Appendix 2: Ofgem Response
Introduction
Ofgem welcomes the Committee's comprehensive report
on Energy Prices, Profits and Poverty. The report is an important
contribution to the debate on prices and profits. We agree with
the Committee that at a time of rising costs there is an urgent
need to rebuild consumers' trust and to reassure them they can
have confidence in the energy market. We also agree that greater
transparency is an important part of the honest conversation the
Committee wants the energy industry to have with all consumers.
The Committee makes a number of recommendations about
steps Ofgem should take to help improve competition and to give
customers greater confidence in the market. We have actions in
hand in many of these areas, but we have listened to the Committee's
recommendations and we are looking again at what more we can do.
The Committee acknowledged the important role of
our Retail Market Review in stripping away complexity to give
consumers clearer information and make it simpler to compare tariffs.
We are pleased to confirm that in August we directed the necessary
licence changes and suppliers are now required to implement our
reforms. The Standards of Conduct which we introduced on a faster
track are already in force. Backed by fines if necessary, these
require suppliers to treat their customers fairly.
We recognise the need highlighted by the committee
for us to be transparent and rigorous in our monitoring of the
impacts of RMR. We are currently developing the detail of our
monitoring approach and will take the Committee's recommendations
on board as we do that. In particular we are planning to produce
an annual report which will provide a clear picture of the state
of the market.
The Committee also highlights the important role
that liquidity reforms and our new REMIT powers can play in making
the wholesale market more effective and driving competition for
consumers. We agree with the committee about the importance of
these areas and the need for timely action. Our proposed measures
to improve liquidity are on track to come into effect early next
year and we have consulted on how we will use our REMIT powers,
which came into effect, as anticipated, at the end of June this
year. We have also been looking at the role of price benchmarks
in the Over The Counter (OTC) market which is another area where
there is scope to improve transparency and market confidence.
We set out in more detail later in this response the work we have
in hand in these areas.
The committee further recommended that we improve
our supply market indicator (SMI) methodology to better reflect
the activities of energy companies. In that context, we have already
adjusted the methodology to take account of the significant reductions
in gas and electricity consumption over recent years. It is important
to recognise that the SMI, which is a forward looking indicator
based on public domain information, can never provide a fully
accurate picture of industry profitability.
On the issue of profit transparency we share the
Committee's view that this is critical to building consumer trust
and confidence in the market. As we noted in our evidence to the
Committee it is solely because of Ofgem's actions in recent years
that companies are now required to publish Segmental Statements.
We have consistently sought to improve the way they are prepared
and presented year-on-year in order to shine a light on companies'
profits.
The Committee's report recommended that we adopt
all of the BDO recommendations as a package. Our decision not
to take forward some of these recommendations was based on the
detailed advice provided by BDO and the feedback from extensive
consultation. There are costs to increasing transparency which
will be born ultimately by consumers in higher bills and it is
important that any steps we take are proportionate and do not
damage competition. We are currently not persuaded there is a
case to adopt BDO's recommendations in full. However, given the
Committee's recommendations and continuing consumer concerns about
profit levels we intend to revisit this issue. We plan to consult
later this month on how best to build confidence in the market
through greater transparency around revenues, costs and profits,
including looking again at all the BDO recommendations - both
individually and as a package.
Everything Ofgem does is aimed at making a positive
difference for consumers. We pay particular regard to consumers
in vulnerable situations and have recently published an updated
Consumer Vulnerability Strategy. This sets out our work to support
these consumers in engaging in the market and explores how to
identify those who need extra help in particular circumstances.
Rebuilding trust and confidence in the market is
vital. This was a key theme of Ofgem's Retail Market Review. Listening
to the Committee has encouraged us to take a wider look at what
more can be done to reassure consumers and give them confidence
in the energy market.
Ofgem is identified in recommendations 2, 7, 8, 9-13
and 14 - 16, 20, 26, and 29 of the Committee's report. Below,
the Committee's recommendations are shown in bold and the paragraph
references at the end of each recommendation correspond with those
in the Committee's report. Ofgem's response is given beneath each
recommendation.
