Select Committee on Constitution Minutes of Evidence

Memorandum by OFGEM

  This memorandum sets out the principles that Ofgem follows in combining independence with accountability; and answers the specific questions of the Committee.


  2.  Ofgem is established through statute as an independent regulator, with defined duties and powers. Its principal objective is to protect the interests of consumers of gas and electricity, present and future, wherever appropriate by promoting competition. Its independence is central to achieving this objective, as it enables a more durable regulatory framework to be set, and greater regulatory certainty to be established, than if Ofgem were subject to political direction. Regulatory independence, within a statutory framework laid down by Parliament, is widely accepted by commentators and analysts as a necessary condition for successful regulation. It has been established as a principle of Energy White Paper as a critical element in making energy markets work to the benefit of consumers.[1]

  3.  Ofgem is acutely aware that independence can be represented as lack of accountability. It believes this criticism, if valid, would damage the legitimacy of the organisation. It therefore has worked hard to demonstrate how it discharges its responsibilities, to explain the reasons behind its actions, and to ensure that its decisions are based on as open processes as possible. Over the life of Ofgem, it has significantly extended its procedures to effect this. In particular, the following:

  Parliamentary reporting: Ofgem, like its predecessors, has always had a legal duty to report on its activities annually to the Secretary of State, who lays the report before Parliament. Ofgem now links this report to its annual plan, so that, for example, the report for the year 2001-02 can be compared with what was said a year earlier in the plan for that year. The result is a much simpler and more comprehensible means of comparing plan and outcome, and hence greater accountability;

  Parliamentary scrutiny: Ofgem welcomes the part played by Parliamentary Committees in scrutinising its decisions and actions. This has been extensive: since 1999 Ofgem has been called to give oral evidence to Select Committees on 12 occasions. In addition, Ofgem has sought opportunities, both formal and informal, voluntarily to brief Committees on particular topical issues: thus in relation to the draft Electricity (Trading and Transmission) Bill Ofgem not only answered questions at the request of the Trade and Industry Committee, but also initiated briefing meetings with the Enterprise and Lifelong Learning Committee of the Scottish Parliament and with the Scottish Affairs Select Committee;

  Consultation: Ofgem attaches great importance to consulting on its proposals and to explaining its decisions. Consultation occurs in many ways. In 2002-03, for example, Ofgem published on its website more than 50 consultation documents. Ofgem has worked to make these more accessible through, for example, including a summary, and a rationale explaining both the range of options considered and the reason for the preferred choice. In addition, Ofgem consults via a range of meetings, typically with either individual companies affected by its work, or with organisations representing wider interests such as energywatch, the Major Energy Users Council, or Age Concern. Ofgem sets out full reasons for its decisions in its decision documents, which typically relate the decision to Ofgem's legal duties;

  Planning process: Ofgem consults not only on its specific proposals, but also on its overall priorities and its allocation of resources. This Plan now covers three years, against a legal requirement to produce a plan covering one year only. For the first year of the plan, all major programme targets are identified with, where appropriate, target dates by quarter for their achievement. The actual achievement of individual targets is subsequently reported—a degree of transparency which Ofgem believes to be clearer than any other part of Government.

  4.  In all these ways, Ofgem seeks to show all parties interested in its activities that it discharges its powers and duties in a responsible and careful way. Ofgem regards this as essential for its continuing legitimacy.

1.  What is the legal basis for Ofgem?

  1.  Ofgem is the name used to describe the office of the Gas and Electricity Markets Authority (the Authority), which determines strategy and decides upon major policy issues but delegates day to day operations to its executive members. The Authority's powers are provided for by Parliament under the Gas Act 1986, the Electricity Act 1989 and the Utilities Act 2000[2]. The Authority also has powers under the Competition Act 1998 to deal with anti-competitive agreements or abuses of a dominant position, which relate to the gas or electricity sectors. The Authority will acquire additional powers under the Enterprise Act 2002.

What is the nature of Ofgem's powers and how does it exercise them?

  2.  Ofgem's duties are set out in the Gas Act 1986, the Electricity Act 1989 and the Utilities Act 2000[3]. Those Acts limit the Authority's and therefore Ofgem's activities. Ofgem has a principal objective to protect the interests of consumers (existing and future) in relation to electricity conveyed by distribution systems and to gas conveyed through pipes, wherever appropriate by promoting effective competition.

