but for the average profit as a percentage of the bill you also need to look at the capital employed there and-

Q40 Mr Lilley: No, I do not. I just want an answer to my question, so I am sorry. Why are you so reluctant to give it to me?

Andrew Wright: We can come back and give you a number for that based on the segmented accounts that we are provided. For all segments, the average margin is 7.6%. That is simply the straight average of generation and retail, according to the segmented reports.

Q41 Mr Lilley: All this emphasis about different tariffs is talking about modulating as 7.5%.

Andrew Wright: No, I think it is more than that and we would be more ambitious than that. It is worth noting that about 15% of the bill is the supply business’s operating costs, their sales and marketing costs and their profit. If competition is not working well it will not only potentially impact the profit, it will also impact the efficiency of the companies. We think there is probably more to go for than just these few per cent.

Mr Lilley: That brings me to my next question, if I may, Chairman.

Q42 Sir Robert Smith: Can I clarify something? You said in answer through that exchange on the £1,000 bill that 3% was the supplier, but isn’t the 3% margin on their chunk of the bill?

Andrew Wright: Yes. The 3% is on the total bill and it is a percentage of revenues and it is not on their value-added bit, which would be a higher figure.

Q43 Sir Robert Smith: So their margin on their actual operation is higher than 3%?

Andrew Wright: On their value-added, if you take their pass-through costs, if you like, the purchase cost of electricity, the environmental cost, then it would be significantly higher, yes, which is one of the reasons why we don’t go as far as to say that 3% is a low level of profitability. We have never said that but it is on a-

Q44 Sir Robert Smith: Just one other thing, from the consumer’s point of view, as Peter was saying, they do not really want to know all the breakdown and the detail, they want to know if someone is making-

Dan Byles: How many pounds out of that £1,000 is somebody’s profit somewhere in the system?

Sir Robert Smith: They then also see the brand connected, sent through companies who have the whole vertically integrated, so while the supplier is not making a great margin, the overall company quoted on the stock market is making a big profit.

Alistair Buchanan: Indeed, and I think we have to be quite careful there. I see no reason, with the data that we have, for not sending you a table showing you the pounds and/or percentages. We are quite happy to do that. I think we have to quite careful, though, with the link to the Stock Exchange. Reading the Sunday newspapers, the inference was-if they know and I am not being rude to them but it may be different tomorrow when British Gas Centrica bring out their results-that the real driver of the operating profits for the group appeared to be non-regulated and North American. We will have to look very carefully to see where a headline "X% profit" has come from. I don’t mean to be picky but I think it is quite important.

Sir Robert Smith: But difficult.

Alistair Buchanan: Oh, indeed.

Andrew Wright: Most of the big six companies are international companies with very diverse businesses across the value chain and there are many things moving in terms of their profit numbers. I think it is worth saying that we do as much as we can to provide consumers with transparency on this issue. Not only do we provide our sort of spot and forward looking indicator through the supply market indications that we publish every week, retrospectively we publish the segmented accounts of the companies, which the companies themselves were not putting into the public domain. On top of that we also provide energy fact sheets that provide the breakdown of the bill in a more easily digestible form as well. I think we do an awful lot to try to make this information available to consumers in a transparent way.

Q45 Mr Lilley: Clearly, if the overall margin profit is 7.5% say, the maximum you could reduce the household bill, which otherwise was £1,000, by saying companies may make no profit would be by £75. The other thing that would then happen would be no one would ever invest in providing electricity and gas in the future, so this would be a silly thing to do. If you had nationalised it you would still have to provide the capital and there would have to be a return on it to the people you had borrowed money from. The amount by which you can squeeze margins is small but, as you say, competition, if it can be made to operate, can reduce costs of the gross margin, not the net margin, which can over the long term dwarf any variations in that net profit margin.

Have you seen Stephen Littlechild’s latest comments on the impact that restricting companies’ abilities to charge different tariff levels will have? He points out that The Sunday Times did a review and came up with the best tariff for household domestic consumers. I forget what it was called, but that is now going to be prohibited by the regulations that the Government is introducing that mirror those that you proposed. Can it be good for competition that you prohibit the most competitive tariffs?

Andrew Wright: First of all, we just wanted to highlight that we don’t prohibit the most competitive tariffs. There is nothing in our proposal that will stop companies providing low-cost tariffs for their consumers.

Mr Lilley: But this tariff would be.

Andrew Wright: The reason this tariff would be prohibited is not because it is low cost. It is because it was complicated and it is very difficult for consumers to work out what they would be paying under this tariff, given the complicated mix of discounts, some of which were time limited, and the limited availability of it, only available through certain routes. The reason we are doing this is because we had a very clear message back from our consumer research that one of the main reasons they were inhibited from engaging in the market is because they found it too complicated. There were too many tariffs, those tariffs were too complex and it was very difficult for them to make comparisons.

We are seeking to tread the fine line between simplifying the market to make it easier for consumers to engage and to increase the number of consumers that participate, while at the same time providing full commercial freedom for the companies to compete on price, service and other features. We think we have struck that balance right, and the companies have varying views on that but our view is that our proposals would increase engagement and increase competition in the market, not reduce it.

Q46 Mr Lilley: Are you saying that you think that consumers are too stupid to read The Sunday Times, see that for a typical average consumer this was the best buy and therefore it is worth removing this offer from the market so that they can be enabled to choose less good things more clearly from a narrower range of options?

Andrew Wright: No, I am not saying that. I am probably saying that I am too stupid because I think it is not clear what this offers to consumers. It is a variable tariff so the price can be increased with 30 days’ notice. Despite the fact prices can be increased unilaterally, consumers will be locked in with an exit penalty for, I think, the first year on the tariff. There is a discount of 11% for the first year and 2% thereafter, so that is a variable tariff that could change. It is very difficult for consumers not only to even determine what they would be paying under that tariff, let alone compare it with their current tariff.

It is worth saying that, according to the story in The Times on Saturday, which I have not been able to confirm since, the company has since withdrawn that tariff under pressure from Consumer Focus. If that is the case, I think that is probably a good thing because it is very difficult for consumers to understand what is going on with tariffs such as that. I don’t particularly want to pick on SSE here because there are many companies with similar tariffs in the market. We are trying to make it easier and simpler for consumers to engage. We think that will be good for competition. Our proposals don’t restrict innovation in any serious way, nor do they stop companies offering cheap deals to their customers if they want to win them.

Q47 Barry Gardiner: Mr Buchanan, if it is indeed your last appearance before us, can I say I was very pleased that-

Alistair Buchanan: I am leaving?

