Consumer engagement with energy markets

Written evidence submitted by First Utility (CE 33)

Introduction

1. First Utility is the largest independent electricity and gas supply company in the UK, serving both domestic and non-domestic customers. We are committed to actively engaging with our customer s by pr oviding them with access to data and tools that empower them to take control of their energy usage. This offering has been attractive to consumers as t his year has been another one of growth : to date this year we have increased our customer base from 50,000 to over 100,000 electricity supply points , with over 90,000 of those being dual fuel domestic customers .

2. First Utility was the first company to undertake a national rollout of smart meters . T o date approximately 25% of our customers have a smart meter installed. While the delay to the specific ation and availability of SMETS- compliant smart meters has slowed our rollout , we intend to accelerate the rate of installation again in the near future when industry compliant meters become available.

3. Building on our smart approach , we have this year, in partnership with opower, launched the my:energy service to both our smart and non-smart metered customers . This service provides customers a detailed view of th eir electricity and gas usage . M ost importantly, it enables a customer to rank their usage relative to nearby customers of a similar profile . It also provides a range of energy - saving advice , profiled to the particular consumption pattern.

4. We believe that our active approach to consumer engagement with ener gy markets is something unique in the market. However, our ability to continue to grow and innovate in terms of product, service and consumer empowerment is dependent upon energy market reforms opening up retail competition rather than exacerbating barriers to competition.

A: Competition in the energy market and how effectively the market is working

5. Competition in the UK energy market should be examined in two key areas: (i) UK wholesale energy markets and (ii) UK retail energy markets. We believe there are strong linkages between the structural issues in the illiquid wholesale market and the lack of energy retail competition.

A1: The UK Electricity Wholesale Market is Illiquid

6. The UK electricity wholesale market is extremely illiquid. Ofgem estimates that the current churn rate in the whole sale electricity market is ~ 300% . This stands in sharp contrast to Ofgem’s idea of liquid markets, defined as having a churn rate of above 700% .

7. The main reason for the low liquidity is the vertically integrated structure of the ’Big Six’ energy companies . 70-80% of UK generating capacity and 90% of retail customers are in the hands of the six vertically integrated players. In the domestic retail market, the incumbents market share rises to 99% . When companies align their upstream of market (generation) and downstream of market (supply) physical positions in this way, they no longer need to sell or source large proportions of their power in the wholesale energy market. Instead they can internally transfer the bulk of their physical position, avoiding the market for all but residual t rading around the edges of the combined portfolio . This reduces their exposure to wholesale volatility but more importantly to the punitive cashout mechanism, which creates a big economic advantage over independent suppliers who cannot leverage upstream generation positions in this way. By avoiding the market, such integrated players make wholesale trading decisions based more on ‘wanting’ rather than ‘needing’ to trade , so that market prices are not driven as strongly by fundamental supply and demand considerations . T h e kind of trading activity taking place in the incumbents has more in common with that of market intermediaries than that of physical asset owners. Large amounts of the physical market being in the hands of integrated players results in an illiquid , non-ro bust wholesale market price signal that can be gameable. This undermines certainty of access to product and robustness of prices for new entrant s either upstream or downstream, creating a strong barrier to entry and growth .

8. First Utility note s that the structure of the incumbents is a natural result of the punitive dual priced cashout mechanism, which creates the economic incentives associated with pairing up generation and retail businesses.

9. In order to generate vigorous competition and robust liquid wholesale electricity markets, Ofgem need s to make an intervention that drives a ‘need’ to trade in the incumbents. However, the current Mandatory Auction proposals will fall far short of the more than doubling of wholesale trading activity that is required, and are in fact likely to fragment rather than increase liquidity. We note that liquidity and cashout design are strongly related and believe that Ofgem would see a benefit in combining the workstreams in these areas.

A2: Drivers of Poor Competition in the Domestic Retail Market

First Utility believe s that vigorous competition in the domestic electricity retail market will naturally result if the hub - the wholesale market - is deep ly liquid and vigorously competitive. Lack of competition in retail markets is a consequence of the structure of , and illiquidity in , the wholesale electricity market. Below we outline the kinds of barriers to entry that independent energy retails such as First Utili ty face which are indicative of a lack of competition in the retail market.

10. I f incumbent energy retailers w ere collecting a n unreasonably high profit from their customers or providing a poor service in a competitive retail environment , one would expect new retail entrants to emerge and undercut the incumbents on price and/or deliver more innovative , transparent, and empowering services to end consumers and in doing so take significant market share away from incumbents. The domestic energy retail market is approximately a £30 billion per year market, and yet to date new entrant domestic retailers have been able to take less than 1% of the market share. One of the following two possible reasons could account for this:

· Vigorous retail competition might already exist, meaning that the margin opportunities in the UK energy retail markets are unattractive to new entrants .

· Very poor retail c ompetition exists , but the structure of the UK energy wholesale market creates insurmountable barriers to entry and growth at the retail level .

11. First Utility believes that the latter is closest to the truth. As an example, look at the difference between the standard tariffs of fered by incumbents and their best online deals. The price difference is often up to £200 per year, or 20% of the annual spend of an average domestic consumer . We believe that a £200 per year margin should be sufficient incentive for new entrants to compete for market share in a competitive market. However, in order to win customers, a new entrant supplier must win business at the competitive fringe of the market and to do so, they must price in line with the online tariff offerings of incumbents. There is clearly a much lower margin opportunity at this competitive fringe which is often £200 lower priced than the standard tariffs , making it extremely hard to create an economically viable new entrant energy retail business. We believe that the difference between standard tariffs and online tariff is an example of sticky customers on high margin products cross-subsidi s ing acquisition tariffs, making it hard for new entrants to compete for market share.

