Energy and Climate Change CommitteeWritten evidence submitted by Cornwall Energy

Cornwall Energy is an independent advisor and commentator on energy policy, regulation and markets in the United Kingdom. Our customers include suppliers, generators, public bodies, service providers, financial institutions and law firms.

We specialise in “demystifying” the policy and regulatory environment for clients and, among other things, provide forecasting services, including how third-party charges (environmental/social programme costs and network charges) are likely to evolve over the short- and medium-term.

Our Third Party Charges Index that shows that the network, environmental, and energy efficiency elements of the average household electricity bill have risen by 68% since 2010. We estimate that for 2013–14 third-party charges will account for almost two-fifths of the typical household electricity bill. Significant increases in third party charges for all consumers are locked in for the future.

Changes in third party charges are very difficult for suppliers to predict and are becoming a major inhibitor of supply competition in the non-domestic markets.

We believe more work is needed by government and Ofgem to understand the impact that third-party charges have on costs to all consumers and the effectiveness of competition in the domestic and business energy markets, especially electricity.

We provide more detail below.


What factors determine energy prices (wholesale prices, company operating costs, green levies, company profits etc.)? What contribution do these factors currently make towards a typical household energy bill and how might this change over time?

Energy suppliers will assess the commodity, collateral, third-party charge and operating costs they have or will incur when designing their energy tariffs. Each supplier will approach this differently, depending on their trading and risk strategies and available resource to track and model third party charge movements.

We have observed that third-party charges (that is non-discretionary charges suppliers face for use of networks to move energy to customers’ premises and fulfil environmental and social obligations placed on them by government) have become increasingly volatile, difficult to predict, and on a general upward trend.

Where suppliers have insufficient time to account for third-party charges (or are simply too resource intensive to try and predict) they are likely to take a “best guess” view of charges to include in their tariffs and hope they are neither pitched too low to eat into working capital/profit nor too high as to make them uncompetitive.

To differing degrees all suppliers struggle to account for these third-party charges in their retail offerings, primarily due to the short notice they have of final charges and the year on year changes seen. To quantify these elements of the typical retail electricity bill Cornwall Energy has developed a Third Party Charges Index to assess how electricity third-party charges have evolved since 2010 (see Annex A).

We have focussed on the electricity bill because:

all households have electricity supply, whereas around 4 million households do not have access to piped gas;

third-party charges are more volatile and regionalised than those seen for gas, making it more difficult for suppliers to assimilate changes into retail offerings; and

the majority of costs related to supporting government’s social and environmental policies are collected from the electricity bill.


The cost of subsidising renewables is increasing. The two current environmental schemes that are payable through electricity bills are the Renewables Obligation (RO), which supports the deployment of large-scale projects, and feed-in tariffs (FiTs), which encourage small-scale micro-generation.

Electricity suppliers are obliged by statute to meet the costs of supporting accredited renewable generation under both schemes; with the expectation their costs are recovered from the end consumer. Suppliers have little control over the level of charge to be recovered—the decision is made based on the amount of renewables capacity that is accredited in a given year and they amount of power each project produces.

FiT costs now exceed typical gross profit margins in the larger non-domestic market meaning unexpectedly high costs cannot be readily absorbed by suppliers. So in the non-domestic markets it is becoming more common for suppliers to take powers through their contracts to “pass through” unexpectedly high increases in third party charges. Sometimes suppliers have acted on these clauses seeking retrospective payments, causing distress to their customers, damage to their own reputations and undermining customer confidence in the market. This is particularly the case with FiTs where a quarterly reconciliation process has consistently resulted in higher than expected costs for this scheme. In our opinion competition in the non-domestic energy markets is being severely inhibited by the FiT reconciliation

From 2016 bills will be subject to a new environmental charge. Contract for difference (CfD) FiTs will eventually replace the current RO, which closes to new projects in 2017. But rather than one scheme recovering payments over another, both schemes will be recovering money for the projects accredited under them for a time. Payments under the RO will completely cease in 2037 (20 years after the final opportunity to become accredited under the scheme).

We expect the combined effect of these three environmental schemes to more than double in real terms by 2020.

Where suppliers are subject to energy efficiency programmes the expectation is that the compliance costs are passed through to customers. Unlike the FiTs and RO there is little information on the actual costs incurred by suppliers to fulfil these programmes. The costs of the new Energy Company Obligation (ECO) will be more closely monitored than its predecessor programmes (CERT, CESP etc.), which is welcome.

We note that as smaller suppliers become subject to ECO (and other programmes) there is a real concern that the additional compliance costs placed on these parties are likely to have a significant impact on their ability to continue to provide competitive offers to the market as fixed (and on-going) costs will be spread over a much smaller customer base.


Network companies recover their allowed revenues (as set by Ofgem via the price control process) from users. Charges are set annually (although there is scope for within year change) and must be derived from charging methodologies approved by Ofgem. At their core these charging methodologies should produce cost-reflective charges—that is network users should see a price signal that takes account of the cost of providing the assets they are deemed to use.

