Written evidence submitted by Energy UK (WIN0044)

 

Introduction

 

The Russian invasion of Ukraine in 2022 has been one of many drivers of ongoing volatility in international wholesale gas prices, but a range of other factors have also been impacting customers' bills over recent months and years. These include the COVID-19 pandemic, suppliers exiting the energy market, geopolitics, weather, and even industrial action at gas terminals. Over this period the retail sector has been, on average, loss-making which is a major impediment to industry investing in innovative or expanded customer services. Recent reported profits have been a result of temporary changes to Ofgem’s default tariff cap which have been designed to offset some of the losses forced on supplier’s during the crisis.

 

Government action to protect customers from price shocks over winter 2022 focused on financial intervention. This level of support was unprecedented at £40bn between October 2022 and March 2023[1]. A number of factors could have mitigated some of the costs of intervention and ensure it was better targeted:

 

Ahead of this winter, industry data is showing that average energy debt levels are increasing quickly, as millions of customers struggle to cover the cost of their essential expenditures, even in summer. Therefore customers, Government and industry remain exposed to current price and future price shocks.

 

To address these issues over winter and beyond, we are asking the Government to:

 

Looking back: Could winter 2022-2023 prices have been lower?

 

Despite progress being made to scale up renewable generation infrastructure in the last decade, the UK is still heavily dependent on gas as a source of electricity generation and for heating its homes. As gas is traded on international markets it is subject to impact from global events, exposing the UK to fluctuations and price shocks. While customers did benefit from low-cost renewables (over the course of October 2021 to April 2023, payments were in fact flowing from Contract for Difference windfarms back to suppliers to the tune of £660 million[2]), accelerated deployment of renewables, home energy efficiency measures and electrification/low carbon technologies would have helped shield our energy system from these shocks and further mitigated the impacts of higher prices.

 

At present there are several barriers preventing customers benefitting from the cheapest sources of electricity generation, including:

 

Action on these issues is imperative to reducing future exposure to gas prices. There are, however, other non-wholesale costs that relate to how we balance the system and ensure that supply meets demand at all times.

 

Reducing balancing costs

 

Electricity supply and demand must be aligned to keep the lights on. While largely aligned ahead of time through the wholesale market, National Grid Electricity System Operator (NGESO) uses tools to fine-tune this alignment throughout the day. Fast-acting gas plants currently deliver most of this energy balancing. The high price of gas, along with tighter system margins, meant that last year GB spent over £4bn on energy balancing. This 250% increase on 2019 costs feeds through to the energy bill via network charges.

 

Great Britain has 3GW of installed grid-scale battery installations, along with increasing amounts of available Demand Side Response (DSR), where users increase or decrease energy usage based on system signals. These assets could play a larger role in energy balancing to reduce reliance on volatile gas markets and balancing costs[3].

 

While some energy storage and DSR can take part in balancing markets, there are remaining barriers to entry. While complex, NGESO acknowledges that the legacy system cannot integrate these newer technologies[4] effectively. We welcome the series of measures NGESO is introducing to improve competition in this space from December 2023. However, the gas price crisis highlights the need to go faster.

 

We recommend that NGESO accelerates proposals to modernise control room capabilities. This would enable NGESO to bring forward new tools and markets faster, bringing down balancing costs and lowering customersbills.

 

Enhanced measures to preserve system margins over winter

 

In winter 22/23 the ESO introduced two new measures to provide extra capacity in case the crisis restricted gas supplies to the extent that, in the worst scenario, rolling disconnections could be required to preserve national system stability. In the event, the relatively mild winter, and well-managed Liquified Natural Gas (LNG) supplies meant that the winter passed without undue risk, but it was important that these safeguards were in place in case they were required.

 

The first measure introduced ahead of winter 22/23 was to contract three coal-fired power stations (combined capacity of 2.5GW) to stand-by in case needed. The second measure was to develop the Demand Flexibility Service (DFS). This allowed suppliers and other intermediaries to compensate end customers for reducing their power consumption at certain times. DFS was called twice (for 2.5 hours in total) and ran for 12 tests, saving over 3,300MWh of electricity during peak times and engaging 1.6 million homes and businesses. DFS showed that:

 

The trial highlighted the role that DSR could play in future balancing markets, contracting capacity of 330MW- the equivalent of a small thermal (e.g., gas) plant – over last winter. Under the right conditions this could scale to a 2GW resource (or double that once the smart meter rollout is complete).

 

The DFS is a cost-effective vehicle to develop DSR further, costing £11 million over the winter. It is a flexible resource with ESO paying for balancing/capacity on a ‘pay as you go’ per-event basis. This is compared to the up-front costs seen with winter 22/23 coal power station contracts, a reported £340 - £395 million[5] to ensure the plants were staffed and maintained throughout the winter.