Energy Prices
Recommendation 2: We recommend that the regulator
compel energy companies to: (Paragraph 25)
a) Standardise the presentation of their
bills to make it easier to understand bills, and compare prices;
We share the Committee's view that a key factor in
rebuilding consumer confidence is simpler and clearer bills.
A key outcome of our Retail Market Review (RMR) is
the requirement we have now placed on suppliers to standardise
and simplify elements of the presentation of a range of customer
communications, including the bill. We have recently made the
changes to suppliers' licences and suppliers have until the 31
March 2014 to make the necessary changes to bills and other communications.
We are also requiring the use of a Personal Projection and Tariff
Comparison Rate which will allow consumers to compare their current
tariff with others more easily, to support more informed switching
decisions.
b) Identify the various components which
make up the costs of the bill, the costs of UK/EU policy and company
margins;
We share the Committee's view that consumers need
to be able to find out what makes up the costs of the bill. However
we are not persuaded that providing information on the bill is
necessarily the best way to achieve this. Our consumer research
shows that consumers already find bills confusing and the priority
is to ensure they are clear what they need to pay and what tariff
they are on. Some suppliers do provide a breakdown of the costs
on the bill but we do not propose to require it.
We do however publish regular information for consumers
on the components of the costs of energy supply including providing
topic specific factsheets[9].
We also publish our Supply Market Indicators (SMI) which are updated
every week with information about the elements of the costs of
energy supply. Both of these tools are publicly available on our
website[10].
c) Express price changes in pounds and
pence as well as percentages.
We agree with the Committee that it is important
information is communicated to consumers in a way which is simple
and easy to understand, to facilitate informed engagement with
the market. Within RMR we have made the decision to implement
a range of information based proposals, which provide consumers
with new tools to help them engage, and make existing communications
more informative. As a part of this we have required information
to be presented in pounds and pence.
More specifically, our existing rules require suppliers
to inform consumers in advance when prices increase, or any other
changes that may significantly disadvantage them. We have tightened
these rules to ensure consumer receive personalised information,
in pounds and pence when prices increase.
We are now requiring suppliers to use a Personal
Projections on price change notices, and other communications.
Personal Projections create a common way of projecting the estimated
annual cost for a specific customer tariff and consumption. Suppliers
will be required to present this personalised cost information
in pounds per year.
When prices, or any other term increases, supplier
will be required to provide the consumer with a comparison of
the difference in cost, in pounds per year, personalised for their
consumption and tariff. This must be provided in a clear table
format, set by Ofgem and on page one of the communication. This
will ensure this information is prominent and the personal impact
of the price increase is clear for all consumers.
Recommendation 3: If the requirements proposed
under Ofgem's RMR are not in place by August 2013 as promised
we recommend that the Government stand ready to use any statutory
powers to compel greater transparency from energy companies, early
in 2014. (Paragraph 26)
We can confirm that Ofgem made the licence changes
to implement RMR in August, in line with its commitment to the
Committee. The appeal period has now passed and the licence conditions
come into effect in phases with suppliers required to have simplified
their tariffs by the end of the year and to provide the additional
information on bills and elsewhere by the end of March 2014.
The Standards of Conduct and the non-domestic rules
were on a faster track and came into force in August. Suppliers
are now required to treat their customers fairly and are exposed
to financial penalties if they do not.
We note the Committee's disappointment with the time
taken to reach this position. This is a complex area with different
stakeholders having strong views on the best approach and a need
for Ofgem to consult fully on what are quite detailed proposals.
We will however reflect on whether there are lessons that we can
learn for policy development going forward.
Recommendation 7: We recommend that Ofgem also
include 'profit margin' and 'rate of return on capital' (because
excessive profit margins are a symptom of poorly functioning markets)
in the list of metrics to help determine whether the supply market
was competitive. (Paragraph 40)
We share the Committee's view on the importance of
looking at a range of metrics to help determine the level of competitiveness
in the supply market. We are currently developing our approach
to monitoring and evaluation but would expect to include most
if not all of the metrics suggested by the Committee.
