Energy and Climate Change CommitteeSupplementary written evidence submitted by British Gas
BRITISH GAS COMMITMENTS MADE IN ORAL EVIDENCE
Question from John Robertson MP
Q85 John Robertson: You obviously have too many shares. What about you gentlemen?
Ian Peters: I would have to come back with the precise number. We have 700,000 small shareholders, which is a legacy of privatisation.
Q86 John Robertson: Does this include all parts of the industry? I don’t know how you are going to do it if you are including part of your international wings.
Ian Peters: I suggest it does not give you the figures from Centrica in this context, because the dividends come from Centrica. Last year we reported £2.7 billion profit, of that, on the tax point, we paid £1.1 billion of tax, £773 million of that—
Q87 John Robertson: Don’t worry about the tax, my colleagues will come back to that later. I am sure they have some nice questions for you. What I am trying to say, the same point I made to your colleagues, is that the shareholders get all the benefits from the whole company and yet the general public are basically getting screwed into the ground because everybody always talks about retail.
Ian Peters: I was going to give you all the numbers, Mr Robertson. Of that £2.7 billion, around £600 million, less than 25%, comes from residential energy supply, the rest of it comes from our operations in North America. Our upstream business, which again is a focus of some questioning, last year made £1.23 billion. That is pre-tax 17%; post-tax it is 13%. Given the billions of pounds we invest in generating that, the return on that capital is in high single digits. So I think that is a fair return for all of that. These need to be looked at in the aggregate on a post-tax basis.
Q88 John Robertson: Do you know how much you get from Government to help you with that?
Ian Peters: Virtually nothing.
Q89 John Robertson: They don’t give you anything?
Ian Peters: Virtually nothing. I will have to come with precise amounts.
Centrica response:
Centrica does not receive specific Government help to underpin our investments, other than (for example) capital allowances which are available to any business investing in this country. Once those investments are operational, UK tax will be payable on any profits.
Question from Alan Whitehead MP
Q90 Dr Whitehead: So what proportion of what you might call pre hoc trading really occurs over the counter and what proportion really occurs in terms of what you might call competitive trades informed by transparency of those forward markets at the point in which you are undertaking your initial trades? Is it fair to say that there is very little relation between what you are yourself generating and what you are yourself purchasing at that point?
Ian Peters: As I say, our own purchases from our upstream division is 10% in electricity and 6% in gas. I have no problem disclosing the splits but I do not have them with me in terms of over-the-counter.
Dr Whitehead: It would be very helpful if that could be sent to us in writing.
Ian Peters: I would have to come back to you, because I don’t run the upstream division.
Centrica response:
All of our power trades are based on market prices, regardless of whether they are internal trades or external, or whether they are executed on exchanges or OTC. Our power sales (selling our generation into the wholesale market) and our power purchases (buying power for our customers) are executed through separate trading books, and decisions in relation to each book are made independently of each other. Each book follows its own hedging strategy and this is the main driver of the trading activity for each book.
Our power trading activity is organised along two different timeframes:
Up to the day-ahead stage, our generation and supply businesses hedge their positions independently. Each business is required to execute its hedging strategy by entering into transactions with market counterparties at the best possible price. Our different businesses are allowed to trade with each other, but in practice this is relatively rare. For example in 2012, British Gas only bought 4.5 TWh from Centrica Energy, representing 10% of the power supplied to end-consumers; British Gas bought the remaining 90% from the open market. Any internal trade between our production and supply businesses is executed at market prices. The valuation of these internal trades is verified annually by our external auditors PWC.
At the day-ahead stage, our trading desk aggregates any un-hedged positions from our generation and supply businesses and manages the net position in the market. This can lead to internal trades between our different businesses, but in practice the volumes involved are very small. For example in 2012 the net transfers between our generation and supply businesses only amounted to 0.23TWh, representing 0.5% of the volumes we supplied to end-consumers.