Barry Gardiner: No, I was not going to say that. We may have had our spats in the past, but I was going to say I think what you presented to the Committee at the beginning today was an absolutely magisterial overview of the pressures facing us as we go forward and I think that is extremely helpful. There are a lot of people who should read it very closely and I certainly shall reread it. I want to turn to probably a more boring subject, which is transparency. I will try to keep my questions to you fairly short and if you can respond in kind then we will try to get through it.

At the moment energy companies can participate both in speculative trades for the pursuit of profit and non-speculative trades for the cost-effective management of their supply to consumers. At the moment they are not required by you to report the results of their trading. As a result of that there is considerable scope for the companies, some say, to give a misleading picture of their genuine generation costs and, some would say, to under-report their overall profitability. At the moment what I am asking you is, is that a fair setting out of the criticism that there is a lack of transparency here?

Alistair Buchanan: I think we have gone a long way to improve the-this is, effectively, getting to reporting and accounting of transparency. For those members of the Committee and following this, we were very concerned when the companies hit their very rough patch in 2010, early 2011, to get additional comfort that the companies, in addition to mis-selling, misrepresentation, mispricing, were not also playing hooky with our accounts. We hired BDO as our consultants to have a look at the companies’ accounts and they came back with three statements. Firstly, that the companies are playing it straight with their accounts, secondly, that they are not abusing any international accounting methodology, but that in some areas it is deeply confusing and difficult to get to the bottom of. One of the areas that they alighted on was trading. They made eight recommendations. We took five of them, we rejected two of them, and the one that sorts of sits in the middle is trading.

With trading we took the view that they had to identify where their trading sat but we did not take it to the next level, which was to say that we, effectively, wanted them to give disclosure because we felt, as a board-and this is where a board is very useful because you get people coming in from a range of different backgrounds-that this was starting to move into an area where legitimately a company could have speculative trades, could have a range of trading instruments that a downstream regulator, questionably, should be involved in or not. BDO looked at what we required and they said, "Broadly, we would suggest that you might do it another way but in going down the route that you have chosen-"

In fact, so concerned was I about BDO that I went and got further comfort from them last November, when the issues in the gas market and market manipulation were around, and they gave me comfort that in pursuing the route we had, rather than the route they had suggested, that we would not have had extra information. It is the only thing that I have brought with me today but I think it is very important, "BDO advises neither the approach we took nor their original recommendation would have given Ofgem sufficient information to identify or investigate wholesale gas trading irregularities". This is a very interesting area as to whether we should be moving further into this area and I welcome your view on it.

Barry Gardiner: If that was the short answer that I asked for, I am glad I did not ask for the long one.

Alistair Buchanan: It is such an important issue and I know exactly what you are driving at.

Q48 Barry Gardiner: What I want to do though-and I think it is probably helpful for the Committee and certainly for anybody watching the Committee-is to try to take it at a segmented pace here, because what you have given is a very comprehensive overview of what happened and what the response was. Let me just focus in on what you said about trading. The trading arms of the vertically integrated companies were implicated in fixing of the benchmark price for gas. That was the ICIS Heren report.

Alistair Buchanan: Yes.

Barry Gardiner: An unusual trading activity reduced the price of gas just before the end of the financial year that they did that. That type of activity was precisely what enables the big six to reduce the cost of gas relative to the price paid by independents, creating further barriers to market entry. Is that not the case?

Alistair Buchanan: I know you would not expect me to be able to go here at the moment because you have already made a number of inferences and this case is live. I am not even allowed-

Q49 Barry Gardiner: Sorry, let me then take ICIS Heren out of this. I want your comments, not on the specifics of that case. I want your comments generally on the capacity for trading arms of vertically integrated companies, their ability to engage in such activity as I have just outlined and, as a result of it, your comments on the scope that they-

Andrew Wright: Are you just talking about their ability to potentially take profits or remove profits from the reported segments into an international trading arm? I think that possibility exists and it would be wrong of us to deny that. However, it is worth saying that BDO said they were confident that speculative trading activity had been kept out of the supply and generation profit, so I think that gives us some-

Q50 Barry Gardiner: I know, Mr Wright, that both you and Mr Buchanan have been very keen to bring in that clean bill of health report at various stages here.

Andrew Wright: I would not go as far as saying it is a clean bill of health, but I just wanted to say, first of all, the challenges we would face in doing this. These trading arms are international businesses. The trading arms of many of these international companies cover, let’s say, for example, the whole of Europe. They are unregulated activities as far as price controls and so on are concerned. There is the question about our powers to be able to get access to this international information.

Barry Gardiner: That is where I want to come to. That is exactly where I wanted to come to.

Andrew Wright: Then there is the question of what would we do with the information, if we had it, given it is outside of our vires about how much money they are making and trading in Europe.

Q51 Barry Gardiner: Again, by preference I would have taken this much more slowly, but in seeking to be comprehensive in your response to one part of the question you are sort of jumping ahead of me here. The BDO report that was prepared for you recommended that, "Ofgem required the reporting of trading function results, including disclosure of the risk each trading function assumes as part of the companies’ segmented accounts". That, in particular, is one of the recommendations that you have said you do not intend to take forward. Correct?

Alistair Buchanan: Correct.

Andrew Wright: Yes, correct.

Q52 Barry Gardiner: You put it out to consultation and in response to the consultation questions the Consumer Focus response certainly to that was that, "The consultation assumes that the costs will outweigh benefits were this recommendation to be taken forward but it does not plausibly quantify either. We feel that the benefit from increasing short-term comparability to the efficient market operation could offset the additional accounting costs." The first thing is I want you to deal with the issue that they have raised as to whether this was a cost benefit issue from your point and then I want to come, separately if you will, to the point that Mr Wright just raised about your powers.

Andrew Wright: I think the two are related. The cost benefit issue is that this is a difficult international business to get your arms around, so the cost of getting that information would be significant. Due to our potentially limited powers in getting access to international information, it is still the case that we will be just shifting the boundary out to whether or not companies can move profits across international borders, for example. Given those questions, the benefit of having that information would be limited. There is the question of what we would do about it if, for example, we did find that one of the companies was making an awful lot of money in power trading in its European power trading arm. So I think that is what we meant by that. I think Consumer Focus is right that there was not a precise quantification of that.

It is worth saying that to make progress in this area you have to start telling companies how to organise their business. You have to start ring-fencing those companies. The approach we have taken is that, because these are companies operating in liberalised, competitive markets, transparency is one thing but then telling them how to run their businesses to aid that transparency is another, and that is a bridge that we felt was not appropriate in this work-stream.