  3.  Within this statutory framework, Ofgem has powers to grant, revoke and enforce licences (including imposing financial penalties on licence holders who contravene licence obligations and specified statutory obligations). Ofgem may also propose any licence modifications that it considers necessary to meet its objectives.[4] Ofgem may also approve or reject modifications proposed by industry participants to the codes that govern access to the electricity and gas networks.

  4.  The statutory objectives of Ofgem are not solely based on economic factors, but include duties to have regard to social and environmental matters. The Authority has been given discretion under the Gas and Electricity Acts to determine how best to protect the interests of customers, in instances where there may be a need to prioritise between the range of general duties which the Authority has been given.

  5.  The Utilities Act 2000 gave the Secretary of State the power to issue guidance in relation to environmental and social matters to which Ofgem must have regard. Guidance was issued in November 2002.

How could Ofgem's powers be revoked?

  6.  As the Authority's powers are derived from statute, in most circumstances primary legislation would be required to change or revoke these powers.

From where does Ofgem obtain its financial and administrative support?

  7.  Ofgem operates within the public expenditure framework laid down by HM Treasury. Most of Ofgem's expenditure is financed by income from licence fees paid by network operators. However, the Government directly finances the work that Ofgem does in relation to implementing some of the Government's environmental polices, such as the Climate Change Levy.

  8.  Since 1999-2000, when Ofgem was established, considerable progress has been made to improve working practices and manage costs efficiently. By 2003-04, the costs of Ofgem will have fallen by 17 per cent (excluding NETA). Ofgem's net costs for 2003-04 are forecast to be £36 million. Ofgem has projected indicative budgets of £34 million for both 2004-05 and 2005-06 and has published these figures in order to provide transparency to industry and licence fee payers of likely future costs. In preparing these projections, Ofgem has managed to contain expected inflation throughout the period of its three year Corporate Plan.

2.  By whom and how is the continuing need for regulators such as Ofgem measured? How is their role changed or ended?

  9.  It is of course for Parliament to determine Ofgem's statutory remit, and occasionally to modify it, as Parliament did most recently in 2000.

  10.  In line with its principal objective, Ofgem has pursued pro-competitive policies to deliver consumer benefit. Therefore, Ofgem and its predecessor organisations have introduced competition into a range of activities within the gas and electricity industries. For example, competition in retail electricity and gas supply is well established and has produced huge benefits to all customers in terms of reduced energy bills and greater service variety. Since privatisation, domestic bills have fallen in real terms by 37 per cent for gas and 28 per cent for electricity.

  11.  As competition has developed in the various liberalised markets, Ofgem has withdrawn from prescriptive economic regulation. For example, residual controls on the prices that suppliers charge their customers were lifted in April 2002, without prompting the immediate price hikes that were feared by some at the time. Overall, Ofgem has withdrawn from some 70 per cent of the activities subject to regulation at the time of privatisation. Where competition has been established, Ofgem has a role to monitor its progress and, if necessary, enforce licence obligations, competition and consumer law, so that all customers continue to benefit.

  12.  Where competition is not developed there will be a continuing need for prescriptive regulation so that customers receive value for money and secure and reliable service. This approach applies to the monopolies that run the pipes and wires bringing gas and electricity to homes and businesses. Ofgem has taken steps to make the ongoing regulation of network operators such as Transco less intrusive by creating incentive schemes that reward the network operators for responding efficiently to the requirements of network users.

3.  Who are the members of the Authority; how are they appointed; are they adequately representative; and do the "Nolan principles"" operate?

  13.  Ofgem instituted a management board structure well before the Authority was created under the Utilities Act in November 2000. This reflected Ofgem's belief that moving to a structure in which responsibility was shared by a number of people rather than vested in one individual would be likely to de-personalise regulation and promote greater consistency and stability in decision making.

  14.  As at 1 April 2003 the Authority comprises 11 members. Callum McCarthy holds the posts of Chairman of the Authority and Chief Executive of Ofgem until 31 October 2003, whereupon the Government intends to appoint a different individual to each of these posts. There are three other executive directors and six non-executive directors. The executive members of the Authority are Callum McCarthy, Boaz Moselle, John Neilson and Richard Ramsay. The non-executive members are John Belcher, Richard Farrant, Margaret Ford, James Strachan, Sir Keith Stuart and Professor Leonard Waverman.

