Analysis: What is a fair price?

The CMA has accused the big six of overcharging customers by as much as £1.7 billion a year – something the suppliers angrily deny. So who is right? Utility Week investigates.

The debate around whether consumers are paying a fair price for energy hit the headlines again when the Competition and Markets Authority (CMA) published its analysis last month.

It stated that customers on standard variable tariffs (SVTs) could save more than £300 a year, and it repeated its claim from last summer that energy customers have been overcharged by £1.7 billion a year.

That £1.7 billion figure is contentious. The major energy suppliers dispute it, while in the CMA’s own analysis another metric for assessing overcharging says the figure could be below £700 million a year between 2007 and 2014 for domestic customers.

There are a number of different elements that go into the final price consumers pay. These include: the wholesale price; the success – and honesty – of wholesale traders; transmission and distribution costs; operational costs of the supply companies; money that is turned over for investment; and, finally, profit for the companies involved.

With wholesale costs continuing to fall dramatically but energy tariffs down by roughly 5 per cent in the latest round of cuts, it begs the question, why haven’t they come down more? And are consumers being charged a fair price?

Breaking down the bill to show what’s a fair price

Calls for clearer, more transparent and more informative bills have echoed throughout the industry for years. These have included calls for the wholesale price – the largest single element of an energy bill making up 47 per cent of the cost – to be included on a domestic energy bill.

At the start of the year, SSE redesigned its bill to lay out usage costs for customers in a move described by pressure group the Campaign for Plain English as a “fine example of clear commercial communication”.

The new bill however, created with the input of consumer focus groups and designers, still does not include a precise, item-by-item breakdown.

SSE said: “The challenge is in balancing information and simplicity. A breakdown of the bills is currently included on SSE’s bills but is not a part of the new design. The research told us that there was other information that customers wanted and needed more than this.

“However, it is important to note that the new simple bill is theoretical at this stage. It is not being sent out to customers and we have no plans to remove the bill breakdown from our current bills at present.”

British Gas also regularly produces – but does not publish on its bills – a breakdown of the elements that make up a typical dual fuel bill.

The inclusion of this information on bills is supported by Energy UK’s chief executive, Lawrence Slade. He tells Utility Week: “I don’t think if there was just wholesale pricing on the bill that would work in proving to consumers what their energy is costing.

“I think overall having an average breakdown of the bill, updated on a regular basis, would be very useful to help consumers understand the cost of the energy system and the cost of decarbonisation.”

However, he adds: “The problem is there is one hell of a lot of information on the bill already. We need to find ways to simplify it and get to the bottom of what it is people want to see.” SJ

The CMA on fair prices

In its provisional findings document, the CMA claims the big six energy companies overcharged domestic customers on average £1.7 billion a year between 2012 and 2015, because of a lack of switching.

For dual fuel and single fuel electricity customers, this detriment was biggest among prepayment customers, followed by standard credit customers and then direct debit customers.

The £1.7 billion figure was arrived at via the CMA’s preferred “direct” methodology. This uses First Utility’s and Ovo’s retail tariffs as benchmarks. However, the large suppliers, Centrica in particular, have been vocal in expressing their disagreement with the suggestion that customers have been overpaying. Chief executive Iain Conn says: “We have provided strong evidence to the CMA that the UK energy supply market is competitive and achieving positive outcomes for consumers.”

SSE director of retail economics Richard Westoby agrees, and he tells Utility Week the CMA’s analysis is “seriously flawed”.

The CMA’s indirect analysis came out with an overcharge figure appreciably lower, at between £600 million and £1.1 billion a year, largely stemming from supplier inefficiencies.

The view that customers are being overcharged by the big suppliers is largely backed up by the figures put out by Ofgem and the Department of Energy and Climate Change. Both the government and the regulator say the 70 per cent of customers who have never changed their tariff could save more than £200 a year if they switched. MB

Preventing market manipulation

Whether or not consumers are paying a fair price for power partly depends on whether suppliers are themselves paying a fair price in the wholesale market. If other participants are manipulating the market, they probably aren’t.

According to Ofgem’s most recent review of the market, there is little room for manipulation from generators altering their output, because participants just aren’t big enough to exert significant influence. The review said that in the preceding year (2014) the largest player was EDF Energy, accounting for more than a quarter of total generation. However, with most of the company’s generation coming from inflexible nuclear plants, it said it was unlikely that EDF could “exert market power by withholding electricity”.

Ofgem also said there were few instances of “pivotality”, where a given company’s portfolio of power stations is needed to clear supply and demand in a particular period – at least on a national level. It did say there was more scope for pivotality on a sub-national level, such as in Scotland.

The market can also be manipulated though by traders without any control over generating assets. Up until recently, the energy market has been very opaque, making it difficult to assess whether this has happened. A significant majority of trades are over-the-counter (OTC), meaning they take place outside of exchanges. Price-reporting firms contact traders to get information on such trades to calculate a wholesale price, but it is up to traders to report information accurately.

Things will have changed somewhat with the introduction of new reporting rules as part of the Regulation on Wholesale Energy Market Integrity and Transparency (Remit). The European legislation was introduced in 2011 and in October the first tranche of reporting rules came into force, requiring traders to report all exchange-based trades to the European Agency for the Co-operation of Energy Regulators. The second tranche took effect earlier this month and required traders to also report OTC trades as well.

It means Ofgem, which enforces the regulations in the UK, should now have more accurate information available.

Since Remit was first introduced in 2011 only two penalties have been handed down by regulators, and both instances occurred elsewhere in Europe. That could, of course, change with the introduction of the new OTC reporting rules. TG

Opinion: David Smith, chief executive, Energy Networks Association 

Network costs make up around 22 per cent of a dual fuel energy bill, or around £300 a year for the average customer. That 82p a day pays for the upkeep of over 1 million kilometres of electricity network and 272,000km of gas network.

Network operators are used to a very high level of scrutiny on these costs, having gone through regular and thorough price control negotiations with Ofgem since privatisation in the 1980s and 1990s. Customers today pay 17 per cent less in real terms for their networks than they did when the sector was state owned. Looking ahead, network costs are projected to remain flat in real terms into the 2020s, while Decc estimates that investment will reach up to £41 billion over the same timescale.

While costs have fallen, levels of service have improved dramatically. Power cuts have reduced by 30 per cent since 2002, and the transmission and gas distribution networks are over 99.9 per cent reliable. DNOs are meeting the challenge of a rapid increase in renewables connections, having connected 11.5GW since 2005, largely without imposing additional costs on bill payers. Gas network operators have made over 27,000 new connections to fuel-poor households.

This high level of network performance and service is reflected in the consistently high levels of customer satisfaction, which is over 8/10 for network companies and is monitored by Ofgem. This level of customer satisfaction would be impressive in any sector and companies are justifiably proud of these scores given the focus on customer service in the energy industry.

Under the RIIO (Revenue= Incentives + Innovation + Outputs) regulatory model, introduced in 2013 and now in place across all network sectors, the emphasis is on delivering strong network performance and encouraging vital innovation, to ensure that today’s and future cost to customers stays low. The high degree of scrutiny from Ofgem throughout the price control process has been supplemented by wide-ranging stakeholder engagement to ensure the networks are delivering outputs that customers want. Where customers aren’t happy with what’s being delivered, their feedback can directly impact company’s revenue under the price control.

At the same time, under the RIIO framework companies are rolling out new innovations and smarter network solutions which will help the UK meet its climate change objectives at the most efficient cost for consumers over the coming decades.