Q53 Barry Gardiner: Thank you. I think that is extremely helpful. Do you see any parallel between this aspect of your drive for transparency, inhibited by your lack of powers to instruct a company as to how to structure their business, given that it is a global business, and what has been happening in the banking and financial sector over the past month or so?

Andrew Wright: There may be some parallels, although it is worth saying that we are starting from a point where I do not think we have any particular evidence to suspect that the profits are being artificially massaged down by companies taking profits out into their trading sector. But I think there are some big questions that you are raising. Fundamentally, these are companies operating in a competitive arena and there is a question about how intrusive a regulator should be in telling companies how to run their businesses in that sort of framework. Once again it comes back to Alistair’s answer that if you want to move towards a more intrusive approach then maybe that is something for Parliament to consider. But it is not something we think is appropriate for a regulator operating in a competitive framework.

Alistair Buchanan: I think this is a very big challenge for Ofgem, for the Select Committee and for the Government going forward. In a way it does come back to what I opened with. In one of my previous jobs I worked in New York and I followed American utilities. One of the things that was very clear to me as an investment analyst, which was my job, was that as you got pan-state regional markets created, as the markets talked to each other, that a number of companies that had companies in either jurisdiction could take tremendous advantage of the arbitrage because the local state regulator stopped at Connecticut’s border or stopped at New York’s border and FERC in Washington had no real responsibility. Their responsibility was for super grids, transmission, and was not for the interface between states. I think we are at the cusp now of seeing what is going to happen with regards to the European regulator, ACER, and their powers because I think this is touching on a really important pan-European dimension. At the moment ACER are doing a good job but they are a small outfit in Ljublijana with some very able people. How are they going to be able to assert some kind of control over the 27 member states and massive conglomerate style utility companies as Europe starts to talk more and more? I think one of the leads here to us is going to be how well or how badly the member states carry out the provisions of REMIT. I think this is really important.

Q54 Barry Gardiner: Can you talk about the additional powers that you are being given under EU REMIT Directives and will they be sufficient to address the type of manipulation that we are talking about here?

Andrew Wright: I will start with the powers under REMIT. REMIT are European-wide regulations to address market abuse, which is market manipulation, insider dealing, in parallel to laws that already exist in the financial sector. The prohibition against those activities already exists and has done, I think, from the end of 2011. There is a process under way where we are being given the powers to monitor and enforce. A lot of the activity under REMIT is being taken on by ACER. There will be eventually routine collection of information on trading activity by ACER, which will make it easier for us to investigate and monitor and detect market abuse than it is at the moment. All of that is under way. The Government is working closely with us to ensure that we have those powers without delay and also we are working with ACER to ensure that the market monitoring functions of ACER are in place at the earliest opportunity as well.

Q55 Barry Gardiner: My question, though, was about the sufficiency of those powers to address the type of manipulation that we are talking about.

Andrew Wright: They are sufficient to address what they are designed to address, which is market manipulation and insider trading. They are not designed to provide pan-European transparency on the profitability of trading activities and whether or not the reporting profitability of supply businesses is being manipulated down. We will not be able to use that information to get a handle on that activity.

Once again, I suppose if the concern is that customers are somehow being disadvantaged by companies’ trading activities, either that losses are being passed through to them or profits are not being passed through to them, then the first way in which we are intending to address that is by making the markets more competitive and ensuring that abuse is not taking place.

Q56 Barry Gardiner: That is one aspect of it, but I think the wider issue here is, what is the capacity of national Governments and national regulators to control companies that spread not just across Europe, but globally, in their reach and in their capacity to show profits in jurisdictions under different regulatory regimes?

Andrew Wright: The framework provided by both the European Union and by the UK national Government is one of liberalised competitive markets covering retail generation trading and the way in which we ensure the consumers do well out of this is through making sure competition is effective. If there needs to be a debate about whether regulation is to play a greater role in these markets then that is one I am sure we would be happy to engage with, but that is not the legislative context that we operate under at the moment.

Q57 Barry Gardiner: You are working though, are you not, with the FSA to look into allegations of irregular trade activity, particularly in the gas market? When will you be reporting on those findings?

Andrew Wright: These investigations are underway. We are co-operating with the FSA in getting to the bottom of the allegations that appeared in The Guardian. I am going to prevaricate because these are ongoing investigations.

Barry Gardiner: Okay, stop there. They are ongoing.

Andrew Wright: They are long and they are complex. They will take as long as they will take.

Q58 Barry Gardiner: In that case, let me come back to something that you may be less able to prevaricate on. In July 2011 you imposed a £1 million fine on British Gas for under-reporting the electricity supply to its business customers and that led to a £2.8 million distortion in the market for Renewables Obligation Certificates. If British Gas had not owned up to their error would you have found out ever? How do it go unnoticed for seven years, I suppose is the question? If it had gone unnoticed for seven years, is it realistic to think that you would ever have found out?

Alistair Buchanan: The answer to that is some areas we will find out. It is a bit like auditors can’t promise that they will find fraud all the time. Quite often they find fraud because the financial controller says the financial director is on the fiddle. We have in place an auditing process, a management process; the NAO, as you know, have been over us regularly over the last two years, sometimes under your instruction. Our external auditors and internal auditors do the same thing. Will we always pick it up? No, we will not. Sometimes it will be picked up because another party flags it up to us. I may have to send a correction here if my staff beat me up on this, but I think the E.ON fine at the end of last year was again flagged to us by E.ON and then we had a dialogue with them.

Q59 Barry Gardiner: Just to understand this-and I am not trying to lead you anywhere in particular here, although it may look like it-when you have not found these things out but they then subsequently have been reported to you by the companies themselves and owned up to, is the reason that you have not found them out because you lacked the powers or because you lacked the resource or the competence? I do not mean to put it rudely.

Alistair Buchanan: Resources we feel comfortable with, as we do with competence, because we have third parties looking at us all the time. As you have seen from the report that you commissioned, E-Serve manages £5.2 billion of business, effectively of monies, with Ofgem acting as a clearing house. We try to ensure that we have mechanisms in place. We have risk management, fraud management, internal audit looking to see if there is anything going wrong in all of these processes. Something might. It is a little bit like we are a small audit firm for half of Ofgem and we do our very best. There will be, therefore, items that get brought to our attention by others, which we have not picked up. We have to acknowledge that. Would we like to have picked it up ourselves every time? Yes, we would.