In particular we agree with the Committee that the
level of profit margin is a relevant indicator of supply market
competition. That is why we introduced the requirement on the
six largest energy suppliers to prepare and publish Consolidated
Segmental Statements which made public, for the first time, information
on the profit margins of the supply and generation businesses
of vertically integrated companies.
It is unclear how useful ROCE is as an indicator
of profitability for the supply market given these are not infrastructure
businesses. More generally, there are a number of complexities
surrounding the robust calculation of ROCE. However as part of
our consultation on further steps to improve transparency we will
look again at the practicality of calculating ROCE for the generation
aspect of vertically integrated businesses.
Ofgem is committed to ensuring stakeholders understand
the level of energy company profitability. Going forward we will
continue to look at ways in which we can ensure that clear and
accurate information about energy company profitability is available
to all consumers and stakeholders. We will use this alongside
other metrics to inform our view of the state of competition.
Recommendation 8: We repeat our recommendation
that when Ofgem implements its final RMR measures, it should publish
its targets for improvements in the market as a result of these
measures and the criteria it will use to judge the success of
the measures. (Going forward, Ofgem should also publish an annual
assessment of the effect those measures are having on competition
and consumer engagement). (Paragraph 42)
We agree with the Committee on the need for robust
monitoring of the effects of RMR. We have set out in our consultations
the broad approach that we intend to adopt and the outcomes that
we expect to see from the RMR.
The RMR measures are designed to ensure consumers
receive fairer treatment to facilitate trust; to provide greater
tariff comparability through simpler choices; and improve the
quality of information provided to consumers, to allow more informed
decisions. This should make it easier for consumers to engage
with market, and encourage them to so do.
Ofgem routinely tracks a number of retail market
indicators and carries out regular consumer research to understand
consumers' experience of and attitudes towards the energy market.
For instance, in June this year we published the results of our
Consumer Engagement with Energy Market Tracker Survey 2013[11].
This analysis has helped us identify areas where further action
may be necessary.
We already publish all our consumer research and
anticipate publishing regular reports on aspects of our evaluation
of RMR. Responding to the Committee's desire for an annual assessment
of the effects of RMR on competition and consumer engagement,
we confirm that going forward we plan to produce annual reports
looking at the state of the market.
While we are clear about the broad outcomes that
we expect from RMR we do not consider it would be appropriate
to set specific quantitative targets for success. RMR is intended
to deliver a complex series of outcomes that cannot easily be
captured or published as simple targets. The package needs to
be viewed in its totality in order to judge the impact of the
reforms.
We are now in the process of developing our approach
to reviewing the effectiveness of the RMR. As a part of this we
are looking to articulate what a successful outcome will look
like both in terms of the changes we would expect to see in consumers'
trust and understanding of the market, as well as how that then
translates through into more effective competition. We expect
that our approach to monitoring will include a wide range of market
indicators as well as qualitative information on consumer behaviour
and attitudes to the energy markets. We have already committed
to work with stakeholders on the detail of our approach to monitoring
and evaluation over the coming months.
Profits
Recommendation 9 - 13:
We recommend that Ofgem require the big six
to include trading activities in the statements. (Paragraph 62)
We recommend that Ofgem require the statements
to be audited. (Paragraph 65)
We recommend that Ofgem require SSE to change
its financial reporting period to align with the other large vertically
integrated energy companies. (Paragraph 67)
We also encourage Ofgem to consider requiring
implementation of BDO's recommendations in full and to publish,
in its response to this report, its analysis of the cost to energy
companies of full implementation. We also recommend that Ofgem
undertake further work to assess current transfer pricing policies.
(Paragraph 71)
We share the Committee's view that increased transparency
around prices and profits is key to re-building consumer trust
and confidence in the market but we are currently not persuaded
of the case for implementing these particular changes. We will
however revisit the issue in the light of the Committee's views
and continuing consumer concerns about the levels of prices.
When we consider action in the area of transparency,
we have to be mindful of the policy framework that governs our
energy markets. This establishes that end-user gas and electricity
prices should be set - and kept in check - through competitive
markets, recognising the additional benefits that competition
can bring such as providing customer choice and driving innovation.
Ofgem has an important role to promote competition to protect
the interests of consumers. Transparency can be an effective tool
in supporting these objectives, especially where it promotes confidence
among consumers.
