Energy and Climate Change CommitteeWritten evidence submitted by SSE

SSE is a UK owned and based energy company. It is involved in the generation, transmission, distribution and supply of electricity and the production, storage, distribution and supply of gas.

This response considers all three parts of the inquiry.

Summary

Energy prices

There are a number of costs which feed directly into customers’ energy bills. The wholesale costs of energy make up around half of the average bill. The rest is largely made up of the costs of using the energy networks and funding Government mandated schemes.

Around 90% of the costs in the average energy bill are out of suppliers’ control.

In recent years three principal factors have increased energy prices: the wholesale costs, the costs of using and improving the energy networks and the costs of Government mandated schemes, particularly those intended to improve household energy efficiency.

The UK’s energy prices are, on average, cheaper than in comparable EU countries. Government statistics show that in the first six months of 2012 the UK had the cheapest gas prices and the fourth cheapest electricity prices in the EU 15 (including taxes).1

Energy company profits

SSE is a broad-based utility. In its Annual Report and Consolidated Segmental Statements it is transparent about the levels of profit which it makes.2

Given the breadth of SSE’s operations, and the many factors which make up energy prices, drawing correlations between energy prices and company profits is misleading.

SSE has publicly stated that over the medium term (3–5 years) it expects to make around 5% profit per customer account (less than a £1 per week per customer). This level of profit is reasonable for a business of the scale of SSE. It is less than other household services such as telecommunications.

Across the SSE group it currently invests more in the UK’s energy infrastructure than it makes annually in profit. It needs to make fair and reasonable profits across each of its businesses areas in order to continue investing at similar levels going forward.

Fuel poverty

SSE will spend around £50 million on support for its most vulnerable customers this year.

Any attempts to address fuel poverty must address the key issue of identifying vulnerable customers and tailoring support to meet their specific needs. SSE advocates that a central “agency” be appointed to match customers in need with the available support.

Household energy bills are dependent on the amount of energy used, therefore rising energy prices do not necessarily equate to similar rises in customer bills. Improved household insulation has reduced energy usage. So much so that if customers continued to use the same amount of energy as they did in 2005, a typical SSE customer bill would be around £400 higher using current prices.

Part 1: Energy Prices

How energy prices are determined

1. There are a number of costs which feed directly into customers’ energy bills. Currently the wholesale costs of buying electricity and gas on international markets accounts for around half of the average customer bill. The rest is largely determined by the costs of using the energy networks (25% of the average bill), the costs of funding Government and regulator mandated schemes (10% of the average bill) and VAT at 5%. See figure 1 in annex.3

2. The majority of these costs, almost 90%, are determined by either international markets or set by the Government or Ofgem. These costs are largely outside of the control of energy suppliers and are passed through to customers in their energy bills.

3. As wholesale costs account for just half of an energy bill, attempts should not be made to draw conclusions solely by considering the relationship between the wholesale and retail prices of energy.

The three principal factors which are increasing energy prices:

The price of energy in the wholesale markets—SSE (and the UK) operates in a global commodities market. SSE has a responsibility to secure the gas and electricity that customers need and prevent its customers facing the volatility of global markets. It does this buying energy in advance, sometimes up to three years.

The cost of using the electricity and gas networks—suppliers have to pay the companies which own the UK’s electricity and gas network for transporting energy along the wires, cables and pipes to customer’s homes. The cost of using the networks is controlled through a long-term regulatory formula determined by Ofgem and increases in costs are a result of significant and necessary investment undertaken by the networks in this infrastructure.

The costs of Government and regulator mandated schemes—these principally account for suppliers’ social spending, energy efficiency measures, feed-in-tariffs and support for renewable energy. These costs are introduced by the Government on the basis that they will be paid for by consumers through their bills (see points 9—14 for more).

4. Whilst UK energy prices have increased in recent years, UK consumers are, on average, paying less for their electricity and gas than those in many comparable markets in neighbouring European countries. DECC statistics show that in the first six months of 2012 the UK had the cheapest gas prices and the fourth cheapest electricity prices in the EU 15 (including taxes).4 This statistic not only assists when seeking to benchmark UK prices, it also demonstrates one of the benefits of the UK’s liberalised energy supply market.