 

Optimising the potential from DSR requires concerted efforts from the Government, NGESO and Ofgem – it will not emerge in current markets. While DSR and other forms of short -duration flexibility can reduce system costs today, the real prize would be to reduce additional infrastructure spend. A Government-led strategic approach on maximising the benefits, including future ‘avoided costs’ of generation capacity and network infrastructure, would be welcome. If clearer insights on the role that DSR could play are not gained over the next few years, additional infrastructure will need to be commissioned to ensure future system needs are met as more low carbon technologies, from renewables to heat pumps, connect to the system.

 

Were customers protected adequately from high prices?

 

The Government and industry successfully put in place blanket financial support schemes for domestic and business customers for winter 22/23 including the Energy Bill Support Scheme (EBSS), Energy Price Guarantee (EPG), Energy Bill Relief Scheme (EBRS) and Energy Bills Discount Scheme (EBDS). This was the right approach at the time to ensure the speed of delivery needed in order to mitigate the most damaging customer impacts, although many still suffered considerable hardship. These schemes provided some lessons for future delivery – in particular the importance of simplicity and the challenges of redemption rates for voucher-based approaches.

Things are not getting easier for customers - average debt levels are increasing quickly, and we expect to see debt increase over summer and into the winter. Customers, Government, and industry remain exposed to future price shocks, and Government-provided financial support is needed to protect customers over this coming winter.

 

However, subsequent scheme iterations should be more targeted, for example by using the EPG or Warm Home Discount (WHD) with a form of data matching against that which Government holds. This would set the groundwork for delivering enhanced support to those who are not able to manage their bills while providing less support to those that do not need it. This represents a more efficient, fair, and effective use of taxpayer spending that reduces the inflationary impact of Government support.

 

The EPG, the domestic support scheme, was extended at the £2,500 level in April to avoid a cliff edge in support in July. There was also a drop off in protection when the EBSS ended in July, however. There are significant concerns about customersability to cope with the increased costs of energy that are still almost double pre-crisis levels. Customer energy debt levels carried into this winter will weaken their ability to manage their finances.

 

The non-domestic support scheme saw a more pronounced cliff edge with the end of the EBRS and the introduction of the EBDS. This has caused significant affordability challenges for non-domestic customers, which may be further exacerbated as the coming winter approaches. Government could be seeking to ensure that credit risk from this scenario is minimised in a similar way to its COVID-19 approach, where it provided a credit insurance scheme.

 

What is being done to support and protect customers?

 

Ofgem’s approach to customer protection

 

The price cap was intended to act as a backstop protection for unengaged customers, not to set a price level for the market. However, prices rose faster than the rate at which the cap could adjust, leaving suppliers unable to recoup the costs they incurred. This contributed to many suppliers going out of business the costs of which were spread across all customers.

 

Ofgem had to adjust the cap in order to stabilise the market, introducing additional allowances including the backwardation allowance, Market Stabilisation Charge and additional wholesale energy allowances. This has meant that suppliers made heavy losses through the crisis which were subsequently offset to an extent by one-off profits allowed under the cap this year. This sits alongside the requirement on suppliers to build up capital reserves to ensure they are financially resilient to future shocks. Allowing a fair return and allowing suppliers to compete will encourage innovation which will lead to better customer outcomes.

 

Supplier approach to vulnerable customers

 

Suppliers are required to protect their most vulnerable customers and take efforts to identify and respond to the needs of those in vulnerable situations. They must offer certain customers a number of free services, such as providing information in an accessible format and reading the customer’s meter if the customer is unable to do so.

 

Over 90% of UK homes are currently covered by Energy UK's Vulnerability Commitment which was developed in consultation with consumer and charity groups, the energy regulator, and customers. Its aim is to support people in vulnerable circumstances above and beyond existing regulations. Commitments include all signatories offering a freephone number and multi-language and communication channels for support, alongside hundreds of millions of pounds in emergency credit, payment plans and payment holidays offered since the start of the pandemic.

 

The use of prepayment meters (PPMs) as a last resort enables customers to effectively budget their energy use and suppliers to support them. However, it is also crucial that some vulnerable customers are not put onto PPMs if it is not appropriate. The new PPM Code of Practise introduces further voluntary actions suppliers need to take before, during and after an involuntary PPM installation. We think this is a good step forward in protecting customers, but it must be noted that these measures are yet to be widely tested across industry and that there will be customers who are simply not able to afford their bill and should be considered for other support, such as a social tariff. It is also important to note that PPMs help customers avoid falling further into debt. Lower use of PPMs as a result of the Code of Practise will likely result in higher debt levels which can have negative impacts on individual households and also lead to increased prices for other customers as bad debt costs are currently spread across all billpayers.

 

Social tariff

 

The concept of a social tariff is well supported across customer groups, the energy industry[6] and elected representatives. The introduction of such a tool ahead or during the gas crisis would have supported better targeted intervention.

 

We also understand that Government is not currently planning to extend the existing support schemes discussed previously or introduce further schemes. Therefore, an adequate level of support is unlikely to be in place to manage the affordability issues arising this coming winter, and that further debt build up is likely.

 

We urge the Government to put plans for a social tariff to public consultation and take steps to design a targeted financial support mechanism ahead of this winter.