As we made clear in our evidence to the Committee
it is only because of Ofgem's actions that companies are now required
to publish annual Segmental Statements which provide separate
information on the profitability of their generation and supply
activities. This is now the fourth year that these Statements
have been produced and they are generally welcomed by stakeholders.
We have consistently sought to improve the robustness and usefulness
of the Statements year-on-year in order to shine a light on companies'
profits.
As a part of this commitment to continuous improvement,
in 2011 we commissioned BDO to carry out for us a detailed review
of the Statements. BDO concluded that the methodologies used by
suppliers to compile their Statements were broadly fair and appropriate
and the contents were consistent with their audited numbers. They
also found no evidence of distortions of company profitability.
As requested they made a number of recommendations to improve
the transparency and comparability of the Statements.
We consulted on a range of proposals based on these
recommendations and made a number of changes last year. We consider
that these modifications strike the right balance between the
potential benefits from promoting transparency of energy company
profitability with the potential costs which will ultimately pass
through to consumers. For example, requirements on energy companies
to organise and operate their businesses in a specific way to
facilitate reporting may reduce their ability to manage costs
efficiently, leading to higher prices to customers. Similarly
disclosure requirements can in some cases harm competition by,
for example, revealing details of commercial strategies. We are
required by law to ensure that our interventions are both necessary
and proportionate.
In terms of the specific recommendations, the evidence
that was presented to Ofgem as part of our consultation suggested
that the benefits to be gained from requiring SSE to alter its
financial reporting period, or from reporting trading function
results, were small and outweighed by the costs, which would be
passed through to customer on their bills. There are also questions
about our ability to require information on trading activities,
for example where they are managed on a pan-European basis.
With regard to having an independent auditor's opinion
on the Statements, we concluded that the cost was not justified,
given that we already require each company to reconcile its Statement
to a set of audited financial accounts. However we did implement
a variant of BDO's recommendation and obtained an independent
review of the 2011 Statements by the accountancy firm PKF. PKF
concluded that the companies had completed the Statements appropriately
and the reconciliations to audited accounts had been carried out
in line with the licence condition.
The Committee express surprise that we did not adopt
BDO recommendations in full. We would reiterate that it was our
initiative to seek BDO's advice initially. Their written advice
made clear that the methodologies used were broadly fair and appropriate
and acknowledged some of the risks and issues with their recommendations.
We are required to consult on changes we make to suppliers' licences
and the responses we received to this consultation led us to conclude
that it would not be appropriate to take forward certain of the
recommendations in the form proposed.
However we recognise consumers remain concerned as
to whether current profit levels are justified and we acknowledge
the Committee's views on the need for further action. We therefore
propose to consult how best to build confidence in the market
through greater transparency around profits. This will include
but not be limited to potential improvements to the information
made publicly available about energy company profitability by
Ofgem and the companies themselves. We will set out in full the
reasoning behind our existing measures and will explore whether
new evidence has emerged since their implementation that would
now justify a different approach. We will look, in particular,
at the Committee's views and BDO recommendations.
The Committee recommended that we should look at
the recommendations as a package and not consider the costs of
individual elements. While we recognise the interplay between
the different elements, in assessing proportionality we will need
to look at the costs and benefits of the individual recommendations
as well as the overall package.
Recommendation 14: We recognise the methodological
concerns and recommend that Ofgem actively review the methodology
and improve it so that the SMI more accurately reflects the actual
activities of energy companies. (Paragraph 77)
We welcome the Committee's comments on the Supply
Market Indicator (SMI) and their support for it as a tool for
assessing trends in average energy supply bills, costs and margins
of the six large energy companies' retail businesses. Our aim
in producing it is to help stakeholders to better understand the
relationship between wholesale costs and retail prices.
We aim to keep the SMI accurate and representative
of the position for the average consumer. We are committed to
making periodic and proportionate adjustments to the data when
the available evidence warrants it. In particular, as we noted
in our evidence to the Committee, we have been reviewing the domestic
consumption assumptions used given concerns that these were out
of date.