  15.  Members of the Authority are appointed by the Secretary of State for Trade and Industry and, importantly, they are appointed for their expertise in a variety of relevant fields rather than to represent certain interest groups—an approach supported by the Better Regulation Task Force.[5]

  16.  Callum McCarthy and all the other members of the Authority were appointed by the Secretary of State following a selection process that was fully consistent with the Nolan principles.

4.  What is Ofgem set up to achieve? To What extent does Ofgem achieve its purposes?

  17.  Competition and regulation has developed significantly over the years and has produced great benefits for British consumers of gas and electricity. This has been recognised by the National Audit Office in various recent reports[6]. For example:

    —  there is genuine competition throughout the gas and electricity supply chains—from the production and wholesale trading of gas and electricity, and the provision of meter reading and gas storage services, to retail supply markets;

    —  as stated above, domestic prices have fallen in real terms by around a third since privatisiation (37 per cent for gas and 28 per cent for electricity);

    —  prices for domestic and industrial customers are among the lowest in Europe;

    —  lower energy prices resulting from competition and effective regulation have helped remove 2.5 million households from fuel poverty since 1996;

    —  Britain enjoys generous capacity margins in generation, and more diverse energy supplies today than ever before;

    —  competition has developed to allow Ofgem to withdraw from many areas which were previously regulated; and

    —  price controls on the network businesses, where competition is unavailable, have transferred £1.25 billion annually from the companies to their customers, without preventing the companies from raising new finance, and with improved service standards.

  18.  In exercising its functions, Ofgem must consider the merits of competing interests and take policy decisions that are consistent with its statutory objectives; this is almost by definition not a consensual activity and in many cases Ofgem's decisions will produce both gainers and losers. Ofgem uses the consultation process as a means of informing itself about the likely consequences of its proposals, and may refine its proposals in the light of responses, which helps Ofgem to minimise adverse consequences where it is possible to do so. This process will be strengthened when Ofgem begins publishing regulatory impact assessments later this year.

How is Ofgem's effectiveness assessed?

  19.  Ofgem's effectiveness can be assessed by referring to the outcomes achieved to date by introducing competition and regulating the network monopolies (see above). In addition, Ofgem's annual report measures progress against and success in achieving specific policy deliverables in a very visible way. In drawing up its Corporate Strategy, Ofgem consults extensively with all interested parties to find out their views about what Ofgem is doing well or not so well, what other things Ofgem should be doing and what things it should stop doing. This provides an excellent opportunity for interested parties to give their views on how effective Ofgem has been.

5.  To what extent is Ofgem both prosecutor and jury on an issue; what rights of appeal are there against decisions made by Ofgem?

  20.  All of Ofgem's decisions are subject to some form of appeal. Where Ofgem wishes to modify a licence condition, for instance in relation to a price control, and the licensee does not agree (or a prescribed percentage of licensees in the case of a standard condition), Ofgem can refer the matter to the Competition Commission. The Commission can then propose its own modifications as appear requisite to deal with the adverse public interest effects. Decisions taken by Ofgem under its Competition Act powers are appealable on their merits to the Competition Commission Appeals Tribunal.

  21.  Decisions to impose enforcement orders and financial penalties are subject to specific statutory right of appeal to the courts. Other decisions, such as approving changes to industry codes and regulatory statements of methodology, are all subject to judicial review.

  22.  In the Energy White Paper the Government said that it would consult on the issue of whether it would be appropriate to provide for appeals against Ofgem decisions on certain code modifications. The Government said that the consultation would take place within the wider context of the Committee's present inquiry. Ofgem is keen to work with the DTI in developing its thinking in this area.

  23.  Industry codes are contracts that set out many of the terms by which network users may connect to and use the pipes and wires networks. Ofgem believes that very careful consideration needs to be given to any proposal to change the existing code modifications process, to ensure it produces benefits rather than harm.


6.  How is Ofgem held to account by parliament? What other accountability does Ofgem have to auditors, Government departments or other public bodies?