How the factors making up energy prices have changed over time:

5. SSE has taken a number of steps to improve the transparency about how it determines energy prices. This includes publishing a market outlook which details the likely medium-term direction of energy prices. See figure 2 in annex.5

6. The contribution of each of the factors within energy prices has changed in recent years. Looking backwards, the trends from the last eight years are:

Wholesale prices have been volatile and have doubled due to international events, such as the Arab Spring and the Fukushima nuclear accident. However, these costs now make up less of the total costs in an energy bill than was the case eight years ago.

Retail prices broadly reflect wholesale prices. Its movement has a slight lag after the wholesale price reflecting the fact that companies buy energy up to three years ahead of customer use.

The costs of Government and regulator mandated schemes and network (UoS) costs have increased.

Profit margins have varied significantly and been both positive and negative at different times. Since 2004 they have been net negative.

The rising costs of Government and regulator mandated schemes:

7. Of the factors changing energy prices over time, the costs of mandatory schemes are rising significantly. These costs are forecast to continue increasing in the coming years.

8. These costs account for policies such as supplier social spending (such as the Warm Home Discount), the Renewables Obligation, and energy efficiency programmes such as CERT, CESP and, from January 2013, the Energy Company Obligation (ECO). Next year a typical duel fuel customer could be paying over double the amount paid in the previous year to fund these schemes.

9. Of these costs it is the delivery of energy efficiency obligations which is principally causing this increase in costs. Research carried out by the economic consultancy NERA concluded that the annual cost of delivering ECO could be over £2.35 billion, far exceeding the £1.3 billion forecast in DECC’s Impact Assessment6. The costs of ECO will be borne by all customers of the larger energy suppliers and on a per customer basis this could equate to almost £100 a year rather than the £52.50 forecast by DECC in the IA.

10. The reasons for the potential ECO cost escalations are the potentially low take-up of Green Deal and the subsequent costs to suppliers of meeting their carbon reduction obligations. At the same time the costs to suppliers of identifying “hard to reach” customers to offer energy efficiency measures.

11. One of the reasons why the costs per customer of delivering the ECO are increasing is that these costs are not borne by smaller suppliers and their customers. In effect this means that smaller suppliers (>250,000 customers) are able to offer customers deals that do not account for the £100 in costs incurred by larger suppliers. This is detrimental to the majority of UK consumers and competition in the retail market.

12. If the Government intends to encourage competition in the retail market it should address barriers to entry not exempt small suppliers from policy costs. In the interests of equity across all UK energy consumers and to ensure cost reflectivity, all suppliers should therefore be levied (in some way) for the costs of delivering this Government policy.

13. Whilst SSE firmly supports the principle of improving the energy efficiency of UK homes as part of a long-term strategy to reduce household energy bills, this must be done cost-effectively. The Government should take these issues into account as ECO develops. For these reasons SSE has called for Government to cap the cost of ECO.

Part 2: Energy Company Profits

14. SSE is a broad based utility. The majority of its operations are in England, Scotland and Wales. SSE also has a growing business in Ireland. It is the second largest electricity generator in the UK, owns and operates economically-regulated electricity networks and has a 50% ownership of gas distribution networks. It also supplies electricity and gas to over 9 million customers. As well as this within its core businesses SSE is also the UK’s largest street lighting contractor, owns gas production and storage facilities and runs businesses in the water and telecoms sectors.

15. It reports to shareholders on its financial performance across the three core segments that make up its business: wholesale, retail and networks. With energy retail just one part of SSE’s business, and given the many factors that determine energy prices, attempting to drawing correlations between energy price rises and company-wide profits is misleading.

16. SSE is transparent in how it reports its financial performance to shareholders and customers. It breaks down performance in each part of its business in its Annual Reports7 and publishes Consolidated Segmental Statements to Ofgem which breakdown profits by each of the three core segments that make up its business.8

17. It has consistently said that it aims to achieve an average profit margin of around 5% over the medium term (3–5 years) in its retail business (this equates to less than a £1 per week per customer). A profit level of 5% in the retail business is fair and reasonable for a business of its size and scale. It is comparable to other household sectors such as food retailers and below that of telecoms providers.

18. Across the UK and Ireland SSE employs around 20,000 people and is investing the equivalent of almost £4 million a day in the UK’s energy infrastructure to maintain secure supplies and help decarbonise the UK’s economy. Without reasonable profits across each of its businesses, this level of investment would not be sustainable.