Question from Barry Gardiner MP
Q91 Barry Gardiner: Mr Peters, there are areas of accounting estimates, aren’t there, and they can distort the presentation of figures can’t they?
Ian Peters: Are you talking about allocations of overheads here?
Barry Gardiner: No, I wasn’t, although it is a perfectly reasonable one and I did mention that earlier, but with you I was looking more at the depreciation on asset values. Centrica has a disclosure that, “Generation EBIT earnings before interest and tax excludes depreciation of fair value uplifts to property, plant and equipment relating to the strategic investment in British Energy”. Do you think that that is fair and transparent?
Ian Peters: It is very hard for me to comment on the specifics because I wasn’t a party to those conversations, and if there is anything I want to come back to you on—
Barry Gardiner: So you are going to have to write to us as well then, I take it?
Ian Peters: Yes, I suspect—
Q92 Barry Gardiner: But you take my point about accounting estimates and depreciation of fair value on assets?
Ian Peters: I do. As a slightly broader point, we have not changed our methodologies for two years, and Ofgem and BDO recognise the consistency of that. I would surmise that the British Energy—
Q93 Barry Gardiner: Have not changed it in two years? That is not an awful lot of time, is it?
Ian Peters: We have only been going since 2010, but this is the point about consistency and the way the segmental accounts are put together. As I say, there are no black holes. Depreciation, to an extent, is clearly a judgment call. The investment in British Energy was conditional upon the valuation around the new nuclear build, so I suspect that is what is behind it but I will have to write to the Committee and confirm.
Centrica response:
The Committee raised a question whether the presentation of the Generation EBIT earnings before interest and tax excluding depreciation of fair value uplifts to property, plant and equipment relating to the strategic investment in British Energy was fair and transparent.
We feel that this presentation is both a fair and transparent. The adjustment is made by the Group to provide useful information on the underlying business performance of our generation business. As the accounting for the depreciation of the fair value uplifts bears little relationship to current market conditions, operational performance or underlying cash generation. We clearly identify and disclose the quantum of the adjustment, so our stakeholders can view and understand the generation result both including and excluding the adjustment. We also include a detailed explanation of why we are making the adjustment (see below).
“The Directors of Centrica believe that reporting adjusted profit and adjusted earnings per share measures provides additional useful information on business performance and underlying trends. They have determined that for Strategic investments (including British Energy) it is important to separately identify the earnings impact of increased depreciation arising from the acquisition-date fair value uplifts made to Property, Plant & Equipment (PP&E) over their useful lives. As a result of the nature of fair value assessments in the energy industry, the value attributed to strategic assets is a subjective judgement based on a wide range of complex variables at a point in time. The subsequent depreciation of the fair value uplifts bears little relationship to current market conditions, operational performance or underlying cash generation. Management therefore reports and monitors the operational performance of Strategic Investments before the impact of depreciation on fair value uplifts to PP&E. The segmental results are presented on a consistent basis, as mandated by IFRS 8.”
Question from Barry Gardiner MP
Q94 Barry Gardiner: Can I ask all of you as well how often you have check listed, in relation to trading activities, the “another part of business” box?
Neil Clitheroe: We check listed it I think on the 2011. We show that the activity is done within our energy management business and that is notated at the bottom very clearly, and we actually show where the P&L impact of that activity is within our retail and generation business. It is very clear on the last page of our segmentals where the responsibility and then where the profit and loss impact is for those activities.
Ian Peters: To the best of my knowledge we have never done it, but I will come back and confirm that when—
Q95 Barry Gardiner: You never ticked the “another part of business” box?
Ian Peters: To the best of my knowledge, but I will come back and confirm that when I write back on depreciation.
Centrica response:
We have always excluded our propriety trading activities from our segmental statements. All of our ticks in the “Another part of the business” section of the Ofgem Segmental Statements business functions checklist relate to our propriety trading activities. Our proprietary trading activities are excluded from the Segmental Statements to transparently reflect the results of our supply businesses on a standalone basis.