 

Home energy efficiency

 

Energy efficiency measures

 

Measures which increase home energy efficiency imply lower customer usage and therefore expenditure. The Energy and Climate Intelligence Unit has suggested that home insulation could be cost neutral on the Treasury by the end of the current Parliamentary term if high energy costs return. It also claims that an investment of as little as £1,000 per home could cover a basic package of measures that would move an Energy Performance Certificate (EPC) Band D home, the UK’s average, to EPC band C, the Government’s target for 2035, providing a higher return for customers.

 

Meanwhile the Climate Change Committee’s (CCC) 2023 Progress Report[7] suggests that delivery of energy efficiency measures needs to scale up from 150,000 installs per year in 2021, to 1.5 million in 2025 - and almost 3 million in 2028 - for Government to reach its Net Zero obligations.

 

An ambitious strategy from Government, combining regulations (minimum energy efficiency standards) and incentives/ tailored fiscal policy is needed to create a private market for energy efficiency measures and reach these levels of delivery. Enabling policies - such as EPC reform and support for skills and training in the construction industry - are also essential.

 

The number of measures delivered[8] through the Government’s fuel poverty schemes was lower in 2022 than in 2021. Government must urgently publish its forthcoming consultation on changes to the ECO4 scheme design to unlock delivery at the volume required. Government should consult on:

 

The energy industry commended the introduction of the GBIS, following its own proposal for an ECO+ style scheme[9], but would welcome more ambition in terms of budget and number of households in scope. Government should explore the scope to expand the GBIS, in partnership with the energy industry, to bring forward a more ambitious offer for customers and enable companies to develop bundled customer propositions.

 

New homes standards

 

Government must urgently publish the technical consultation on the Future Homes Standard to allow industry sufficient time between consultation and implementation. The Government should maintain its commitment to no new gas connections under the standard, to ensure that new homes built from 2025 are fit for the future. This will generate the best outcomes for customers, as the CCC estimates[10] that the cost of retrofitting heating technologies is estimated at £5,500 per household.

 

Electric heating

 

Supporting households in moving away from fossil fuel heating and towards electric heating is a key tenet of improving the UK’s energy security, decarbonising buildings, and reducing overall system costs for customers. The transition to low carbon heating enables further decarbonisation of the whole energy system by reducing demand for natural gas. This process will also support the flourishing of domestic flexibility markets, key to reducing costs within the balancing market and reducing generation requirements.

 

Government should urgently publish its consultation on rebalancing policy costs on energy bills to examine options for reducing the running costs of electric heating. The current approach is working in opposition to the Government’s objective[11] to roll out 600,000 heat pumps annually by 2028 and position the UK as one of the largest markets in Europe for heat pumps by the end of the decade.

 

While the Boiler Upgrade Scheme, and its recent extension, are positive steps to removing barriers to households switching to electric heating, the up-front costs of the units, household improvements and labour are proving to still be prohibitive for many people. A policy framework that ensures low-to-middle-income customers can access these technologies is needed to accelerate the transition.

 

Investing in energy efficiency at a consistent pace over the 2020s would have saved households and the Government well over £1bn over the course of the energy crisis[12].

 

Smart rollout and Market-wide Half Hourly Settlement (MHHS) delivery.

 

The widespread rollout of smart meters and delivery of MHHS will enable and encourage further time of use tariffs – meaning customers will have more choice and have sharpened incentives to shift their demand to off-peak times. A broader policy approach to the smart rollout which drives uptake will help ensure no customer group is left behind and support the benefits case for the programme.

 

August 2023

 

6

 


[1] https://www.gov.uk/government/news/40bn-spent-protecting-families-and-businesses-from-energy-costs

[2] https://eciu.net/analysis/reports/2023/offshore-wind-all-at-sea

[3] Continued development of the electricity networks will also help reduce balancing costs by reducing constraints in the system.

[4] https://www2.nationalgrideso.com/document/285016/download

[5] https://utilityweek.co.uk/eso-stands-down-backup-coal-units/

[6] https://www.energy-uk.org.uk/news/government-must-switch-on-to-help-vulnerable-energy-customers-this-winter/

 

[7] https://www.theccc.org.uk/wp-content/uploads/2023/06/Progress-in-reducing-UK-emissions-2023-Report-to-Parliament-1.pdf

[8] https://www.gov.uk/government/collections/household-energy-efficiency-national-statistics#headline-releases

[9] https://www.energy-uk.org.uk/publications/eco-report-sept-2022/

[10] https://www.theccc.org.uk/wp-content/uploads/2019/02/UK-housing-Fit-for-the-future-CCC-2019.pdf

[11] https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1166439/heat-pumps-investment-roadmap.pdf

[12] https://www.carbonbrief.org/analysis-why-uk-energy-bills-are-soaring-to-record-highs-and-how-to-cut-them/#:~:text=(See%20Carbon%20Brief's%20January%20article,%2Dcarbon%20standards%20(red)