Energy and Climate Change CommitteeWritten evidence submitted by Caroline Flint MP

Executive Summary

1. Improving the perception that profits are fair is essential for increasing consumer engagement with the energy market.

2. Prices and levels of profits should be set by a properly functioning competitive market. But there are strong grounds for believing that liberalisation has not led to a properly functioning competitive market.

3. To make sure people are paying a fair price for the energy they use, we need to tackle the root cause of the problem, and to do that we need a radical overhaul of the energy market. We believe that radical action needs to be taken to reform the energy market to make it more transparent, more liquid, to overhaul the regulatory system to ensure it is fit for purpose, and to protect those most at risk of fuel poverty. In the policy review document Real Energy Market Reform, published in October 2012, we set out a number of proposals, including:

(a)Requiring the energy companies to pool the power they generate and to make it available to any retailer, in an attempt to open the market and to put downward pressure on prices.

(b)Replacing Ofgem with a tough new energy watchdog with a new statutory duty to monitor wholesale and retail energy prices, and the power to force energy suppliers to pass on price cuts when the cost of wholesale energy falls.

(c)Requiring energy companies to put all over-75s on their cheapest tariff, which could save as many as four million pensioners as much as £200 a year from their annual energy bills.

4. Energy bills are soaring, driving up inflation and contributing to the cost of living crisis affecting millions of families. At a time when families are facing record fuel bills and energy companies are enjoying huge profits, we believe that the government has a responsibility to step in and support families.

5. But research by IPPR says that ECO combined with the Green Deal, will make only a limited contribution to either of these goals.1

6 And Government proposals on the cheapest tariff do not address the key problem of lack of transparency and liquidity in the energy market, particularly in the forwards market—the cheapest tariff in an uncompetitive market will still not be a good deal for customers.

Prices and Profits

7. Improving the perception that profits are fair is essential for increasing consumer engagement with the energy market.

8. The launch of the inquiry into energy prices, profits and poverty makes reference to the Committee’s findings that public trust in energy companies is low, and that there is a lack of transparency around energy company prices and profits. I agree with this analysis, and believe that there is an urgent need for reform of the energy market and the way it is regulated in order to restore that trust.

9. Unlike most retailers, energy companies sell us a product that we all have to buy; people cannot choose to opt-out of buying energy. There is, therefore, a strong case for arguing that energy needs regulation of a different order to almost all other goods and services, and that even consumers who do not wish to engage with the market, should be protected from being ripped off.

10. At the moment, any attempt to accurately estimate the true costs of energy supply is hampered by the lack of publicly available information. Electricity companies can either trade bilaterally (ie directly between a generator and a supplier) or on the open market through power exchanges. The vast majority is currently traded bilaterally. The details of these bilateral deals are never made public, so we do not know how much energy suppliers are paying generators (or the generation arms of their own businesses). This means that the wholesale energy market is only an indication of energy prices, not a definitive guide, because most trades are not made publicly.

11. In addition, there is currently no obligation on either generators or suppliers to make their sales or purchases on the open market or to sell outside their business (eg a vertically integrated company is free to trade between its generation and supply businesses). Current transfer pricing (ie the prices at which different parts of the same company sell things to each other at) may allow for the movement of profit around the group (eg from supply to generation)—any assurance that transfer pricing methodologies are fit for purpose are meaningless as the outcome of that transfer remains publicly invisible.

12. At worst, the complexity and lack of transparency in the way energy is bought and sold leads to the suspicion that a wholesale price movement can be found to support pretty much any retail energy price change—whether up, down, big or small—and that energy companies can, therefore, use wholesale prices as an excuse for inflating customer bills unnecessarily.

13. Prices and levels of profits should be set by a properly functioning competitive market. But there are strong grounds for believing that liberalisation has not led to a properly functioning competitive market.

14. The domination of the market by six businesses does not, in itself, indicate that competition in that market is ineffective. However, the fact that since liberalisation no new entrant has achieved anything like the scale of operations to challenge the “Big Six” suggests there are significant barriers for newcomers.

15. Energy companies frequently assert that electricity and gas prices in the UK are among the lowest in Europe. However, this is only true when tax is included (because UK tax levels for gas and electricity are comparatively low), and tax is a government instrument, not a feature of market efficiency. When tax is not included, the UK compares much less favourably. In 2011, UK electricity prices (in pence per kWh) were 5.3% higher than the EU-15 and G7 median and 19.1% higher than the EU-27 median. UK gas prices (in pence per kWh) still compare favourably, although in 2011, for the first time, the UK gas price was above the EU-27 median.2 Although international comparisons are an imperfect measure of market efficiency, they do suggest there may be scope for greater efficiencies.

16. If pricing is competitive wholesale cost falls should be passed on as quickly as cost increases. In 2011, Ofgem themselves found evidence that energy suppliers were slower in passing on reductions in wholesale energy costs than they were increases.3 Analysis by the consumer watchdog Consumer Focus has also found a gap between the price energy companies buy electricity and gas at, and what they sell it to the public for. Their research shows that even though the wholesale prices of electricity and gas have both fallen since 2008, retail prices for both are still significantly higher in 2012 compared to 2008.4

17. In a competitive market, operational costs should converge. In their report on the energy market earlier this year though, IPPR found that operational costs for energy suppliers had in fact diverged, which again suggests a lack of competitive pressure on suppliers.

