Energy network costs: transparent and fair? Contents

1Introduction

1.Following our evidence session on ‘Energy Prices’ on 29 October 2013, we agreed to undertake a further inquiry into energy network costs (which cover the transmission and distribution of gas and electricity from energy installations to households and industry), as part of our ongoing scrutiny into energy prices, profits and poverty.1 The Government also agreed that network costs deserve more scrutiny.2

2.Ofgem estimate that network costs currently make up around 23 per cent of a dual fuel (gas and electricity) bill.3 20 per cent of the bill represents the cost of transporting gas and electricity on local power and gas mains (or distribution) networks. Three per cent of the bill is the cost of transporting gas and electricity through the high voltage grid and the national high pressure gas mains (transmission) network.

Breakdown of an annual dual fuel bill

Percentage

Wholesale cost

44%

Network costs

23%

Environmental and social costs

7%

Supplier operating costs

13%

Pre-tax margin

8%

VAT

5%

Source: Ofgem website: https://www.ofgem.gov.uk/information-consumers/domestic-consumers/understanding-energy-bills

3.The energy network can be divided into four main categories, with two for electricity and two for gas:

4.These transmission and distribution companies operate within a virtual monopoly and therefore their profits and industry structure are regulated by Ofgem price controls. There are a small number of independent distribution network operators (IDNOs) that own and run smaller networks embedded in the DNO electricity networks. They are small and typically focus on new housing or commercial parks and are outside the general scope of this inquiry.

5.Network charges reduced by more than 40 per cent between 1990 and 2006.10 However they have been rising again as new networks are built to help connect low carbon energy, replace old gas mains and renew ageing parts of the network.11 Both Ofgem and DECC have indicated that energy bills are likely to rise as a result of increased network costs. Ofgem have stated, however, that network costs are expected to remain stable in real terms (i.e. excluding inflation) until at least the start of the next decade, which coincides with the end of the current RIIO price control period.12 Energy companies told us about the improvements to the energy networks and the customer benefits that have accrued since privatisation. Phil Jones, CEO of Northern Powergrid, said:

We are talking about a sector whose prices are a third of what they were at privatisation. All the industry stats would say that power cuts are 20% shorter or less likely, those kinds of things. So service is 20% better, prices are a third what they were, operational costs are half of what they were around the 2000 mark.13

While Graham Edwards, CEO of Wales and West Utilities, said:

Since….2005 we have seen customer service improve dramatically. We have seen reliability further improve. When you consider that the average gas consumer can expect to see an outage once in 40 years, we clearly provide a very reliable supply.14

6.Despite this, questions remain on how transparently current and future network costs are determined and how effective Ofgem is at monitoring and scrutinising the charges and profits of network companies. The purpose of our inquiry was to assess this and to form a view on:

7.In February 2014 we launched this inquiry to explore network costs. We received 39 submissions of written evidence and held three oral evidence sessions between July and November 2014. A full list of witnesses can be found at the back of this report. We are grateful to all those who took the time to contribute to this inquiry. We are also grateful for the assistance we received for our inquiry from our specialist advisor, Nigel Cornwall.

1 Energy and Climate Change Committee, Inquiry on Energy Prices, October 2013

2 Q276 (Matthew Hancock)

9 Ofgem, History of Energy Network regulation, 27 February 2009

10 Q213 (Dermot Nolan)

13 Q125 (Phil Jones)

14 Q125 (Graham Edwards)