Supplementary written evidence submitted by Ofgem (WIN0061)

 

 

Additional information following Energy Security and Net Zero committee hearing on 13 September 2023

 

Thank you for the invitation to attend the Energy Security and Net Zero committee yesterday, Wednesday 13 September.

 

As we discussed at the Committee, whilst energy bills have come down from historical highs, this winter will remain difficult for many households. We have been working at pace to build financial resilience in the sector to protect customers from the volatility we saw in 2021 and improving service standards through our ongoing market compliance reviews and new rules on involuntary prepayment meter installations.

 

As we head into winter we are focused on further strengthening our customer service rules and working with suppliers to ensure those consumers who are in debt are properly supported and our rules are applied consistently; and ensuring an effective retail pricing regime which means consumer bills reflect only efficient and economic costs.

 

We know there is much debate about standing charges and we understand people’s frustrations when they are trying hard to reduce their bills but can’t make a difference to their standing charge. For instance, a dual fuel customer on prepayment meter would see a standing charge of around £1 per day before they pay for any electricity and gas that day. We have set out below how fixed and variable costs in the energy system are reflected in domestic consumer bills, findings of previous distributional analysis of standing charges, and the reviews we are currently undertaking to ensure the balance between fixed and variable costs are fair. In short, we are committed to a programme of work on standing charges working with consumer groups, suppliers, and government and we will keep the Committee updated on this work.

 

Additionally, we have provided further information on our conflict of interest policy and a senior member of Ofgem staff as I committed to do. Finally, we have provided further clarification regarding the levelisation of payment methods between pre-payment and direct debit.

 

Yours sincerely,

 

Jonathan Brearley

Chief Executive

 

Annex

 

Standing charges: fixed costs and variable costs

 

All customers’ bills are made up of variable costs and fixed costs. Variable costs include electricity and gas energy wholesale costs and are the most significant element of customers’ bills. Fixed costs include electricity network operating costs, some supplier operating costs such as billing systems and cost of customer contact, and some government social and environmental policy costs. These fixed costs are generally recovered by energy suppliers through the standing charge.

 

Ofgem does not dictate how fixed costs are recovered from consumers on fixed tariffs. Suppliers today could offer fixed tariffs in the market with no standing charge, if they consider standing charges are not in their customers’ interests. There are no Ofgem rules requiring suppliers to set a standing charge, nor do we ban suppliers from incorporating the costs into unit rates.

 

We think it is important for customers that the price cap is set at a level which allows suppliers generally to recover reasonable and efficient costs. The price cap sets the maximum charges that suppliers must comply with for their default customers. When setting the price cap we set it based on the total charges a supplier can charge a customer at ‘typical’ consumption, and at ‘nil’ consumption. Nil consumption implies a level of standing charges.

 

As of 1 October 2023 the typical domestic consumer’s bill will be £1,923, and at nil consumption will be £303. The breakdown at nil consumption is below:

Component of standing charge

Cap at ‘nil consumption’ for dual fuel, direct debit customer: Oct–Dec ‘23 cap period

Electricity network costs

£108

Operating costs

£139

Policy and other costs[1]

£56

Total

£303

 

Suppliers are free to set a standing charge below ‘nil’ consumption if they wish to do so, provided the overall tariff structure complies with the price cap requirements. Price cap rules allow suppliers to request approval for alternative charging structures, but none of the existing suppliers has to date made requests to us under these provisions.,

 

Distributional impact of the standing charge

 

Any change to standing charges and unit rates that is imposed by Ofgem and not accompanied by government support will have distributional impacts. A blanket ban on standing charges, for example, would benefit low income, low energy users, but would also benefit high income users with low consumption such as second homeowners or customers with solar panels. Importantly, there are a significant population of high use and low-income groups such as the elderly and disabled, or low-income renters of old, energy inefficient housing stock that already pay the highest proportion of their income on energy, and who would end up paying much more, as they cannot necessarily reduce their electricity consumption.