Power Trading Questions
1. What percentage of your total electricity trades are over-the-counter (OTC) versus trades on the wholesale exchange?
In the first four months of 2013, we executed 4% of our power trades on regulated exchanges (N2EX and APX), and 96% over-the-counter (OTC), as measured by traded volume, in the GB market. The exchange cleared volumes are split between the financial futures market and the physical spot auction, which clears day-ahead physical power volumes each day. The vast majority of our OTC trades are executed through specialised brokers over the Trayport platform. There is total transparency over the trading activity done over Trayport. The platform continuously displays current bids and offers and the detail of completed trades is made available to all market participants in real time in anonymised form.
2. What are your criteria for trading OTC versus on the wholesale exchange?
The key factors we take into account in deciding whether to trade OTC or on an exchange are market liquidity, the availability of bilateral credit agreements and management of the company’s credit exposure.
Trading forward contracts on exchanges tends to be costly (relative to the alternative of bilateral credit agreements) due to the requirement to provide cash covering the full mark-to-market valuation of the contracts on a daily basis. This is one of the reasons why we do most of our forward trades OTC. Centrica also benefits from a high credit rating, which enables us to have lines of credit with our major counterparts and helps us limit the costs we face from OTC trading.
We keep under continuous review our choices of platform for our trading activities. One of the regulatory factors we take into consideration is developments in European financial regulation. Under the European Market Infrastructure Regulation (EMIR) energy companies that exceed a prescribed threshold level of OTC derivative trades may be required to undertake mandatory central clearing of trades.
This could significantly increase the cash and collateral requirements that some energy companies face through their trading activities. It may also lead to more energy trading activity to move to exchanges over time.
3. What is the average difference in price for your OTC versus wholesale exchange trades?
Prices tend to be aligned between the OTC market and exchanges. There is total transparency over trading prices in the market, so any price differential between exchanges and the OTC market is quickly identified and arbitraged away by market participants. Therefore, where markets are liquid, the price differentials should only reflect the different transaction costs of trading OTC versus exchange.
The price difference between futures contracts and OTC physical products is usually around 5p/MWh or 10p/MWh to account for the additional costs of clearing and exchange fees.
4. Does your company deal in long-term contracts? Who has access to the information contained in the contracts?
We enter into 3 types of contracts, OTC, exchange-based and bilateral contracts. We trade standardised OTC forward contracts in the wholesale market up to 3 years ahead of delivery. We will trade equivalent contracts (futures) through exchanges, although contract terms will tend to be less than 3 years on exchanges. We provide information on the fair value of these contracts in our financial statements in accordance with international accounting standards (IAS 39). We are also preparing to report the details of these trades to ACER under the Regulation on Energy Market Transparency and Integrity (REMIT). Implementation of transaction reporting under REMIT stretches into 2014 and potentially beyond.
We also have a range of bilateral contracts, including contracts with other large generators as well as power purchase agreements (PPAs) with a number of independent renewable generators. We have, for instance, a contract with Drax for 300 MW of baseload power, running until 2015. The price is set with reference to international coal prices and agreed fixed clean dark spreads. The purpose of this contract is to reduce Centrica’s exposure to the gas price in GB. We published this information on our website when we concluded the contract in 2009.
Our renewable PPAs are typically complex contracts that provide independent generators with a number of essential services (including the management of balancing risks and the monetisation of Renewables Obligation Certificates and Levy Exemption Certificates). These contracts are tailored to the needs of each generator and the terms are commercially sensitive. We are currently working with DECC to develop contract templates and a voluntary code of conduct to increase transparency and streamline the contracting process in the PPAs market.
While we may sometimes publish details of the contracts we conclude (as in the case of Drax), Centrica, like other market counterparties, will generally treat key transaction details, such as price, as commercially sensitive and confidential and as such that information is known only to counterparties to the contract.