We implemented new, lower consumption figures in
mid September, which brings SMI consumption data more in line
with the observed declining trend in domestic consumption. As
a result, the SMI more accurately reflects the current average
bill, costs and margins. The resulting September 12-month snapshot
margin for the average consumer is now £65 (down from £90).
While we aim to have robust, updated and publicly
available data, the SMI has some limitations as an indicator.
Some of the data is necessarily lagged, and we have to estimate
other components. In addition, the indicator does not seek to
provide estimates of companies' profits, either collectively or
individually. Detailed information on individual companies' revenues,
costs and profits in both their generation and supply arms is
available on a backward-looking basis in their Consolidated Segmental
Statements.
As always, we remain open to ideas for improvements
and will consider for inclusion in the SMI any robust evidence
that stakeholders provide us.
Recommendation 15: We recommend that the Government
ensure Ofgem takes full advantage of these new REMIT powers. (Paragraph
79)
We share the Committee's view of the important role
of our new REMIT powers in providing confidence that wholesale
gas and electricity prices are set in an efficient manner and
that profits cannot be made from market abuse.
Member States are required to establish an effective,
dissuasive and proportionate regulatory framework for investigating
and penalising breaches of the REMIT Regulation. UK Parliament
passed regulations that included civil powers for Ofgem to impose
unlimited financial penalties. These regulations came into effect
on 29 June 2013 and are a significant first step in creating an
effective regulatory regime. We look forward to discussing the
case for strengthened enforcement powers (including criminal sanctions)
with the Government. We hope that, moving forward, this will take
proper account of developments in the regulation of market abuse
across the European Union.
In the meantime, we have consulted on our approach
to the use of our new powers under REMIT (including our policy
on imposing penalties) and expect to finalise guidance in October.
As the competent National Regulatory Authority for wholesale energy
markets in Britain, Ofgem routinely monitors the market for suspicious
activity. Where appropriate, we will initiate investigations and
use new civil enforcement powers. Decisions on carrying out enforcement
action will be taken in line with our enforcement guidelines for
REMIT, which are part of our consultation package.
Recommendation 16: Ofgem needs to implement
its proposals to improve liquidity as soon as possible taking
a more assertive approach than it has in the past. (Paragraph
87)
We agree with the Committee that we need swift action
to improve liquidity and transparency in the electricity wholesale
markets, the aim of which is to ensure that consumers get the
full benefit of a competitive energy market. Ofgem has an important
role to promote competition to protect the interests of consumers.
Our proposals should allow independent suppliers
and generators to access the full range of wholesale market products
they need to compete effectively.
Our proposed Secure and Promote licence condition
aims to provide small suppliers with a level playing field when
accessing the wholesale market. This means that they can compete
effectively with the established players. It should also improve
liquidity and transparency in the forward market, by requiring
the six large vertically integrated energy companies to 'market
make'- i.e. to post the prices at which they are willing to buy
or sell power - in a range of forward market products.
The Authority will take a decision on whether to
proceed with the licence condition in the coming months taking
account of responses to our consultation. If we do decide to proceed,
we would expect to see the licence condition fully implemented
early in 2014.
As well as our work on liquidity we are looking at
how to improve the robustness of price benchmarks, which are an
essential component of the way in which gas and electricity is
traded on the over-the-counter (OTC) market.
Following allegations about the potential manipulation
of benchmark prices last Autumn, Ofgem launched a review to consider
some specific activity in the market that took place on 28th
September. In parallel we considered that the formation of benchmark
prices and the processes of Price Reporting Agencies (PRAs) more
generally might be an issue requiring further investigation. We
issued a call for evidence in June. This sought views from market
participants about how they both contributed to and used price
assessments and indices, and sought stakeholders' views more broadly
on whether current arrangements are fit for purpose.
This is another area where we believe there is scope
to improve transparency and market confidence.
Fuel Poverty
Recommendation 20: We further recommend that
Ofgem considers introducing a licence condition to ensure that
energy companies share data on household energy consumption and
spend with Government, in order to facilitate identification of
fuel-poor households. (Paragraph
106)
We agree with the Committee that improved data sharing
has a role to play in helping identify those in fuel poverty but
note that there are difficult privacy issues involved.
