Written evidence submitted by Cadent Gas (WIN0032)

About:

Cadent Gas is the UK’s largest gas distribution network, covering the North West, West Midlands, East Midlands, South Yorkshire, East of England and North London. We believe our experience managing the network is important for the committee’s inquiry into preparing for the winter.

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

Winter 2022/23 saw a rise in gas prices across the world.  This was driven in part by Russia’s invasion of Ukraine in February 2022 which provided a supply-side shock to the European energy sector (and therefore increased demand for other global sources of energy) at the same time as an increase in demand as economies around the world came out of lockdown. Although the UK imported little Russian energy at the time, our energy markets remain linked to European markets through trading, interconnection and competing for supply.

In the UK, and many other energy markets including the EU, the price of electricity is set by the last producer needed to meet whatever demand is on the system at that point. As this producer (known as the marginal producer) is typically a gas-fired power plant today, the price of gas generally sets the price of electricity.  As a result, both domestic gas and electricity prices were high during winter 2022/23.

These price impacts occurred regardless of the UK grid.  The UK did not experience a shortage of supply in either gas or electricity markets, and the design of the electricity market was such that any mix of generation technologies which still involved a single gas producer as the marginal producer would have led to the same outcome.

Finally, we note that proposals to divorce renewable and other forms of electricity production[1] could change price formation in the future electricity wholesale markets.  Non-renewable sources of capacity, including gas peaking plant, will still need to recover their costs through any procurement contracts agreed with them however.  These costs in turn will ultimately flow through to customers, through energy bills or through taxation depending on the funding mechanism chosen. 

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

Ultimately energy must be paid for.  The choice is how the costs are distributed, typically on income (taxation) and usage (energy bills)

Longer-term hedging or energy procurement contracts would have helped reduce the costs faced by consumers by ‘smoothing’ the weighted average price paid by customers.  This is not without consequence however as it would have also ‘smoothed’ the weighted price paid by customers as energy prices then fell, i.e. left customers paying higher prices for longer. This is therefore a judgement call over how the Energy Price Cap is set, and how volatile (on both the upside and downside) we want domestic costs to be.

Our view is that competitive markets deliver the best outcomes for consumers, and that the short-term externalities this creates, such as price shocks, can be best dealt with by the State.

 

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

Energy is an essential good.  Disconnection should therefore be reserved for extreme cases such as theft or safety related matters.  In all other cases, ways must be found to balance the need to keep the customer on supply and avoid creating unsustainable debt.

We believe fuel poverty should be addressed through the State.  To do so through the energy bill or energy suppliers, for example through a price cap, risks creating distortions in the competitive market which ultimately have negative impacts on customers.  We note that the cost to consumers from the failure of 29 energy suppliers since July 2021 was found to be £2.7bn[2].

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

No response.

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

No response.

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

Our view is that competitive markets deliver the best outcomes for consumers, and that the short-term externalities this creates, such as price shocks, can be best dealt with by the State.  We therefore argue that price caps should be replaced with targeted social support such as a targeted social tariff or additional benefits outside of the energy bill.  This ensures those who need support receive it without necessarily creating market distortions that can lead to unforeseen market failures.

We have particular concerns about the powers reserved in the Energy Prices Act (2022) and believe these will actually serve to increase costs for consumers.  Specifically, this Act gives the Secretary of State power to amend regulations, revoke licences or “acquire” infrastructure assets in the event of a “relevant change in the price of energy” [3].  These are too loosely defined and open-ended. They cut across the established regulatory regime for network companies, which has allowed those companies to deliver investment in infrastructure at the lowest possible cost. In its current form, the Act creates additional risk for investors and so potentially increasing investment costs to energy bill payers. 

The Act means that Government now has unlimited powers over the running of energy network companies, allowing the Secretary of State to undertake action that might undermine or even jeopardise the safe and secure supply of energy and the financial health of network companies, due to their investment obligations.  The bar for intervention is extremely low, does not set out how the Government will determine “the price of energy”, in terms of what index or reference point it will use for that or whether it is the wholesale or retail price of energy.  This creates a material risk to investors in UK energy networks, increasing the cost of capital associated with the future investment we need in both gas and electricity sectors.

We recognise the Government’s need to ensure it can act during an energy crisis.  But these powers are too wide and need better defining.  Amendments are needed to better define which “infrastructure” the Secretary of State may acquire under the Act, introduce appeal mechanisms and compensation routes for affected investors, place stricter time limits on both the existence of these powers and the duration of any action taken, and restrict any changes in regulation to those directional in accordance with sector development.

August 2023

 

 

 

 

 

 


[1] Review of Electricity Market Arrangements

[2] Public Accounts Committee

[3] Section 28(1), Energy Price Act