  24.  Although the Authority is an independent statutory body, it is formally accountable for the exercise of its powers to Parliament. It must submit an Annual Report to the Secretary of State for Trade and Industry, which must be laid before Parliament. In addition, it is subject to Treasury financial control and its Estimates are approved by Parliament. The Authority is accountable to Parliament in several ways:

    —  it must submit annual Resource Accounts for audit by the head of the National Audit Office (the Comptroller and Auditor General (C&AG)), and the Chairman and Chief Executive is responsible as Accounting Officer for the activities of the office[7];

    —  the C&AG may examine the economy, efficiency and effectiveness with which the Authority has used its resources and produce a report for the Public Accounts Committee (PAC);

    —  the PAC may call upon the Chairman to give evidence to it in relation to matters covered in reports from the C&AG. The current Chairman has given evidence to the PAC on five occasions;

    —  Ofgem may be called to give evidence before other Select Committees of Parliament, such as the Trade and Industry Committee (which has taken evidence from Ofgem on five occasions since 1999), the Environmental Audit Committee, and the Science and Technology Committee[8]; and

    —  the actions of the Authority are open to review by the Parliamentary Commissioner for Administration.

  25.  Ofgem is proactive in seeking opportunities to discuss topical issues with Select Committee members. Ofgem did this most recently in relation to the draft Electricity (Trading and Transmission) Bill, which it has discussed with the Enterprise and Lifelong Learning Committee of the Scottish Parliament and also with the Scottish Affairs Select Committee.

  26.  The Authority is not accountable to other Government departments, but liaises effectively with them wherever appropriate as part of maintaining an effective working relationship.

  27.  Organisations such as the Better Regulation Task Force, the International Energy Agency and the Organisation for Economic Cooperation and Development may review the activities of Ofgem and publish reports containing recommendations about Ofgem's policies and processes. All these organisations have produced reports of this nature in the last two years.

7.  How is Ofgem accountable to those whom it regulates?

  28.  Ofgem takes account of the views of regulated companies principally through the consultation process, and the existing appeals process balances the rights of all parties appropriately.

  29.  Ofgem's activities have a significant effect on the economy. As a result of effective competition and tough regulation British energy prices are among the lowest in Europe. For example, the introduction of more competitive electricity wholesale markets in March 2001 has greatly improved the competitiveness of British businesses. Businesses—and other large organisations such as hospitals and schools—have saved over £1.8 billion pounds since the reforms were first announced in 1998.

  30.  The NAO has estimated that domestic electricity customers have seen their electricity bills fall by £750 million a year since competition began, and that domestic gas customers had enjoyed a reduction of £1 billion a year in their bills since the introduction of competition. The NAO has also reported that the regulation of the network businesses by Ofgem had helped to deliver lower network costs without diminishing service quality and investment levels.[9]

How transparent are Ofgem's methods of working?

  31.  Utilities legislation imposes a number of obligations that promote transparency, but Ofgem strives to go further than the Acts require where it is sensible to do so.

  32.  The Authority must publish its forward work programme and it does so in its Corporate Plan and Budget, which establishes the priorities and work plan that it will pursue for the following financial year. Ofgem has taken an innovative approach in this area in that it consults interested parties on a plan over a three-year time period rather than the one-year period stipulated in the Acts. The Corporate Plan includes detailed policy deliverables for the first year.

  33.  The table below sets out the steps that Ofgem takes in producing its Corporate Plan.

JulyOfgem writes to representatives of key audiences inviting early views on priorities for the coming year.
DecemberOfgem publishes its draft Corporate Plan for consultation.
January and
Ofgem hosts a series of meetings in London and Glasgow with the representatives of key audiences (in 2003, Ofgem hosted seven meetings attended by around 120 organisations).
MarchOfgem finalises the Corporate Plan and publishes it along with its response to the views of respondents. The Corporate Plan includes the key deliverables for the coming year (there are 73 for 2003-04).
JulyOfgem publishes its Annual Report setting out its achievements against the previous year's objectives.

  34.  Ofgem must subsequently submit an Annual Report to Parliament on the work carried out during the previous financial year. In doing so Ofgem is required to pay particular attention to whether it has achieved specific deliverables in its plan on time and to budget.