19. As a UK owned and based company SSE is a responsible tax payer and makes a significant UK tax contribution. PWC’s annual survey of the tax contributions paid by the companies in the FTSE 100 confirms that SSE is one of the most significant taxpayers in the UK contributing almost £400 million in 2011/12. This makes SSE the 17th highest tax contributor in the FTSE 100.9

Earning the right to make a profit:

20. SSE is aware that it needs to earn the right to make a profit, particularly in its customer facing retail business. Its customer service is consistently rated as among the best of the energy suppliers however it recognises that further steps could be made to improve transparency, simplicity, service and fairness for its customers. SSE has been first in the sector in introducing the following changes:

Restoring simplicity: by reducing the number of tariffs from over 60 to just three core products;

Enhancing transparency: by voluntarily improving wholesale electricity market liquidity and publishing a breakdown of costs on customer’s bills;

Improving customer service: by introducing a Sales Guarantee and offering all customers an Annual Energy Review to ensure they are on the right products and taking advantage of energy efficiency measures and financial assistance;

Introducing Customer Service Guarantees: in which SSE will give customers £20 if it does not meet the service standards which it sets itself.

Part 3: Fuel Poverty

21. Fuel poverty is caused by three principal factors i) the price of energy ii) household income and iii) the level of insulation and energy efficiency in homes. There are practical ways in which energy suppliers can support those customers who are in need, however it can only do this in collaboration with Government, local authorities, other interested stakeholders and the customer themselves.

22. SSE broadly concurs with the conclusions of the Hills Review into fuel poverty. What is needed following the report is a series of practical solutions which ensure measures target those customers most in need of support with their energy costs.

23. As a leading UK energy supplier SSE will spend almost £50 million in this year alone to provide support to customers who are struggling to pay for the energy they need. This accounts for a variety of assistance including the Warm Home Discount, access to discounted or free energy efficient products and benefit entitlement checks. The level of spend will increase in the coming years.

24. For SSE, the greatest challenge to addressing fuel poverty is identifying customers potentially at risk of fuel poverty and offering them the support that is available. Put simply, suppliers do not have the tools to identify those potentially at the greatest need, as for most customers they are equipped only with names, addresses and payment information. The data-sharing which informs the Warm Home Discount Scheme has seen some improvement in this area. However, there are concerns that suppliers are being obliged to seek information about their customers that are beyond the normal customer/commercial company relationship, such as benefits data and health conditions.

25. Therefore, any solutions to fuel poverty must address the key issue of identifying vulnerable customers and tailoring support to meet their needs. SSE has long advocated that some form of central “agency” be appointed to match customers in need with the support available. This will help to ensure that policies are meeting their intended aims.

Energy efficiency is the long-term solution:

26. Rising energy prices do not necessarily have to equate to similar rises in customer bills. The size of a customer’s bill is not just determined by the movements in prices, it also depends on the amount of energy used. Measures to reduce energy usage and improve the energy efficiency of UK homes are the long-term solution to reducing the cost to the consumer.

27. Household insulation has been improved in recent years through policies such as CERT and CESP and improvements in the energy efficiency of household technology. As figure 3 in the annex shows, this has reduced average energy demand for gas and electricity. The effect of this should not be underestimated. Using current tariff prices and usage for a typical SSE customer, bills would be around £400 higher if customers continued to use the same amount of energy as they did in 2005.10

28. As a result of the energy efficiency measures installed by SSE and other companies these trends are expected to continue for gas usage over the next few years. Electricity demand is harder to predict as electrical appliance usage is expected to increase.

29. Too often research into the relationship between wholesale and retail prices ignores the impact of reduced average demand. This is the case with Ofgem’s Supply Market Indicators, which can lead to an overestimate of profits as margin is attributed to sales that never happened as the energy was not used.

30. Over the long-term the Green Deal presents a significant opportunity for the further improvement of the energy efficiency of UK homes. SSE is fully committed to its objectives and continues to work hard to deliver a programme which works in the best interests of consumers.

February 2013

ENERGY PRICES, PROFITS AND FUEL POVERTY INQUIRY: SSE RESPONSE

Annex

Figure 1

HOW ENERGY PRICES ARE DETERMINED

Figure 2

HOW THE FACTORS MAKING UP ENERGY PRICES HAVE CHANGED OVER TIME

Figure 3

REDUCTIONS IN ENERGY DEMAND FOR SSE CUSTOMERS