Gas Questions
1. What information do you use for making trades (market information)?
Our trading decisions are made upon a balanced and thorough consideration and understanding of supply and demand fundamentals. The information used is publicly available through the various Grid operators in Europe, and includes flow and flow nomination data, demand forecasts, storage inventories, and production forecasts. Other information includes other market/industry relevant news data from sources such as Bloomberg, Reuters and various other news agencies.
2. What analytical tools do you use (market models)? What data do you use for these models? How frequent is the data (quarterly, monthly, weekly, daily)?
We track available fundamental data in the UK and on the continent to build up a picture of supply and demand. Data is captured from different electricity and gas transmission system operators (TSOs) and websites and uploaded into databases and spreadsheets for analysis.
We model many aspects of the market to inform our trading activities. The models we use include:
Demand forecasting models
For demand forecasts we use proprietary models to model demand as a function of temperature and wind. Models are updated at least daily but normally twice a day. Weather data comes from weather data vendors via email/website/ftp site. National Grid provides hourly updates of demand through their website and Gemini.
Supply models
For supply modelling we track and store historic flows and forecast flows based on price relationships, costs and outages. We collect data from different TSO websites (all publicly available) daily or intra-daily where available. For the UK real time flow data is available via the National Grid website. National Grid also provide the detail of nominations for supply (and demand) intra-day. On the continent real time data is usually not published but intraday flows are sometimes available (hourly flows) and most flows are published at D+1.
Nominations are usually available from TSO’s on a daily basis. Outage data for UK and the continent comes from the different REMIT sites that we cover and TSO websites/Bloomberg/Reuters/Energy publications.
Oil-linked contract price model
Our oil linked contract price model is based on oil/oil product prices. It compares those prices against views from consultants and other published prices (from company accounts). The model uses live prices on a Bloomberg terminal.
Stack models
We use supply, demand and cost data to put together stack models (showing marginal dispatch costs) to find the marginal costs of supply for different energy commodities.
3. Where do you get this data?
We get weather data from various different vendors to which we subscribe. Supply and demand data comes from publicly available sources. Most TSOs now publish supply and demand data on their websites. Outage data is publicly available on REMIT websites. For price data, data comes from broker screens (Trayport) and is captured and stored in a database. Price data is also received via Bloomberg/Reuters/Publications (Argus/Heren). These are all paid-for services.
4. What price information do you use for trading? Where do you get it?
All data described on gas questions 2 and 3 is used for trading purposes. Sources are as set out in gas question 3.
5. How do you calculate your forecast pricing? What sources of data, analytical tools and information do you use to forecast prices?
Our trading business does not forecast prices. We do however develop a view on the movement in forward prices of energy commodities, through an assessment of how we think prices will move in relation to each other (between different fuel types, between different time periods and between different locations). We use a suite of in-house models to assess market fundamentals—see our answer to gas question 2.
6. How much of your trading is on the wholesale exchange versus over the counter? What price references/benchmarks to you use for over the counter trades? What price references/benchmarks to you use for wholesale exchange trades? What is the average price spread between your OTC versus wholesale exchange trades?
In the first 4 months of 2013 we executed 23% of our gas trades on exchanges, and 77% over-the-counter. We rely on the bids and offers displayed by exchanges and brokers, and the prices reported by price reporting agencies such as Argus, Heren and Platts.
Prices tend to be aligned between the OTC market and exchanges. There is total transparency over trading prices in the market, so any price differential between exchanges and the OTC market is quickly identified and arbitraged away by market participants. Therefore, where markets are liquid, the price differentials should only reflect the different transaction costs of trading OTC versus exchange.
The price difference between gas futures and OTC physical gas products is usually around 0.025p/therm to account for the additional costs of clearing and exchange fees.