  35.  In developing policy Ofgem consults widely from the earliest stages and in a variety of ways. In 2002-03 Ofgem published over 50 consultation documents seeking the views of interested parties on policy proposals. All these documents (and other material related to Ofgem's activities) are published on the Ofgem website, whose pages receive over 750,000 "hits" per month.

  36.  The process that Ofgem typically follows in consulting on proposals is set out in the table below.[10]

Consultation stageActivity
"Pre-consultation"Ofgem may discuss policy options with key audiences, whether through bilateral meetings or industry event.
Publish consultation document All include a summary, a rationale in which Ofgem may set out the various policy options, and a recommendations chapter.
During consultation periodOfgem will often host seminars and/or one to one meetings in order to engage key audiences in debate on the proposals, and to help refine the proposals.
Publish formal proposals document   All such documents include the detailed policy proposal, on which further consultation usually takes place.
Publish "decision" document Decisions on licence modifications are subject to a further statutory consultation period.

  37.  Ofgem has also committed itself to publishing regulatory impact assessments for all new significant proposals initiated by Ofgem. The impact assessments will include consideration of security of supply and environmental issues.

  38.  In addition to the consultation process, Ofgem routinely notifies parties who have requested to be kept informed of items that are placed on the website. This service is valued particularly by small organisations that wish to avoid unnecessary effort on monitoring Ofgem's website. For most major policy decisions Ofgem also produces short "easy to read" fact sheets and sends them to representatives of Ofgem's main audiences.

  39.  Ofgem produces regular newsletters for MPs and MSPs and for those who have particular interest in areas of Ofgem's remit, such as the Social Action Plan, Energy Efficiency and Renewables work.

  40.  Ofgem has published the rules of procedure for the Authority. There was no obligation to do so but Ofgem believed that this would improve the transparency of regulatory action, since interested parties would know, as they did not previously, which decisions must be made at the highest level and which can be delegated.

  41.  Ofgem must keep a public register in which determinations, licence modifications and derogations made by the Authority may be inspected by the public.

8.  How is Ofgem accountable to the public other than through Parliament? What opportunities do members of the public have to express particular concerns to Ofgem?

  42.  Changes introduced by the Utilities Act 2000 mean that energywatch now has the primary responsibility for helping customers if they need information about the energy market or if they have a complaint about their energy supplier, which has not been dealt with to their satisfaction. That said, Ofgem holds regular meetings with groups that represent the interests of customers—be they domestic customers, vulnerable customers such a those in fuel poverty, and business customers. Ofgem also commissions consumer research to help inform policy decisions (such as the research that Ofgem commissions to find out about how well competition in retail markets is working for domestic consumers). Ofgem is also accountable to the public by way of correspondence: Ofgem received around 7,800 items of correspondence in 2002.

How does Ofgem relate to the associated consumer watchdog, energywatch?

  43,  Both energywatch and Ofgem are statutory bodies created by Parliament, whose duties towards the protection of consumers' interests are in some respects similar. Ofgem's principal objective is to protect consumers' interests, wherever appropriate by promoting effective competition. In carrying out this duty Ofgem must have regard to the interests of the disabled and chronically sick, pensioners, people on low incomes, and rural residents. Consequently Ofgem, in practice, places the interests of consumers at the heart of what it does, but is reliant upon energywatch to provide accurate data and other evidence in relation to customers' complaints so that, for example, Ofgem can take robust enforcement decisions against licencees.

  44.  Given that Ofgem is reliant on energywatch, Ofgem expects that:

    —  energywatch's advice to consumers will be timely and accurate, resulting in a high level of satisfaction rating for users; and that

    —  when adopting an advocacy role on behalf of consumers, energywatch's arguments will be well-founded in fact and analysis.

  45.  Ofgem is required in certain circumstances to consult energywatch, but often consults energywatch even where it has no duty to do so. Ofgem and energywatch have developed a Memorandum of Understanding that sets out how they will interact.

9.  How effective is Ofgem's public consultation? What opportunities do the public have to contribute? To what extent do the public use these opportunities?

  46.  Ofgem is committed to consulting all interested parties, including the general public, since doing so improves the quality of decision-making and increases public understanding of Ofgem's work. Ofgem has been innovative in providing a variety of different options for interested parties wishing to enter the debate, for instance in relation to its Corporate Plan. However, it should be recognised that the issues with which Ofgem deals are often complex and therefore, in practice, individual members of the public rarely respond to consultations, although consumer groups such as energywatch regularly do so.

