Written evidence submitted by Energy Systems Catapult (ESC) (WIN0021)

Summary

Energy Systems Catapult (ESC) welcomes the opportunity to respond to the inquiry on the lessons learned by Ofgem, the Government, and energy companies last winter, and how to support consumers when energy prices are so volatile.

ESC was set up to accelerate the transformation of the UK’s energy system and ensure UK businesses and consumers capture the opportunities of clean growth. ESC is an independent, not-for-profit centre of excellence that bridges the gap between industry, Government, academia, and research. We take a whole systems view of the energy sector, including in policy design and implementation, helping us to identify and address innovation priorities and market barriers, to decarbonise the energy system at the lowest cost.

Our response focuses on the longer-term conditions for a secure, affordable, and decarbonised energy system, rather than quick fixes for the coming winter. Our work in accelerating energy decarbonisation innovation highlights the following key points:

We provide a response to the detailed inquiry questions in the annex. We would be happy to further discuss our responses with you.

Annex: Response to detailed consultation questions

  1. What role did the UK grid play in the high domestic prices of winter 2022-23?

As the decarbonisation of the UK energy system accelerates, the UK electricity grid will need to significantly increase capacity to accommodate the move to the electrification of heat and the growing numbers of electric vehicles. The system also needs to facilitate increased flexibility to maximise intermittent renewable energy sources in order to mitigate the reliance on gas setting the marginal price.

The current electricity market arrangements are outdated and don’t reflect the new realities of an increasingly intermittent source of power. The cost of managing congestion has increased 8-fold since 2010, which pushes up electricity prices for all consumers. The current design presumes that any generator can provide load at any location, which does not reflect the realities of the transmission system, where output can exceed the capacity of the network.

The single national price of electricity does not reflect local and temporal grid constraints which could be used to manage demand more effectively. Analysis from Ofgem and FTI, where we were project partners, suggests that an electricity market with nodal pricing could save consumers between £28bn and £55bn over the period from 2025-40, reflecting more efficient location and dispatch of generation and storage across the system and more efficient use of network infrastructure. All consumers in each region would be expected to benefit, but by how much would vary between regions.

The ability of consumers, or suppliers on behalf of consumers, to save money by shifting their demand is undermined. There are few flexible tariff propositions on the market, and under current arrangements there is concern about their commercial sustainability.

 

  1. What more could have been done to prevent price shocks being passed to consumer bills?

Ultimately, the impact of price shocks on consumers could have been reduced if the UK was less dependent on imported gas. The two key ways to do this are through wide-scale energy efficiency improvements on the UK building stock to reduce energy consumption, and through moving from gas-powered heating to alternative low-carbon sources. Fewer energy efficiency measures have been delivered through each subsequent round of ECO, and short-term funding for the sector creates uncertainty in developing supply chains for delivery, curtailing the number of measures possible under each scheme. The Government should provide longer term funds for building the supply chain and skills necessary for retrofits, and commit to key dates for banning new gas boilers.

To encourage the acceleration of the electrification of heating, the price of the electricity system needs to be addressed. Electricity market reform is needed to unlock greater opportunities and incentives for flexibility – such as batteries and Demand Side Response. An important part of this would be to align price signals with the true value of electricity according to time and location by introducing locational marginal pricing (LMP), which would reduce bills for all. A single national price of electricity does not reflect local and temporal grid constraints which could be used to manage demand more effectively.

The Energy Price Guarantee provided a short-term mitigation of price shocks to consumers. For longer-term protection, alternative energy market models should be considered. This could include service-based models focusing on the outcome (warmth) rather than units consumed (kWh). This would protect consumers from the price shocks of wholesale market prices as they would not be paying directly for energy consumption. Energy Systems Catapult has explored how “Heat as a Service” models can be delivered through our Living Lab of digitally connected homes.

We found that the Heat as a Service model can provide Demand Side Management through service providers managing their customers’ heating systems in avoiding peak electricity usage. This provided both household and wider system cost benefits, but needs to be balanced with potential increases in energy consumption outside of peak periods. In this model, energy service providers are commercially incentivised to use as little energy as possible.

The Government and innovation funding bodies need to support businesses in developing and testing a wide range of innovative and digitally enabled models, such as Heat as a Service, and creating the conditions to bring the most promising and appealing of these to market quickly. This needs to be collaborative working with consumers and focus on packaging technologies into outcome-based solutions. Ideally this would bring many service providers together to build a shared service language with related metrics and develop service provider outcomes and incentives that encourage uptake whilst also managing risks.

Vulnerable customers will still need focused support against price shocks. Another service model we have piloted with Gloucestershire NHS is Warm Home Prescription, which aims to prevent price shocks being passed on to the most vulnerable households with low incomes and cold-sensitive health conditions, improve mental and physical health, and save the NHS money from reduced hospitalisation. Participants, identified and referred through their local social prescribers, had their heating systems checked and their accounts credited so that patients could heat their homes to healthy temperatures, which resulted in improved wellbeing. A larger trial is currently being held, with results to be published September 2023.

Structured partnerships with the health sector through services such as Warm Home Prescription could be used to focus energy efficiency improvements to people's homes whose lives and health are at risk from price shocks. The 2023 Annual Report of the Committee on Fuel Poverty highlighted this as an exceptional example of place-based joined-up action on fuel poverty.