I would like to come back to you on your question on powers, because I would like to go back and have a look at the cases. I think that is a very interesting question as to whether something happened because we were not looking because we did not need to. I would like to pose that to my SMT and come back to you on that. We will send you a written answer.

Q60 Sir Robert Smith: Is there an incentive for them to own up?

Andrew Wright: Yes, there is an incentive for them.

Barry Gardiner: A fine of £1 million where they have made a £2.8 million profit.

Andrew Wright: There is a very strong incentive for them to own up. I think first and foremost regulatory reporting is critically important for the functioning of this market and I think companies know that any deliberate regulatory mis-reporting will be taken very seriously. Secondly, our enforcement guidelines make it very clear that the more companies co-operate with our investigations and are straight with us then the better they will be treated subsequently, so the relatively modest size of that fine reflects the fact that Centrica came forward.

Q61 Chair: I raised privately with British Gas an issue about consumers who were paying by direct debit being debited twice for the same bill, and I was informed this was a very unusual event. Unfortunately, I was one of the consumers who had suffered this experience. My particular concern was that the second debit occurred on a Friday and the money was returned on a Monday, which for a quarterly bill that may run to several hundred pounds for some households could cause acute financial distress over a weekend period. Is there any mechanism for you to know about that, other than obviously a consumer making a complaint, and is British Gas under any obligation to reveal to you that they have done that to their consumers?

Andrew Wright: The key mechanism is through the company’s own complaints handling and reporting procedures, which should register complaints and that should be reported through us and come through in the statistics, with some potential breakdown of the cause of those. Periodically, we have in the past looked closely at the company’s processes around direct debits, asking the question of whether there was any systematic use of direct debit payments to manage cash flows and whether those are being handled with consumers in the best way. So we do obviously periodically focus on very specific issues where we think there are consumer concerns. But it is principally the complaints handling and complaints reporting procedures, not just for us but also other organisations as well, which alert us to these issues.

Q62 Chair: Returning briefly to the Retail Market Review, Mr Wright, you said to us when you were giving evidence on 3 October you expected to have the bulk of the proposals in place by July this year and the measures to be in place by winter. Is that timescale still going to be achieved?

Andrew Wright: Yes, it is. We have just announced that the authority has approved the package and we are going through to the next stage in the consultation. We will be moving towards a statutory consultation some time around the end of March and that will mean we are still on track for those licence conditions going into the licences towards the end of July. It may well be a week or two either side of that. That is depending on exactly what our lawyers tell us about what we need to do for consultation.

Q63 Chair: Have the Energy Bill measures on tariffs made any of your updated proposals redundant?

Andrew Wright: No. The Energy Bill proposals on tariffs, first of all the Bill will not receive Royal Assent until November and it will probably be some time early in 2014 before the Government can make any changes to the licences under those powers. Our proposals will be in place well before that and certainly we have taken our decisions on RMR independently. If the Government wishes to add anything to our proposals or change anything then that is for them to decide when they have those powers.

Q64 Sir Robert Smith: For the stickiest customers with the RMR, you had suggested that companies should be pointing people to the best deal in the market. How will this work and when do you expect the pilot to start?

Andrew Wright: First of all, we said that customers should be pointed towards the best deal in the market. Our proposal was that companies should do that because that aligns with our views, but we were openly consulting on whether that was the best way of doing it. In terms of the answer to your question, we are starting a process of engagement with the industry, workshops to try to put in place all the aspects that are needed to deliver that trial. A whole range of issues were raised, including alternative ways of achieving the same objectives, and we will also be discussing those with industry. The idea is to come back towards the end of the year with a decision about whether we progress with the trial and if we do progress with the trial how we do it, and hopefully we will have bottomed out all of the practical challenges in doing that with the industry over that period of time.

Our key priority is to get the RMR proposals, the licence changes in place for July. We want to get that done and dusted first while at the same time having this debate with the industry about the best way to take forward that trial.

Q65 Sir Robert Smith: So the trial is not dependent on the licence changes but the resources are more focused on-

Andrew Wright: It is a question that we will resolve towards the end of the year about whether it is possible to take forward a trial and whether it is a good idea-it may be that the practical difficulties and the costs are too great-and if we do take forward a trial, whether we do that on a voluntary or mandatory basis. If it is on a mandatory basis, we will have to put in place licence changes to realise that.

Q66 Sir Robert Smith: Are you still confident that the Tariff Comparison Rate will provide a-

Andrew Wright: The Tariff Comparison Rate is still there as a part of the proposals. We think it improves information to customers. We recognise the Tariff Comparison Rate does not always tell a customer whether one deal is cheaper or not than the other. It is an important prompt to customers to get them engaged and it provides an additional piece of information that will help customers get the best deal. But we think a range of options, including suppliers telling customers whether there is a better deal available from them as well on the bill, are important here.

Q67 Sir Robert Smith: How are we going to measure whether this has improved the market?

Andrew Wright: A number of ways. I think this is a question I was asked previously and we will be at some point coming out with more detailed discussions of how we will continue to monitor the market and see whether these proposals are successful. We are, of course, interested in consumer engagement with the market. In other words, are consumers shopping around, are they looking for better deals, either with their current supplier or across the market, and normal competitive assessments such as changes in market share, the growth of small suppliers, those sorts of issues. We will also be asking consumers about their experiences in the market: are they aware of cheaper deals, are they confident of their ability to engage with the market? We will be looking at all those sorts of things to assess the success or otherwise of RMR.

Q68 Sir Robert Smith: If it does not look like people are switching and there is still confusion, will you look again at the standing charge and whether that needs to be regulated?

Andrew Wright: This is to some extent why we want to keep alive this market cheapest deal proposal and also consider other alternatives of providing that at-a-glance capability so that we do have something in our locker. Despite all the significant simplification that we are putting in place and the additional information consumers get, if it is still the case that not enough of them are engaging to provide a realistic or meaningful, competitive constraint on the industry then we do have something else in our locker that we can bring out. I think it is also important because our research tells us already that there are a proportion of customers who will find it difficult to make the choices even with the simplification that we are putting in place. As I think I have said previously, we do think that something additional is needed over and above these licence changes that we are talking about to ensure that the stickiest and most vulnerable customers are properly engaged in the market.

Q69 Christopher Pincher: On the subject of performance measurement, I have your annual reports and accounts for 2011-2012 here and in them you have, on pages 98 through to 100, your four core themes for Ofgem. Then on page 101 you have your eight performance indicators and on page 102 your nine performance indicators for E-Serve performance specifically. Can you explain to me how the themes translate into the KPIs?