The network companies have licence obligations to notify the market in advance (150 days for electricity transmission and 90 days for electricity distribution) that charges are to change. Indicative charges though are not issued to the market until much later (typically December for transmission and January for distribution charges for the coming April).

Final charges are not known until late January for transmission and late February for distribution. Experience has shown that final charges often materially differ from indicatives. Suppliers then have limited time to assess how they recover these costs from customers.

Alongside the timing issue we argue that the drive from Ofgem to ensure all network companies use “common” methodologies to produce cost-reflective charges has resulted in overly complex models that mean suppliers have little or no chance to confidently assess future costs in retail offerings. The impacts of this are:

it introduces unnecessary risk for suppliers who have little option but to take a “best guess” view on network charges over the coming year or two when setting tariffs;

large swings in network charges could (alongside other cost changes) trigger the need to change existing tariffs, which is costly;

from a consumer’s perspective there is little opportunity to respond to network price signals—households bills are not itemised and so customers see no network price signal (even if they did it is questionable how they could respond); and

current arrangements ultimately have a detrimental impact on retail competition as this regulated element of the bill has become unnecessarily volatile.

As network companies have a very clear view of the revenues they can collect from users, in their entirety, over the life of a price control (now set for eight years) it makes no sense that we are in a situation where we now have designed into the market, via regulation, high levels of cost uncertainty. This manifests as risk and probably unnecessary cost to the customer.

This is a wholly irrational situation given that network costs account for around a quarter of the typical household electricity bill.

To what extent (if at all) should the Government or the regulator intervene in the market to affect the prices consumers (or certain groups of consumers) pay for their energy? Should any changes be made to the Government’s current approach?

There presently exist numerous interventions that affect prices—be these to support desired generation technologies, subsidise network costs in certain locations, improve energy efficiency, or mitigate energy costs for certain groups of consumers. Although these interventions may be necessary they do increase barriers to entry and place constraints on small growing suppliers to the detriment of retail competition and ultimately customers. Volatility in these charges is already damaging non-domestic supply competition and we fear this unfortunate outcome could extend in to the household market.

Interventions should be limited. Regulatory and government efforts should be focussed on ensuring that wholesale and retail markets are functioning in the best interests of consumers.

We believe there is a need for a thorough assessment of how third-party charges impact on wider retail market competition. We recommend an assessment consider:

how suppliers (new entrants, growing smaller suppliers, large vertically integrated companies) can and do assimilate third-party charges;

options to smooth third-party charge changes; and

how third-party charges could be more predictable.

How effective is Ofgem in ensuring consumers get a fair deal? Are there any areas for improvement?

The regulator’s Retail Market Review work is addressing this, and we expect to see final decisions from Ofgem this summer. We believe the impacts on supply competition, including how charges fall on different user classes, and new entry in to the retail market, need to be a much greater feature of Ofgem’s decision making processes in network charging and from DECC in policy design.

Could it be possible to benchmark energy prices to provide greater certainty about whether consumers are getting a fair deal? If so, how might this be achieved in practice?

No comment.

Could any other measures be put in place to ensure consumers are paying fair prices for energy and to provide consumers with greater confidence in this?

See our comments on profits.


Many consumers believe that energy company profits are the reason the energy bills have been going up in recent years. Is this perception fair?

The lack of transparency surrounding commodity elements of customers’ final bills fosters the perception that energy company profits are unreasonable. Ofgem’s segmental accounts have helped increase transparency to a degree. However, good industry knowledge is required to interpret them and there are legitimate concerns about comparability between information produced by different companies. The treatment of internal trades and cost transfers is particular area of concern

Why is there so much uncertainty about the level of profits the large, vertically integrated energy companies are making? What could be done to improve clarity?

Following its 2008 competition review (commonly referred to as the “Probe”) the regulator introduced via licence obligations on the six large vertically integrated companies to publish segmental accounts for their generation and retail businesses.

Despite this being a step in the right direction we believe Ofgem needs to further overhaul the rules for to:

standardise the methodology for inter-business activities (the transfer price), stipulating the basis on which these regulatory accounts should be prepared;

incorporate upstream gas as this remains a major omission; and

the net margin made on an average bill and how this is reinvested.

Without these changes the exercise will remain a compliance burden on the companies without real compensating benefits for stakeholders including consumers.

How useful are Ofgem’s electricity and gas supply market indicators in monitoring the level of profits made by energy companies? Could they be improved?

We have grave concerns with the supply market indicators issued by Ofgem. The hedging strategy model that the regulator employs is too simplified a representation of the Big Six’s actual purchasing; does not reflect how companies procure wholesale energy; and (for power) contradicts its own assessment of the health of the wholesale electricity market.

The current process uses averaged information for an 18-month hedging strategy to estimate supplier wholesale costs. This mechanistic approach assumes wholesale products are procured on a monthly basis for one eighteenth of their needs.

No business trades in this manner. Moreover Ofgem’s own assessment of wholesale electricity market liquidity concludes that there are very low levels of trading in products more than a season out.

The supply market indicators could be improved by using a more accurate hedging strategy methodology. The industry should be asked to help Ofgem refresh its assumptions.