FPAG proposed in its 2011-12 annual report that Government
share more data with suppliers, and the committee rightly notes
that there is widespread support for this. As the report notes,
we think there is a case for greater data sharing and/or matching
on this basis, and we will be discussing this further with DECC
and through our ongoing involvement in the Fuel Poverty Advisory
Group (FPAG).
The Committee's recommendation is different and is
that companies should share consumer data with Government. The
Committee will be aware that this is potentially a sensitive area,
not least in the context of the roll-out of smart meters. There
are obvious potential privacy concerns and so the Committee's
recommendation would need significant public engagement first
and may be a matter more appropriately decided by government/parliament.
Government does already have powers to collect data
for statistical purposes under the Statistics of Trade Act 1947.
It uses this power to collect consumption data for modelling purposes.
As we noted in our evidence we are currently undertaking
a review of the Priority Services Register regime, as part of
our wider Consumer Vulnerability Strategy. This will amongst other
things consider issues relating to the identification of relevant
consumers. We have already undertaken some consumer research for
this project and will be continuing our work through the rest
of this year. We would be pleased to keep the Committee updated
on our work in this area.
Recommendation 26: Ofgem and DECC should consider
further measures as part of RMR and the Fuel Poverty Strategy
to ensure that pre-payment customers and those without internet
access are able to obtain best market deals. (Paragraph
123)
We share the Committee's concern about the need for
additional support for pre-payment customers and those without
internet customers. We already have a number of strands of work
underway aimed at providing additional support to those customers.
We have established a consumer and industry working
group to consider the development of our Market Cheapest Deal
proposal, which is particularly focused on how best to help the
vulnerable and most disengaged, to access the cheapest deals
on the market. We expect the initial outputs from the group to
be made public later this year.
Early this year Ofgem launched a programme focussing
on consumers' interaction with brokers and Third Party Intermediaries
(TPI). As part of this programme we are also considering issues
relating to consumers in vulnerable circumstances, including for
example those who do not have internet access. We will be working
with the Citizens Advice consumer service to consider how best
to take forward our Energy Best Deal collaboration and how this
might fit best with DECC's new Big Energy Saving Network.
Through our RMR proposals, all customers, including
those on prepayment meters will be given regular, personalised
Cheapest Tariff Messaging on their bills and other communications.
This will ensure that these customers are given regular prompts
on the best offers from their supplier.
Recommendation 29: We therefore recommend that
the Government and Ofgem consider how tariffs could be restructured
to ensure that energy conservation is incentivised, while ensuring
that high consuming vulnerable consumers are protected. (Paragraph
138)
We recognise the need to incentivise energy conservation
while ensuring vulnerable consumers are protected. These were
factors we look into account in developing our RMR which outlaws
existing two-tier tariffs that are hard for consumers to understand
and reward higher consumption.
Although the RMR proposals limit the number of tariffs
suppliers offer, we have specifically considered how best to ensure
that more innovative tariffs used to incentivise behaviour, such
as time of use tariffs, can develop and thrive. Our proposals
allow significant flexibility on tariffs for customers who use
smart meters. We will also have the ability to make derogations
from some of our policies in order to allow suppliers to pilot
more innovative tariffs.
Research conducted to inform the RMR proposals also
explored the viability of numerous tariff structures, including
rising block tariffs. Rising block tariffs, where the price consumers
pay for their energy increases in a staged way as consumption
increases, will not be permitted under the current proposals.
We are aware, from research we commissioned from the Centre for
Sustainable Energy, that a considerable proportion (around one-quarter)
of low income consumers have above average consumption levels.
Rising block tariffs would therefore have the potential to increase
energy bills for a considerable number of low income households.
9 https://www.ofgem.gov.uk/information-consumers Back
10
https://www.ofgem.gov.uk/gas/retail-market/monitoring-data-and-statistics/electricity-and-gas-supply-market-indicators
Back
11
Customer Engagement with the Energy Market - Tracking Survey 2013,Report
prepared for Ofgem 12 June 2013, found here: https://www.ofgem.gov.uk/ofgem-publications/74756/customer-engagement-energy-market-tracking-survey-2013.pdf
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