Alistair Buchanan: I can do. I think the easiest way for me, speaking to our finance director ahead of this meeting, is we have taken the NAO’s recommendations and placed them into our four core objectives, so we have them listed. I think the easiest thing for me to do is to send them to you and to the Committee, if that works for you.

Q70 Christopher Pincher: But you must know what they are and you must understand why they translate into key performance indicators.

Alistair Buchanan: Yes, I do. I do not have the list with me but I can send them to you. We have done that work.

Q71 Christopher Pincher: Can I ask you a couple of questions about concrete examples and possibly then you can help me?

Alistair Buchanan: Yes, sure.

Christopher Pincher: Theme 4, which is to ensure the timely and efficient delivery of government programmes for a sustainable energy sector, has within it an action that is, "Make first Renewable Heat Incentive payments to commercial participants". Your period for doing that was quarter 3; you achieved it in quarter 4 because DECC delayed the first payment until quarter 4. In the E-Serve KPIs the Renewable Heat Incentive measure is, "To follow up with generators outstanding issues on their applications for accreditation on RHI, the target of which is 90% within 10 working days". How does that KPI relate to the theme action? I do not quite see it myself, having spent nearly 20 years at Accenture when I wrote KPIs for a living.

Alistair Buchanan: Yes, it is either in the E-Serve objective or we are trying to work on value for money, or indeed you could even dump it into low carbon. There is a judgment call here as to where within the four objectives something like this should lie. I think it is a reasonable question that you ask, which is where does your judgment call fall here? I will send you the copy of where we have placed it, but it may be that on a number of these-and we do have this in our internal reviews-will appear under a number of different topics. It is a good comment. Absolutely it is not an exact science.

Q72 Christopher Pincher: You have a number of themes that are, I am sure, very good. You then have a set of key performance indicators, and if the KPIs relate to multiple actions within multiple themes it is entirely possible to say, "We have failed two or three in theme 4 but we have passed one or two in theme 1, so what we will do is we will say that we have met the KPIs because we will succeed on the actions in theme 1 and we will forget about the ones in theme 4." One can’t see the throughput from themes to KPI.

Alistair Buchanan: I think it is a very good point and I will take it away and check with our finance director and head of KPI management. Yes, I can see exactly what you are saying, which is you effectively hide your failures because they affect a number, if not all, of your objectives and just tick off your success because you make it a very easy one. I think that is something that we need to watch.

Q73 Christopher Pincher: Talking of very easy ones, two KPIs that you have related to markets are to consult on and carry out consultations, which suggests that you are consulting on consultations but there we are. "Consult on and carry out consultations regarding any applications made for exemption from third party access arrangements under article 22 by prospective storage and interconnector operators." The target was 100%, the actual achieved was 100% but you achieved that because no applications had been made during the year. I would say that your actual was "not applicable". You can’t say you have achieved something because nothing has happened, can you?

Andrew Wright: I think if it had happened it was important to achieve that objective, but we have had those applications in previous years and dealing with them in a prompt and efficient manner is important.

Q74 Christopher Pincher: I agree with that, but I just question whether the actual result was 100% you met your target.

Andrew Wright: Probably "not applicable"-

Alistair Buchanan: I think it is an NA and not 100%. You have made a good point and one we will pick up.

Q75 Christopher Pincher: I will make it with respect to another measure, also related to markets, "Send decisions on article 22 exemptions to the European Commission within prescribed timescales if adequate data has been provided". Again, the target is 100%, the actual is 100%, but no decisions were needed during the year so again I would suggest that is "not applicable".

Alistair Buchanan: I think we should follow your advice. My sense is we are going to have to put a very strongly placed caveat because in the past NAs have been picked up as a "did not". I think that has been the nervousness that we have had, which is that you then get accused of not achieving when in fact it just did not occur and often you are on the back foot before you have even started. So I think we should follow what you have suggested but I think we need to make it very clear that NA is not "did not achieve it". It is NR, "not relevant", this year.

Q76 Christopher Pincher: I suspect what I am suggesting is that rather than have a set of tick-list items, what we are looking for are outcomes-based actuals and the measurement of those. Were your bonuses for 2011 and 2012 related wholly or partly to the KPIs?

Alistair Buchanan: You would have to address the Remuneration Committee who look on a range of criteria. That would be the chair in the REMCO.

Q77 Christopher Pincher: But you must know.

Alistair Buchanan: They look at a range of criteria. You are best placing your question to them.

Q78 Christopher Pincher: You have bonus opportunities so presumably you want to know what they are linked to so that you can link them, and if they are linked to KPIs you will know that.

Alistair Buchanan: You are asking a good question, wrong person. You would have to put that question to the head of the REMCO.

Andrew Wright: KPIs are part of our appraisals and the weight they have in REMCO’s bonus decisions, we do not know necessarily.

Q79 Christopher Pincher: As I would expect it to be, which is one of the reasons why I made the point. If you are achieving 100% targets against actions that did not take place or have to take place, possibly something needs to be looked at again.

Can we look at the financial management of Ofgem, which is also in the annual report and accounts. Between 2009-2010 to the last financial year you have three sets of figures of total spend in comparison to Ofgem’s budget. In 2009-2010 your budget was £53.9 million; you spent £51.1 million. In 2010-2011 it was £78.7 million; you spent £58.8 million. In 2011-2012 it was £72 million; you spent £62 million. You have had a history of underspend, which is arguably a good thing. Why then are you looking to increase your planned expenditure by more than a third on last year when you have had three years of historic underspends?

Alistair Buchanan: In the future you have the answer in the past, to a certain extent. If we look at last year at table 6 in the NAO report you see a lumpiness in the percentage of underspend. It is very interesting hearing your part. At times I liken trying to budget Ofgem to rather like trying to budget for almost a financial services company or a law firm or an accountancy firm, because it can be very lumpy. What is interesting is not only is it very lumpy in spend but also we have some very new elements that we are doing. To give you an example, if we look at last year the £10 million undershoot, £72 million plays £62 million, is almost entirely driven by three factors. We did not spend as much on offshore because a number of the projects just did not come through. This is one of the themes we were talking about on capacity. Offshore is running a bit slower than we had anticipated, so about a third of that £10 million is offshore. Smart metering was taken away from us, quite rightly in my view, and taken back to DECC, so another third was that. Then we have RHI, which did not come through. As you know, there had been a delay on domestic and eventually it came through. That £10 million was just broadly three big lumps.