 

Energy use is weakly correlated with income, and many vulnerable consumers are high consumption users (eg those with medical needs). For example, of the lowest income households, a significant proportion are in electricity-only homes, often poorly insulated, and have particularly high electricity consumption from heating as a result. They would be adversely affected by policies that increased costs for high usage groups. Taking these effects together, previous Ofgem analysis found that the overall distributional effects could be negative if costs are shifted from standing charges to unit rates.

 

We are currently updating the consumer archetypes that we use for assessing the distributional effects of our policies. Our latest research suggests that around 60% of households in archetypes with markers of vulnerability, such as households with disabilities or very low incomes, have average or higher gas consumption. The equivalent figure for electricity is around 40%.

 

Review of standing charges

 

Achieving net zero will require substantial investment in the infrastructure that brings energy to homes and businesses. Both the expected, significant increase in electricity demand and the changing location and nature of generation will require large investments in networks. National Grid ESO has proposed £21bn[2] of investment in transmission network assets by 2030, to achieve net zero at lowest overall cost to the consumer. Ofgem analysis indicates that £20-27bn[3] of network investment in the 2030s is likely to follow. Much of this cost will be paid by consumers, through the network charges on their bills. If we do nothing, and maintain the existing system, this could lead to a doubling, or more, of the network portion of the electricity standing charge. So even if the current system is appropriate for today’s level of standing charges, it may not be appropriate for the future.

 

We will conduct a strategic review of standing charges to ensure we have a clear strategic view on the role of standing charges not just in the current market environment, but also over the next decade. This will consider evidence gathered from two already open Ofgem consultations on elements of the standing charge: a call for input on operational costs[4] in the price cap and a separate open letter on strategic transmission charging[5]. We will also take evidence from the industry, consumer groups and government on any potential reforms to avoid unintended consequences.

 

Conflict of interest policy

 

Neil Lawrence correctly declared that his wife held SSE shares during his onboarding process in May 2021, but Ofgem provided him incorrect advice in relation to the conflict, this was down to human error.

 

However, once the shareholdings were again identified in August 2022, Mr Lawrence was this time advised correctly, and agreed, that these shares should be sold in line with our policy requirements. It is normal practice to give individuals up to nine months to sell any share holdings and the shares were sold in April 2023. Neil therefore took all the appropriate steps to flag and then resolve the conflict.

 

We are conducting an internal review of how potential conflicts of interest are identified and dealt with. We have strengthened our processes and implemented controls to prevent this from happening again – such as an annual declaration from all Ofgem employees – to provide additional assurance that conflicts of interest are being identified and dealt with properly. An update will be provided in our next annual report.

 

At Ofgem the impartiality of all our colleagues is an important part of our culture and we take our responsibility as an independent regulator very seriously. As part of our commitment to transparency we regularly publish our register of disclosable interests for our board and senior executive team.

 

It should be noted that the price cap applies to domestic household suppliers. As SSE does not have a domestic supply business, it is not subject to the cap.

 

Levelisation of payment methods

 

In April 2023 we made technical changes[6] to the price cap which significantly reduced the differential between prepayment and direct debt customers. In August we consulted on proposals which would permanently end the differential between direct debit and prepayment standing charges[7]. We have not yet made a final decision on these proposals but plan to do so soon. Should we decide to implement them, we would intend this to take effect from April 2024.

 

September 2023

 

 

 

The Office of Gas and Electricity Markets

10 South Colonnade, Canary Wharf, London, E14 4PU  Tel 020 7901 7000

www.ofgem.gov.uk


[1] Government policy costs, smart meter roll out costs, VAT, EBIT, headroom, adjustment allowance

[2] Pathway to Net Zero, July 2022, National Grid ESO - download (nationalgrideso.com)

[3] Consultation on frameworks for future systems and network regulation: enabling an energy system for the future | Ofgem

[4] Price cap - Call for Input on the Operating Cost Allowances Review | Ofgem

[5] Open letter on strategic transmission charging reform | Ofgem

[6] Decision to approve Uniform Network Code (UNC) 840: Equalisation of prepayment and non-prepayment AUG factors | Ofgem

[7] Levelling the cost of standing charges on prepayment meters | Ofgem