7. Do you have access to any information from your upstream division?
Yes. Once a month Centrica Energy Midstream receives, from Centrica Energy Upstream, forward monthly production data for the rest of the current year and the following two years. This data is broken down by field and is volumetric in nature and subject to change without notice. On a daily basis CE Midstream get the delivery nomination for the expected production for the next day, and get regular updates of within day production volumes to allow for daily balancing within National Grids gas system. This information is sent to Centrica Energy Midstream’s Operations department for balancing purposes. See gas question 13 below on how Centrica Energy’s REMIT disclosures to the market, in respect of inside information, are made.
8. What continental market factors do you track? How do they influence your UK trades? Is there information on the continental market to which you do not have access which would advantage you? If so what information (such as storage levels)?
As the gas markets in North-Western Europe are relatively well interconnected through various pipeline infrastructure and LNG, we track the same market information in Continental Europe as we do in the UK. This includes demand forecasting, production and cross border flows and storage inventories. The EU has made significant efforts and advances over the last few years to make more such data publicly available, and although data is not easily publicly available to the same extent as in the UK, the situation is improving. It is also worth pointing out that the situation is naturally more complex in Continental Europe as the data is handled by more than one Grid Operator.
9. What sort of trading platform do you use?
The vast majority of our trades are executed through electronic screen based platforms. The primary system used is Trayport, an electronic tool that allows brokers and exchanges to list bilateral, OTC cleared and exchange cleared markets. Trading also takes place on the electronic platforms of the various exchanges on which we are active (eg Intercontinental Exchange (ICE), APX, EPEX etc.).
10. What percentage of your total gas trades are over-the-counter (OTC) versus trades on the wholesale exchange?
See our answer to gas question 6.
11. What are your criteria for trading OTC versus on the wholesale exchange?
See our response to power question 2. The same considerations apply in gas as in electricity.
12. What is the average difference in price for your OTC versus wholesale exchange trades?
See our answer to power question 3.
13. What announcements have you made in accordance to REMIT? Where is it posted? If you trade gas outside of the UK within the EU, where do you post announcements for other EU markets?
Centrica plc makes disclosures pursuant to REMIT on its corporate website, which can be found at: http://www.centrica.com/index.asp?pageid=1131
The obligation under REMIT to disclose inside information to the market applies to a market participant that possesses inside information in respect of business or facilities which that market participant, or its parent undertaking or related undertaking, owns or controls or for whose operational matters that market participant or undertaking is responsible. Inside information for the purposes of REMIT is information that is: precise; has not been made public; relates, directly or indirectly, to one or more wholesale energy products; and which, if it were to be made public, would be likely to significantly affect the prices of wholesale energy products.
Accordingly, in the light of this obligation, we consider that the only upstream facility in respect of which we may obtain information that has the characteristics of inside information is South Morecambe. We do not consider that any of our other upstream facilities would be material for the purposes of our REMIT analysis. Our REMIT analysis is kept under review to ensure that it accurately reflects our business and in any event to reflect any changes in law
14. What access to market information do your traders have about any other division of your company? Do they have access to storage levels, upstream information if applicable (geological data), or daily production/consumption data?
Storage holders at the Rough gas storage facility have access to a variety of information on a daily basis [stock level, withdrawal rate, injection rate] that relates to their use of the facility. Each storage holder can only see their own data. Centrica Energy as a holder of storage rights has access to this information in the same way as other storage holders.
Centrica and Centrica Storage Limited (CSL) continue to be governed by Undertakings in relation to the operation of the Rough storage facility (and the Easington processing terminal). Among other measures, the Undertakings require that CSL is to be legally, financially and physically separate from the rest of Centrica and that no commercially sensitive information arising from the operation of Rough is passed directly or indirectly to any business of either Centrica plc or other member of the Centrica group that carries on shipping, trading, supply, storage and asset operations.
Centrica Storage Limited also gives out information relating to the whole Rough facility, and this is available to all storage holders via CSL’s website. CSL also separately publish REMIT information on their website (https://storitnew.centrica-sl.co.uk/STORIT/publicLogon.do).