When we are looking forward, again we have lumpy spend. We have ECO- Management, RHI, RHI domestic, which is expected to come into June. We have the unwinding of CERT and CESP, and we do not know what the enforcement costs of that are going to be. You just have some very unusual lumps of spend. I feel uncomfortable when I look at figure 6 because you have 5% underspend-well, you can just about budget-through to 25% underspend-what the hell are you doing. It is that we are in this very unusual period. It is primarily driven, I have to say, off our E-Serve arrangements.

Q80 Christopher Pincher: But E-Serve costs have fallen, haven’t they? I think I am right in making that point.

Alistair Buchanan: E-Serve costs have fallen this year. Basically, that was accounting for the £72 million down to £62 million and more. They have fallen this year, but looking forward we have to accommodate some substantial projects that, again, we have to account for and take a view on. We also have round 2 of offshore that is going to come in and then on Orange we have continued work that we hadn’t previously anticipated, for example on the gas markets report. That is where we are at. It is something that we have set ourselves to seek to get better but it is a very lumpy business. It is uncomfortable and a lot of these spends are also novel. We have not done a lot of these projects before, nor has anybody else. We are doing a benchmarking exercise with the other regulators at the moment to make sure that we are not getting out of line with some of the core central costs.

Q81 Christopher Pincher: You are saying that because you had the first year of administration activity, for example of the RHI, that has resulted in lumpy E-Serve costs, but E-Serve costs have fallen by 22%, I think-

Alistair Buchanan: Yes, they did.

Christopher Pincher: Over the past couple of years, 14% less than the main estimate. No, that’s Ofgem; it is 22% in the last 12 months.

Alistair Buchanan: The main spend there was smart meters, which had come off. That was the main driver of spend that had fallen away.

Q82 Christopher Pincher: In terms of headcount, you have something like 10% fewer people than you have desks. Doesn’t that mean to say that you are occupying rather a lot of space? Given that the cost of your space equates to something like £10 million a year, £10,500 per full-time employee, you could reduce the cost of your space significantly to meet your headcount, couldn’t you?

Alistair Buchanan: We are working on this. As you see from the NAO’s report, the cost per space has gone down. We have run a situation where we have been trying to catch up. As you can see within the report, we have grown by 142 people to about 592. We are now at 700. Since this report was written, I suspect that 10% has flipped the other way now and we have more people than space. We have grown rapidly, for the reasons that I think we are all aware of, and consequently we are focused on hot-desking, we are focused on how we run our space. Again, it is no secret, because we spoke about it at this Committee, that the lease comes up for review in 2017 and we will have to look at that very carefully to see what the best thing is to do with regard to taking Ofgem forward from there.

Q83 Christopher Pincher: You now have more resources, so those resources fill the desks that you had spare?

Alistair Buchanan: Yes.

Christopher Pincher: That partially accounts for the increased budget that you have set yourself to spend?

Alistair Buchanan: Indeed.

Christopher Pincher: What actions are you taking, though, to ensure that your budget forecasting is much more accurate, or at least much more consistently inaccurate than it has been in the past three years?

Alistair Buchanan: I suppose the most important thing is we are alive to it and so are the NAO and so, very helpfully, are you. It is trying to get our hands around projects like ECO, what the projects costs of those are going to be, and getting our hands around what the enforcement costs are going to be on CERT. We have not done any of this before. You can have lumps. Last year the offshore did not come through as fast as it should; that is a lump of £3 million to £4 million. You only need to get two or three of these lumps, and we are not a big organisation, as you can see. Two lumps of £3 million immediately is going to throw you out by quite a lot on a £60 million to £80 million budget.

We are alive to this and the main focus comes on our discussions with DECC. How much can they help us with regard to the funding for their proposal? It is their proposal; what they think the funding for their proposal will look like. We will obviously have a discussion with them and we will try to get that right. The other thing that we have noticed is that if you look at something like CERT, the legislation and the provisions within CERT changed considerably through the process of it. Each time it changes it costs us money and it might cost us resource. Again, we have not budgeted for that change. We are trying to get better at this and I think you raise a really interesting area for us.

Q84 Christopher Pincher: Two final questions then. First of all, are you able to assess the costs to Ofgem in terms of FTE and then spend on the various demands that DECC make of you? What proportion of your time and effort is expended on dealing with those requests rather than straight-flight operations? Secondly, what support do you get and how accurate are DECC’s assessments of the costs they think they are either passing on to you or asking you to bear?

Alistair Buchanan: If we take the £62 million of this year that is in the accounts, £20 million is funded by DECC. We have, as you can imagine, a regular dialogue with them and sometimes-and again it will not surprise you to hear this-because of the budgeting pressures on Government, they can be fairly tense. We are in an agency relationship with Government but we are also effectively as if we were a consultancy firm and so there are some pretty tense discussions about whether we stop work, because my board will not allow us to work without it being funded. So far we have not had a problem where that has broken down, but there are pressures within Government that mean that we have to make sure that we can carry out this function that we are given properly. Again, this affects some of the lumpiness in the flow of work and the flow of money through a year.

Q85 Chair: If we can turn to National Grid for a moment where you know the Committee has expressed concerns about its role in relation to the future arrangements envisaged in the Bill. We were talking about interconnection earlier on. National Grid obviously has some aspects of its business that are not regulated, which include interconnection. Do you think they are able to resolve their conflicts of interest, for example in that area where they may decide that they want to facilitate access to the UK grid from an interconnector in which they have a commercial interest when there may be competing alternatives?

Andrew Wright: First and foremost, we are doing a joint study with DECC that I think it is due to be published next month on the potential conflicts of interest and how those might be resolved as part of the EMR work-stream. It will be ultimately for Government to decide what measures they put in place. The concerns that you raise are real ones and the important things to consider are: does National Grid have privileged access to information that might be able to benefit these other businesses and how do you ensure that is protected and, secondly, does it have influence over things like the EMR delivery plan that might potentially benefit some of its other businesses. The third area is does it have any discretion in the decision-making and I think we know, from our experience with E-Serve and delivering Government programmes, however tightly the rules are drawn up there are always instances when we have to make decisions and use some discretion. I think those are the three areas that are being looked at and the tools we have at our disposal are information barriers, ring-fencing, business separation and, I suppose in extremis, ownership separation, and all those are being considered as part of this study.

Clearly there are certain things we are looking out for as well and one of them is can National Grid realise the synergies that led to DECC appointing National Grid as the EMR delivery agency in the first place? It would be a shame, in our view, if the opportunities to co-ordinate some of the investments in generation transmission and system operation aspects were lost by too rigorous ring-fencing of the EMR delivery functions from other SO functions.