18. To make sure people are paying a fair price for the energy they use, we need to tackle the root cause of the problem, and to do that we need a radical overhaul of the energy market. We need to open up the market so that there is more competition and greater transparency.

19. Energy companies should be required to pool the power they generate and to make it available to any retailer, in an attempt to open the market and to put downward pressure on prices.

20. Energy companies always cite wholesale prices as the reason for bills going up, but bills never seem to get reduced to a similar extent when the wholesale price falls. One of the reasons energy companies can get away with this is because of the complex and opaque way in which energy is sold. At the moment, most energy is bought and sold through secret bilateral deals between energy companies. As a result, no one really knows what the true wholesale cost of energy is.

21. Requiring energy companies to put all the power they generate into a pool, allowing any retailer to bid for that energy and sell it on to the public, will make the market more transparent. It will stop the secret deals and prevent energy companies selling power to themselves before selling it on to the public. The pool will allow other companies to become suppliers of household energy, increasing competition which in turn should help to drive down prices.

22. This does not necessarily mean going back to the old pool. When the pool was last in operation, there were effectively just two generators and the pool was one-sided with only generators placing bids. But the market has changed—today there are many more generators, so the issues we saw with the dominance of National Power and PowerGen in price-setting would be much less of a problem.

23. There are a number of different energy pools currently in operation including in Ireland and Singapore and the Nord Pool in Northern Europe, which is two-sided with both buyers and sellers able to bid into it.

24. A new regulator should be established with a statutory duty to monitor wholesale and retail energy prices, and the power to force energy suppliers to pass on price cuts when the cost of wholesale energy falls.

25. Requiring all energy companies to put all the power they produce into a pool, which anyone could bid to retail, will allow us to establish a clear wholesale reference price for energy, which could be used as benchmark to measure any increases or decreases. With this information, the new energy watchdog could establish when wholesale prices are rising and falling, and accurately monitor the relationship between wholesale and retail prices, which is effectively impossible at the moment. This would enable a regulator, with the right powers, to either (a) force energy suppliers to reduce their retail prices in line with wholesale cost reductions or (b) take some enforcement against suppliers that failed to pass on reductions in wholesale costs in a timely manner.

26. Ofgem is not fit for purpose. It created and drove the market structure we now have, which is failing consumers. It is so closely aligned to the old model of unaccountable markets that it is incapable of taking the action needed to get fair prices for consumers.

27. Just giving Ofgem new powers is not the answer—because Ofgem isn’t using the powers it already has. Four years ago Ofgem found that some customers were being charged different prices for using the same amount of energy and that these differences were not representative of the suppliers’ costs. A licensing requirement5 was introduced for suppliers stipulating that the tariffs they offer for customers who use different payment methods must be “cost reflective”. But energy companies are still using predatory pricing tactics to lure new customers.

28. Ofgem has failed to enforce the reforms it has already introduced. In 2008, Ofgem launched reforms aimed at supporting consumers, addressing barriers to growth for smaller suppliers and ending discriminatory unfair-pricing practices. According to Ofgem’s own evaluation in 2011 these reforms have failed.6 Across 16 indicators, 12 showed no improvement or deteriorated, three slightly improved and only one, relating to the cost reflectivity of tariffs, was considered to have improved, although even this last verdict is questionable.

29. Time after time, Ofgem has ducked the opportunity to get tough with the big energy companies. In August 2011, OFGEM commissioned BDO, the accountancy firm, to conduct a forensic investigation and make recommendations on how to improve transparency in the energy market. By May 2012, OFGEM had quietly dropped six out of the eight BDO recommendations, and “varied” the remaining two. This included a recommendation to require the energy companies to report on the results of their trading functions.

30. To protect some of the most vulnerable, energy companies should be required to put all over-75s on their cheapest tariff, which could save as many as four million pensioners as much as £200 a year from their annual energy bills.

31. Elderly customers are among those least likely to investigate cheaper tariffs and switch suppliers, with the lowest levels of IT literacy and awareness of the savings they could make in their bills by switching providers. Research by Ofgem has shown that pensioners are less likely to switch supplier than average consumers.7

Fuel Poverty

32. Energy bills are soaring, driving up inflation and contributing to the cost of living crisis affecting millions of families. At a time when families are facing record fuel bills and energy companies are enjoying huge profits, government needs to step in and support families.

33. The most sustainable way people can cut their bills is by reducing their energy use. But the end of Warm Front means that this will be the first administration since the 1970s not to have a Government-funded energy efficiency programme.

34. The aim of ECO is to reduce carbon emissions and fuel poverty. But research by IPPR says that ECO combined with the Green Deal, will make only a limited contribution to either of these goals8.

35. Up to 60% of the funding available under ECO could end up going to people who are not in fuel poverty. Out of this year’s ECO budget of £1.3 billion, just £540 million will go to people in fuel poverty (this includes Affordable Warmth andthe Carbon Saving Communities Obligation (CSCO) target). That is less than the budget for people who can afford to insulate their own homes, and less than half the support available last year.

36. According to the Government’s impact assessment, ECO is forecast over the next 10 years to lift just 250,000 households out of fuel poverty—50,000 fewer than fell into fuel poverty this winter alone.

37. Government proposals on the cheapest tariff do not address the key problem of lack of transparency and liquidity in the energy market. The cheapest tariff in an uncompetitive market will still not be a good deal for customers. In order to make sure customers are paying a fair price, we need to reform the energy market as outlined above.

February 2013