For upstream information, see gas question 7. For daily production/consumption data, we include that in the information we discuss in gas questions 1 and 2.
15. Does your company deal in long-term contracts? Who has access to the information contained in the contracts?
We have a number of long-term gas contracts, most of which are indexed on gas prices. Some are indexed on other commodities prices and foreign exchange rates. We also have long-term contracts for transmission capacity, LNG capacity and storage. We publish the aggregated value of these contracts in our financial statements.
We often announce on our website major long-term contracts into which we enter. For example in December 2011 we announced a £13 billion 10 year gas supply deal with Statoil ASA. This was an agreement for the supply of 50 billion cubic metres (bcm) of gas to the UK. The 10 year, NBP-linked gas supply contract begins in 2015 and secures sufficient gas to meet around five% of total UK annual demand, enough for 3.5 million homes. The link to the press release is here:
http://www.centrica.com/index.asp?pageid=1041&newsid=2275.
While we may publish details of the contracts we conclude (as in the case of the Statoil deal), Centrica, like other market counterparties, will generally treat key transaction details, such as price, as commercially sensitive and confidential and as such that information is known only to counterparties to the contract.
Downstream Questions
1. How many of such “immobile” customers do you have?
At the opening of the retail gas market to competition in 1997, all 19 million gas consumers—by definition—were on a standard variable, gas only tariff with British Gas. We now have 9 million gas customers. Of these, 81% have previously either switched gas supplier or moved house.
Moreover, many customers have exercised further choice by adding electricity, paying by an alternative method or choosing a cheaper tariff. On that basis, together, 91% of our gas customers today have taken some action.
Finally, just 800,000 (4% of the original 19 million) have made absolutely no change. They are still in the same situation in the same property on a standard variable, gas only tariff and on the same payment type with British Gas, and are clearly a small minority.
2. Do you offer all customers all of your tariffs? If not, what are the reasons for not offering the full suite of tariffs?
All British Gas credit customers are offered all of our tariffs. Due to industry-wide technical restrictions to the numbers of tariffs that can be stored on some meters, our prepayment customers are not offered all tariffs.
3. What can you do to reduce the cost of customer service yet also improve your quality?
British Gas has invested substantially in service improvement initiatives over the past few years, in order to both improve our customer service and help to control our costs. We are on track with our publicly announced programme to remove a further £300m of operating costs from our business over 2012 and 2013. At the same time, British Gas has significantly improved its customer service, and we have seen our customer Net Promoter Score (NPS) rise from -37 to +50 from 2006 to 2012. In 2012, we received a maximum 5 star ratings from Which? for our payment policies, billing, and complaints handling, and 5 stars from Consumer Focus for our customer service.
To achieve this we have:
invested significantly in technologies and staff training;
simplified our processes to reduce errors and therefore the costs of re work;
re-engineered our metering, billing and back office;
closed down cold call doorstep selling;
one third of our customers now self-serve to some degree;
enabled our agents to take a complete view of all the contacts a customer has with British Gas and assess their service needs accordingly;
introduced sophisticated call routing technology which allows calls to be diverted to the most appropriately skilled agents. This improves the customer experience and increases agent productivity;
revolutionised our website, which has encouraged customers to transact online, making it easier for them to access the service they require, and reduced inbound call volumes. Customers are now able to undertake a wide range of transactions online including submitting meter reads and booking an engineer appointment. We have launched a mobile phone ‘app’ which allows customer to access all our web functionality via this route; and
reviewed all our customer communications (letters, bills etc) which trigger an inbound customer call and eliminated those which were driving unnecessary contact.
4. What proportion of calls/correspondence are caused by billing queries and by how much do you anticipate this will fall after the advent of smart metering?
Around 41% of British Gas customer calls & correspondence are related to billing queries. We anticipate that the widespread installation of smart meters will lead to a reduction of around half. We are already seeing customers with smart meters call us 30% less than the general customer base, and their complaints are reduced by half.
May 2013