How useful are the segmental generation and supply statements that major energy suppliers are required to produce in understanding where companies are making their profits?

As noted above we believe there is scope to improve the information provided by the large energy companies in their segmental accounts.

We do acknowledge they have some benefit, particularly because they separate out domestic supply from non-domestic supply for both electricity and gas.

Without clear information on transfer prices from generation to supply (together with the volume of traded power and the route the supplied power took) the segmental accounts will continue to have limited benefit.

Do Ofgem’s supply market indicators and the segmental reports provided by energy suppliers help to increase transparency and public trust in energy companies? Could they be improved to provide greater transparency?

Note out comments above.

To what extent does the way energy companies communicate profits to the general public influence the public’s perception of these companies?

No comment.

Fuel poverty

Is the Government on track to meet its target of eliminating fuel poverty by 2016 and will reduced Government spending in this area affect their ability to achieve this target?

Our assessment of third party charges concludes that this element of the household bill is likely to increase over the coming years, adding pressure to efforts to eliminate fuel poverty.

Has the Hills Review resulted in any changes to fuel poverty policy? How could its findings be used to improve the efficacy of fuel poverty policy?

No comment.

To what extent are current fuel poverty policies reaching the right people? Are there any particular groups that are currently not getting the necessary support? And will this change under the move to ECO?

No comment.

What support is available for fuel poor households living in solid-wall and hard-to-treat properties? Could this be improved?

No comment.

Will the Government’s proposals to ensure that consumers are on the cheapest tariff have any impact on fuel poverty?

We believe an intervention of this nature will ultimately be detrimental as the prices of the cheapest tariffs are likely to rise. We fear that suppliers will “level up” their prices.

To what extent do fuel-poor households engage in switching? What are the barriers to greater levels of switching from these groups?

No comment.

To what extent do fuel-poor households currently take advantage of energy efficiency schemes? Could anything be done to increase uptake?

No comment.

February 2013

Annex A


Excluding VAT.

Third party charges levied by suppliers to cover electricity network and policy costs have increased the Cornwall Energy index 48% since 2010.

A further increase in the index of 20% to 168 is projected for 2013–14 based on indicative charges and equivalent to £233 payable per household.

Third party charges will account for 38% in current bills up from 28% in 2010–11.

Significant regional variations in the index due to network charges.


Distribution (DUoS)

Pays for the local network upkeep between transmission lines and the meter.

Charges have increased across each of the 14 distribution regions since 2010–11.

Between 2010–11 and 2013–14 (indicative) the average GB consumer will see a charge rise of 45%.

Distribution in 2013–14 is expected to account for £120 of the average bill.

Transmission (TNUoS)

Pays for national network upkeep.

Charges have also risen across each transmission region since 2010–11.

The 2013–14 (indicative) charge will be 76% higher than in 2010–11

Transmission in 2013–14 is expected to account for £20 of the average bill.

High Distribution Cost Area charge (HDCA)

Provides discount for high distribution costs in northern Scotland.

Typically charge rises by inflation, but in 2012–13 the rise was 10% because of an under-recovery in the previous year.

Charge likely to be under £1 in 2013–14.

Balancing (BSUoS)

Covers National Grid’s costs for keeping system in balance.

Charges are rising over time owing to increasing amounts of renewables. Between 2010–11 and 2012–13 charges rose 16%. 2013–14 charges currently 11% up on 2010–11 but could be much higher.

Balancing in 2013–14 currently expected to cost £5 on the average bill.


Renewables Obligation (RO)

Scheme to support the development of large-scale renewables projects.

Costs of the scheme more than doubled between 2010–11 and 2013–14 (up 112%).

Charge in 2013–14 likely to be £35, up from £17 in 2010–11.

Feed-in Tariffs (FiTs)

Scheme supports deployment of small-scale microgeneration installations.

The charge has risen exponentially since the scheme’s launch in 2010.

Cost to customer in 2010 was under £0.20 but in 2013–14 cost is considerably higher at almost £9.

Energy Efficiency

Carbon Emission Reduction Target (CERT)

Covers the cost of reducing domestic carbon emissions.

Cost of the scheme rose until 2012–13 when it closed. The charge will not be levied in 2013–14.

In 2010 the cost per customer was £18, rising to £32 in 2012–13.

Energy Companies Obligation (ECO)

Pays for insulation in vulnerable and/or hard to treat households.

Replacement for CERT and CESP from 2013–14.

Baseline of zero in 2010–11 to 2012–13.

Forecast cost in 2013–14 is £34 per customer.

Community Energy Savings Programme (CESP)

Supports vulnerable communities in reducing carbon emissions.

Cost rose between 2010–11 and 2012–13. Like CERT, CESP closed in 2012–13.

Annual cost per customer remained under £2.

Warm Homes Discount (WHD)

Rebate on winter energy bills for low-income and most vulnerable customers.

Four-year scheme with zero baseline in 2010–11.

Costs expected to reach almost £8 by 2013–14.

Prepared 26th July 2013