Q86 Chair: You will be aware that there is a lot of interest in some parts of the country-and I shamelessly declare a constituency concern here-about the way in which National Grid is rewarded for decisions to underground new transmission capacity and this is an issue of great interest in several parts of the country as well. Do you think this whole willingness to pay analysis now gives a clear enough signal about whether consumers are happy to bear the extra costs that may be incurred by building underground connections rather than overhead pylons?

Alistair Buchanan: Within the price control that we have just set out, National Grid, on the electricity side, we will be investing £12 billion. £2 billion on top of that is on an uncertainty mechanism. There is more money on top of that that they wanted, another £5 billion. Set against that, we looked at a range of undergrounding rewards. From memory, because there are quite a lot of numbers flying around here, it is £500 million that we set aside. This is very important. It comes back to something that Andrew said earlier. It is up to the company to decide where it will use that apportionment for undergrounding. Whether it is in your constituency or somebody else’s, that is for them to handle. But as a proportion of their total spend, some would argue that is quite a low proportion. We came to a judgment call as a board that with the willingness to pay analysis that looked about correct. I have to say National Grid has not accepted our price control yet. If that is an area that they do not agree with then they can challenge that and it will go to the CC.

Q87 Chair: Under RIIO they will get £20 billion roughly and over the next eight-year period the revenues they will be allowed to have will increase by about 30% compared with the previous period, adding £6 a year to consumer bills. How do you ensure that they will achieve the best value for consumers?

Alistair Buchanan: We will particularly do that through the O of RIIO, through the output mechanisms, and there are a series of mechanisms in terms of their service standards, how long they go out, when they go out, how quickly they can get wired back, their environmental achievements, losses, emissions from substations. There is a whole range of outputs by which we will be judging their performance and that will influence heavily whether, for example, they will be given fast-track at the next price control. If they perform badly on these output measures on behalf of consumers, then it is not for me to say but I would have thought they would be very lucky to get the privilege of fast-track. I think they will get the full Monty on them next time around.

Q88 Albert Owen: I think there is a win-win situation here. You have the Government telling them, "We need to reconfigure the whole system, market reforms coming in and we want some pipes and wires and you have to do it and we are going to pay you for it and the consumer is going to pick up the bill". I am being simplistic but you have raised a figure today, which is echoed by many, that 25% to 30% of the bill is transmission and yet-

Alistair Buchanan: No, 2-4%. 16% is local grid.

Albert Owen: Right, okay.

Alistair Buchanan: But your point is not lost.

Q89 Albert Owen: The main argument has been that bills are going up because of environmental and social tariffs and yet a lot of it is down to transmission costs. There are people in parts of the country, unashamedly-like the Chairman, like my own-where we generate a lot of this electricity, yet we pay a lot for transmission because it goes to the grid and comes back to sparsely-populated areas. Is that something that you are regulating the grid on? This reconfiguration is 21st century electricity generation, I appreciate that, but we are not going to get 21st century transmission from it because a lot of it is upgrading old kit that has been there since the war and not much has been done with it in the past. We are going to have a hike in prices and the consumer is going to bear the brunt of that.

Alistair Buchanan: To give you comfort, if we look at the price control we have just been through-and, as I say, we do not know whether Grid will accept it or not-if you start from the £12 billion that we have awarded and then there is £4 billion on top of that, which is for uncertainty mechanisms, what we have said is, "You are not allowed that £4 billion, because that could sit in your account for seven years. You come to us for identified projects and seek that money during the next eight years, probably to the back end because we don’t at the moment have confidence in that particular project, but if it is going to be built within this eight years come and ask us for the money". Effectively, the money will be provided by the consumer. The first thing we have said is there is that uncertainty mechanism of £4 billion. That is £12 billion to £16 billion. Then on top of that there was £5 billion where they wanted to start.

That is the first bit of comfort we can give you, which is that we have looked, obviously with external advisers, on their overall pitch. It will then interest you that the companies started-this was particularly Scottish and Southern who obviously have grid in Scotland. They pitched for their return on equity at 8.2%, National Grid pitched for their return on equity at 7.5%, and we said, "You are having 7%". Again, they might take us to the Competition Commission on that; they may not be happy with that.

What we have tried to do is ensure that we get value for customers in a period where they are having to rebuild and reconfigure the network, and they are. Equally, it is important that they do because there is a security of supply implication here, one that we are assuming they deliver. Of course, if they do not deliver some of these reconfigurations, our security of supply debate that we had earlier could get worse.

Q90 Albert Owen: They are holding us to ransom in many ways on that.

Alistair Buchanan: Well, they are regulated. This is, in a way, why they are regulated because they are a monopoly and we stand in the place of the market and we try to do our job as well as we can, and you will take a view on whether that is good or bad.

Albert Owen: I am asking for information as much as anything else.

Alistair Buchanan: It is fair for you to say whether that is good or bad.

Q91 Albert Owen: The point is there are proposals in my area now for new build of a number of power stations and they need to improve the grid, offshore and nuclear. We all understand that. Yet they are telling us in local consultation that they have to go for the lowest cost, which is overhead, because of the restrictions that they have. Basically what they are saying is, "If we went for a higher cost we will either have to pass it on or we have to absorb some of those costs". There could be environmental damage as a consequence of that in many ways. It is a difficult one for me to-

Alistair Buchanan: I will give you an example because this is where you have companies that are in the private sector but are regulated. In other words, the managers have to manage. They have to manage the situation. We had one with Scottish Power that sounds very similar to yours where they tried to bring us into the debate that they were having with people who lived aligned to Bannockburn and obviously it is a very major issue for those who live in the area. We said to Scottish Power, "No, you have provision for undergrounding. You have to work out where you are going to spend it". This is a management issue.

Q92 Albert Owen: I am talking more undersea here as well. You mentioned Greenwire and I do not know who is going to pay for Greenwire. There are two Governments talking at a high level now saying, "We want to get some Irish wind into the British system," but I do not know who is going to be paying for that. My argument would be that if they can afford to subsea there, why can’t we have a new subsea grid to bring in all this extra capacity and limit the damage to the environment?

Andrew Wright: Indeed that is an option that we have considered.

Q93 Albert Owen: You are keeping an eye on them?

Andrew Wright: The bootstraps from Scotland to north Wales and northeast England are being considered. These are options that are there. I think the important thing on undergrounding is also the role of planning to ensure the appropriate level of undergrounding.