10.  To what extent do the needs or concerns of the public guide the work of Ofgem?

  47.  Ofgem's policy priorities are set in the light of its statutory remit, hence Ofgem must consider the extent to which its polices are in the interests of consumers, and prioritise accordingly.

  48.  In devising the Corporate Plan, Ofgem consults well in advance seeking views on the key challenges facing the industry; whether any of Ofgem's existing work should be given a greater or lesser priority, or stopped altogether; and whether there were any new areas of work that should be started and, if so, to what extent they should be given priority.

  49.  Ofgem is neither an instrument of Government nor a representative of the public: its powers and duties derive from statute. Ofgem is required to analyse carefully the arguments of interested parties and arrive at a policy that is consistent with Ofgem's principal objective and other statutory duties.

11.  How independent from the Government is Ofgem? What factors might or do compromise Ofgem's independence?

  50.  Ofgem is an independent non-ministerial government department responsible for the regulation of the electricity and gas industries in accordance with legislation passed by Parliament. Parliament has given Ofgem discretion to carry out its statutory duties independent of political direction so that it can concentrate on regulating the energy sector in the long-term interests of consumers. Independence from political direction has been crucial in providing a climate of regulatory stability in which companies could readily secure finance for investment. It has also been crucial in enabling Ofgem to pursue the policies of introducing competition and refining monopoly regulation that have been so beneficial to British energy consumers.

  51.  Ofgem is not responsible for implementing Government policy, except insofar as it is given responsibility in statute for implementing particular environmental polices such as the Climate Change Levy where Ofgem seeks to do so in the most economically efficient manner. In this context, the Government has made it clear that where it wishes to introduce social and environmental measures that would have a significant financial impact on consumers, it will seek to do so through new legislation.

  52.  While Ofgem places considerable importance on its independence, it recognises the need to establish and maintain effective working relationships with other government departments. In support of this, Ofgem operates a policy of "no surprise" so that Ministers are aware in advance of any significant Ofgem decisions.

  53.  Ofgem welcomes the statement by the Government in its Energy White Paper that it remains committed to liberalised and competitive markets as a cornerstone of energy policy. Ofgem also welcomes the White Paper's recognition that independent economic regulation is a critical component of making these markets work in the best interests of consumers.

1   For a fuller treatment of the subtleties of the relationship between the Authority and Ministers see the speech given by Callum McCarthy on 6 November 2002 at a conference on "The politicisation of regulatory policy" organised by the Regulatory Policy Institute. This speech is attached as Annex 1 to this memorandum.


2   While the Authority was formally brought into being by the Utilities Act 2000, Ofgem was created by the merger of Offer and Ofgas in 1999. Back

3   Annex 2 illustrates the Authority's principal objective and general duties as set out in the Gas Act 1986 and the Electricity Act 1989. Back

4   The Authority's powers are however constrained by the Secretary of State's rights of veto on, for example, licence modifications under sections 11 and 11A of the Electricity Act 1989 or references to the Competition Commission made under section 12 of that Act. General directions may be also made by the Secretary of State under section 47 of the Electricity Act 1989. Back

5   Further information on the Authority members' breadth of expertise can be found on the Ofgem website at http:/ Back

6   See in particular the National Audit Office's reports on introducing competition in domestic gas and electricity supply, and on how we regulate the monopoly pipes and wires businesses. These reports were published in May 1999, January 2001 and April 2002 respectively.

To what extent does Ofgem achieve its purposes without adverse consequences? Back

7   It is expected that the Chief Executive of Ofgem will assume the role of Accounting Officer when the posts of Chairman and Chief Executive are split later this year. Back

8   Annex 3 provides a list of all the PAC and Select Committee appearances since the beginning of 1999.

What is the impact of Ofgem's regulation on the economy? Back

9   National Audit Office, "Pipes and Wires"", The Stationary Office, April 2002. Back

10   Ofgem will not always carry out all these activities during a consultation; whether or not Ofgem does so in practice may depend on the significance of the proposals.

Is Ofgem an instrument of Government or a representative of the public? Back

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