 

  1. How should energy companies respond if customers cannot pay their bills and what actions should they not have recourse to?

Energy companies should work with their customers to avoid situations whereby they cannot pay their bills. This should include installing energy efficiency measures to reduce energy consumption and costs, providing information to help save energy and keep warm, simple and clear billing to keep customers informed of costs, and support to help customers shift their demand to cheaper times of the day.

The inability of fuel poor household to pay their energy bills could become an automatic trigger for eligibility for supported application to schemes such as the Home Upgrade Scheme, Great British Insulation Scheme or the Energy Company Obligation. Digitalisation of the energy system could facilitate this, following the recommendations of the Energy Data Taskforce. Energy companies should provide energy efficiency advice, or signposting to tailored resources, to help reduce energy consumption.

Customers who rely on heating and energy for health and energy-using health equipment should be heavily protected from disconnections, self-disconnection and self-rationing. Government support is also crucial to protect those who could struggle to pay their bills, through targeted intervention – including through the universal credit scheme.

 

  1. Has Ofgem got its priorities right in addressing customer protection?

Digitalisation is critical to the delivery and operation of a decarbonised energy system. There needs to be a holistic review of customer data protection, which should not preclude innovation in the system, but provide the necessary protections. There will be increasing connections with adjacent sectors such as telecommunications, so it is important that there is alignment with other regulatory regimes to ensure there are no gaps in customer protection, and that there is ease of redress. The Energy Data Taskforce highlights that cross-sector data ethics needs to underpin the digitalisation journey.

Recommendations from the Energy Digitalisation Taskforce to review the customer protection regime include monitoring where customers are not able to access the best energy products or services due to digital exclusion. The way customers interact with the energy system will change significantly as it decarbonises, and as interactions increase between heat, mobility, storage, and self-generation. It is unfeasible for customers to navigate this complexity by themselves, so forward-looking infrastructure that enables new business models to emerge and thrive needs to also protect the inclusion of the most digitally excluded customers.

 

  1. How effective is the Government's approach towards supporting the sector and delivering a functioning energy market?

Innovation is needed across the energy systems to enable a transition to net zero while keeping costs down for consumers. The Review of Electricity Market Arrangements (REMA) shows current electricity market arrangements hinder the acceleration of low carbon electricity generation, increasing costs for consumers and putting net zero targets at risk. Markets and policy should be designed to stimulate investment in all low carbon technologies and approaches. Shielding industry from risk – and not incentivising companies to mitigate it – means an unfair deal for consumers.

However, REMA must go hand-in-hand with energy retail reform. Policy and market arrangements should reward innovation in retail energy services to accelerate decarbonisation and reduce reliance on imported fossil fuels. An enhanced customer focus will be needed to meet diverse needs and ensure protection from new shocks while unlocking opportunities arising from a cleaner, digitalised, and more efficient energy system.

Commercial innovation – to develop compelling energy propositions that consumers want, such as Heat as a Service models – will require retailers and other energy market players to develop new strategies, invest in capabilities and partner with non-traditional energy players. Government and regulatory reform is needed to enable this. In particular, wholesale market reform is needed to better align incentives with net zero outcomes, rebalancing the roles and responsibilities of retailers so facilitate new players to enter the market, and rethinking the approach to retail competition - with a greater focus on satisfaction and more tolerance of longer-term contracts.

Government’s approach to supporting the sector innovate needs to include a focus on delivering innovation for low income and vulnerable (LIV) consumers. Our review of how innovation projects could enable LIV consumers to participate in a smart, flexible energy market, found a wide range of risks and factors that could be obstacles. There needs to be a conscious inclusion of LIV consumers in the design of products and services and the development of solutions that cover all parts of participation in the future energy system - access, use and purchase. Two main principles emerged which would have a long-term impact on future innovation projects which involve LIV consumers. The first is to encourage relevant innovation projects to follow best practice, human-centred innovation processes. The second is to create a publicly funded innovation ecosystem that supports LIV consumers.

 

  1. Is the legislative framework on pricing controls suitable for protecting consumers?

The transition to net zero will require significant changes to the energy system, and consumer protection measures will need to evolve to keep up. There are big opportunities for consumers to have better outcomes and benefit from net zero with new energy propositions e.g. through investments to improve energy efficiency, self-generation and enabling demand flexibility. However, consumer protection frameworks must be forward-looking to reassure consumers that their interests are protected.

The current price cap system protected consumers when the energy market was relatively stable, but has been too crude for the volatile prices of the last 18 months. The lack of timely updates relative to price changes contributed to the collapse of smaller energy companies, with the cost passed on to consumers. Energy companies stopped taking on new customers, limiting the options of finding cheaper tariffs.

Alternative approaches should be considered. The introduction of a social tariff, similar to those available in the telecoms industry, could protect vulnerable consumers from price shocks. Our Living Lab can be used to test different types of social tariffs to build the evidence base for the most effective version, and to identify any unintended effects. The expansion of our Warm Home Prescription service could help with identifying and protecting the most vulnerable consumers. Direct support through the universal credit system would also be a relatively simple approach.

 

August 2023

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