12. First Utility believe s that such a difference is not cost-reflective and is in fact an example of predatory pricing at the competitive fringes of the market in order to lockout retail competition. Other examples of predatory pricing activities include, but are not limited to: (i) not charging a termination fee for early exit from fixed - price deals and (ii) offering non-cost-reflective retention bonuses to customers who apply to switch away.

13. It is the sticky, less active customers in the retail market, who may include many vu l nerable customers, are paying higher costs to subsidi s e this kind of activity. First Utility believe s that existing Standard Licence Conditions on price discrimination could be actively used to manage this issue . We believe   that Ofgem should include predatory pricing issues in its Retail Market Review workstream as this is a key barrier to retail competition.

14. When this is combined with (i) the higher and more uncertain costs of wholesale power for independents and (ii) the increased cost of imbalance when an independent is penalised for not contracting volumes ahead of cashout (despite often not having liquid access to the product required), it is clear the origins of the current lack of competition in UK energy retail markets are obvious .

15. In summary, c ompetition in the UK wholesale and retail electricity market s is extremely poor. The wholesale electricity market is extremely illiquid, as noted by Ofgem and DECC. Ofgem has had a workstream on addressing wholesale electricity market liquidity issues for several years now, but we are concerned by the lack of progress and the continued hope that voluntary measures will solve the problem . Voluntary measures can disappear as quickly as they appear. Vigorous retail competition and vastly increased consumer choice will naturally develop when the structural barriers to entry and drivers to vertical integration (including dual- priced cashout) are removed.

16. In addition First Utility is concerned as regards further barriers to growth that have arisen as a consequence of the Energy Company Obligation (‘ ECO ’) . Under the current draft of the Electricity and Gas (Energy Company Obligation) Order 2012 once a supplier has over 125,000 dual fuel customers (250,000 customer accounts) their obligation is set at twice the level of the obligation for the Big Six. In financial terms this means that a growing supplier would have to pay approximately £100 per dual fuel customer per annum as compared to £50 per annum for the Big Six in respect of the 250,000 customer accounts over the threshold. As a consequence there is no incentive for a domestic supplier to grow beyond the ECO threshold.

B: Ofgem’s Retail Market Review proposals

17. First Utility is supportive of measures to increase clarity of information provided to consumers and increase ease of tariff comparability. However, we are concerned that Ofgem ’s current Retail Market Review proposals will increase and not decrease customer confusion on tariff comparability. There is a risk that , by trying to simplify tariff offerings from suppliers, Ofgem could force suppliers to design tariffs that do not charge consumers in a cost or risk-reflective way. The increased risks held by suppliers would ultimat ely be borne by end consumers via the tariff pricing. There is also a risk that, by setting a common standing charge for standard tariffs only, consumers might accidentally compare unit rates on non-standard tariffs only , leading to accidental switches to more expensive tariffs. We believe the standard metric for comparison that will work in all scenarios is the total annual bill at a customer s annual level of consumption. We would support measures to increase tariff comparability by prominently displaying this number on all retail bills.

C: Consumer trust in energy companies

18. First Utility believe s that consumers are disengaged and disempowered in the UK energy retail markets and we continue to believe that the key to building trust in energy companies is to create the conditions for vigorous retail competition. In such a situation , one would expect consumers to switch away from companies who have out-dated practices, poor communications, and expensive products, and who do not innovate to the benefit of consumers. They would move to companies that provide fresh, innovative, and competitive product s that engage and empower them.

D: The level and quality of information provided by energy companies to their customers

19. First Utility is supportive of measures to increase the amount and quality of information provided by energy companies to their customers. We believe that information is the key to engaging and empowering consumers to make behavioural changes to lower their energy bills. First Utility has been leading the way in this area over recent years. We were the first energy supply company to begin rolling out smart meters to domestic consumers, and have installed approximately 30,000 meters to date. This year we have partnered with US company opower to launch the my:energy service to all our customers. my:energy allows customers to view their consumption data online and compare their usage with that of similar houses in their area to see how well they are performing in terms of energy efficiency. The service offers customers tips and hints to incentivise further energy saving s . We believe this will lower consumers bills by reducing the volumes of energy they consume. First Utility believes that investing in reducing our customers’ bills and their carbon emissions will enable us to retain our customers and continue to grow.

20. First Utility intend s to further develop this service to offer even more powerful data analytics with smart meters, driving both energy and cost savings for consumers. We would like to continue innovating and leading the way in this area, but this will depend on whether the barriers to entry and growth that characterise the energy retail markets are addressed.

E: The role of smart meters in helping consumers to reduce their energy bills

21. First Utility has been leading the way with smart meter rollout, and with providing analytic services to empower consumers to measure and reduce their energy consumption. We believe the smart meter is key to this message and key to increasing consumer engagement in the energy retail market. We expect to continue leading the way in this area once the next generation SMETS - compliant smart meters become available. Further information is also provided in section D.

F: Consumer engagement strategies for helping consumers to increase energy efficiency

22. First Utility’s innovative my:energy service is free to all of our customers. This service delivers a strong message to customers regarding how their consumption compares with their peers. It offers insight into the ways in which a consumer might not be as efficient with energy as they ought to be, and it allows consumers to measure their performance month-by-month. We believe innovative technology and analytics, combined with consumer engagement, is at the heart of driving energy efficiency improvements in the home. First Utility hopes to lead the way in this arena. However, unlocking retail market barriers to competition will enable us to carry out a larger rollout of this service to our existing and potential customers.

September 2012

Prepared 3rd January 2013