Q94 Albert Owen: But can we move to undersea as well? Much of it is going to go undersea in the future because these new ones are going to be built on the coast and they have to come across. They are not taking economies of scale in the future into account, that if a lot of this capacity went undersea it would be cheaper and it would get over the DC/AC issue. Are these issues that you are in dialogue with them about, is the question?

Andrew Wright: Yes, we are.

Alistair Buchanan: Yes.

Albert Owen: You are?

Andrew Wright: Yes.

Albert Owen: They are not just fobbing us off and saying, "Well, the generator won’t pay us that much money, so we can’t do it"?

Alistair Buchanan: No.

Q95 Barry Gardiner: The DECC estimates of the Green Deal implementation show a level of deployment that is significantly below the level required to meet the sector-specific carbon budgets and, of course, the obligation is on them, the suppliers, to achieve their allocated amount of emissions reductions. ECO is going to be required to pick up the slack and energy companies will be passing that on to consumers. What powers do you have to stop that perverse outcome, that that additional cost over the £1.3 billion that DECC originally estimated is going to be passed on to consumers? You will have seen the NERA report that said that DECC’s analysis of the likely cost of ECO, "Underestimates the cost of installing insulation, overestimates the amount that customers would be willing to pay for it and, therefore, underestimates the total cost to energy suppliers of subsidising the programme". ECO could come out significantly above that £1.3 billion. They have estimated £3.25 billion or more. That is an average of £94 on each domestic bill. Have you any power at all here to protect the consumer?

Andrew Wright: The cost of companies meeting their obligations under ECO, as well as any other obligation, is part of their general operating costs. The prices they charge to retail customers are unregulated. The mechanism by which those prices are constrained is competition. The key is making competition in the retail market work effectively, but if the costs turn out to be significantly higher for all companies than the Government estimates then we would expect that, through the normal workings of the market, to be part of the bill.

Q96 Barry Gardiner: Let me be clear on that point because it is very important to consumers. If that is the case and all the companies show much increased additional costs over what were originally projected, under the powers that you have you will not be able to do anything, will you?

Andrew Wright: Yes, that is right, and we would expect bills to be higher.

Q97 Barry Gardiner: You would just have to accept that £94 excess on top of the bill?

Andrew Wright: We do not have full visibility of the costs under CERT and CESP, but our expectation is that some companies will meet their obligations at a lower cost than others and those will have a competitive advantage in the market that they can use to reduce prices and win customers if that is what they want to do.

Alistair Buchanan: But to be clear to you, we are a functionary. You are right to ask the question and we just function the process.

Q98 Barry Gardiner: Your duties are second supplier obligations, monitoring supplier progress, reporting to the Secretary of State, fraud audit compliance and final determination on whether suppliers achieve their obligations or not.

Alistair Buchanan: Yes.

Barry Gardiner: But the consumer naturally thinks, because that is your primary function, that Ofgem is there to protect them. In this case, what I am trying to be absolutely clear on is you have no power to protect them.

Andrew Wright: But the means of protection in a competitive market is the functioning of competition in that market. We do not have the powers to directly set prices or require companies to reduce prices.

Q99 Barry Gardiner: I understand and, again, it mirrors what you said earlier. I absolutely take that on board, but competition in the market is the only protection that there is here for the consumer because the obligations that are going to be imposed upon the energy companies and the limited powers that you have to intervene in what they do mean that if the cost is more than DECC has estimated then the cost is more that the consumer will pay.

Andrew Wright: That is true, but it is fair to say also that there are incentives on companies to meet these obligations as cheaply as possible, whether that is realised as higher profits or lower costs to consumers. Those incentives are there.

Q100 Barry Gardiner: Indeed, but we are talking about an extraordinarily complex and multi-faceted supply chain here, aren’t we? This is not, "They are going to have a central works organisation that goes out and fits your insulation, guv." They are going to be contracting with somebody who is a provider in a particular area who may have 25, 35 or 40 different suppliers just for that one area. The control that they, as companies, are going to have on the ultimate price that is set down at a local level is pretty remote, is it not?

Andrew Wright: They have every incentive, either for the benefit of their shareholders or their customers, to do this as efficiently as possible.

Q101 Barry Gardiner: Indeed, but again my point is they may have the incentive but they do not have the control, they do not have the power because of the nature of the supply chain.

Alistair Buchanan: I think you raise what is a very interesting issue for us as an institution at Ofgem, because we are effectively a board running two businesses, Ofgem E-Serve with its own logo, its own management team, largely drawn and led by people from the private sector, and Ofgem Orange, the economic regulator. E-Serve is a functionary body, by and large, of what the Government is wanting to do. Therefore, if there are issues with regard to policy and costs of policy they have to be driven to Government.

Q102 Barry Gardiner: One of the things that is often said about CERT is that it took a heck of a lot of money just to identify the people that were eligible. What lessons and what action are you taking to ensure that the lessons from CERT are applied to lower costs of identifying those qualifying groups for ECO?

Alistair Buchanan: We are talking those lessons. I mentioned one of them earlier-I think you had just popped out-which was, please, once you have set it in place, don’t keep changing the legislation, don’t keep changing the rules, because the costs associated with that and the time lag associated with that is something that needs to be looked at very carefully. CERT and CESP tell us slightly different things. On CESP we thought about 100 main counterparties would be involved. In fact, it was 500 and quickly, so we were caught on the speed of pickup. On CERT, as you rightly identified, it took a while before many understood. We got slightly mixed messages there. I think fundamentally why the Government has asked us to provide them with updated information-and the first round of information for ECO is the end of February-is that they are wanting to slice the information earlier. What we will do is give them the information. What DECC have to do is analyse it and work out what that means, but I think the fact that they are after that information much earlier than they have been in previous schemes would suggest to me that they have learned that they need to make sure that their assumptions are going to align with how quickly these projects take off.

Q103 Barry Gardiner: Has there been a hiatus following the closure of CERT and CESP in December and the start of ECO on 1 January?

Alistair Buchanan: It is too early to tell because the first cut of numbers on ECO will not occur until the end of this month and CERT and CESP is working its way through to a report that we will give the Secretary of State in May.

Chair: I am sorry to cut across this but, unfortunately, I think we are out of time. We have some more private business to transact. Thank you very much. Perhaps we might just write to you with one or two small remaining points that were unasked, which we will do as quickly as we can. Thank you very much for coming in and having a wide-ranging discussion with us. If this is the last time we see you, Alistair, in a formal sense, thank you very much for your co-operation over the period.

Prepared 20th March 2013