Written evidence submitted by Energy UK (EPM0028)

BEIS Select Committee inquiry: Energy pricing and the future of the energy market

The Gas Crisis

Since August 2021, the international price of gas has become considerably more volatile, for example in September and December when prices rose between 300% and 400%.

This unprecedented spike in wholesale price has been driven by macroeconomic and geopolitical factors, including high natural gas demand as economies recovered from the pandemic, EU storage levels remaining low, the doubling of the UK carbon price over the past year and Russia limiting gas supplies.

The most visible consequence of the crisis to date has been the failure of 27 energy suppliers since the start of the Autumn, including Bulb Energy, which was the first company to enter the Special Administration Regime. As a result of these failures, 2.3m households have been moved to a new supplier under Ofgem’s Supplier of Last Resort (SoLR) arrangements, at a cost to energy customers of at least £2.6bn to date.[1]

The price cap has protected millions of customers from the international price spikes, however has meant suppliers are unable to recoup costs; despite the price cap increasing by 12% in October 2021 (to £1,277), suppliers have been subsidising customers on Standard Variable and default tariffs, sometimes by as much as £700 per customer, based on analysis of SoLR costs. High and volatile gas prices, have also meant that we have seen the disappearance of cheap fixed deals from the energy market, with tariffs at the price cap becoming the cheapest available prices in the domestic market.[2]

It is, therefore, expected that Ofgem will have to raise the current price cap to near £2,000 from 1 April 2022 (around a 50% increase), and the impacts are also likely to be felt in the October 2022 price cap review. Current estimates suggest given sustained high prices, geopolitical tension and current price cap methodology, that bills will remain high well into 2023 and possibly beyond.

As with our response to the Covid-19 pandemic, industry remains committed to supporting customers adversely impacted by rising prices. This includes ensuring they are complying with the robust set of consumer protection rules required of all suppliers by Ofgem and going above and beyond these rules through initiatives like Energy UK’s Vulnerably Commitment.[3]

At the outset to the Covid-19 pandemic and in advance of the first lockdown, Energy UK and our members worked with the Department of Business, Energy and Industrial Strategy (BEIS), Ofgem and Citizens Advice to put into place a number of consumer principles that would support customers, who found themselves struggling to pay their bills, because of losing jobs or reduced income due.[4]

These principles ensured customers were protected, and that suppliers stepped up to support customers struggling to pay their bills. Resulting actions included payment holidays, restructured payment plans, and in many cases credit for customers on pre-payment meters, totaling hundreds of millions of pounds in benefits for customers. We also worked with customers who were on pre-payment meters, to provide them with smart pre-payment meters, meaning they could top-up their energy meters from home, on connected devices, like smart phones.

As the gas prices started to rises from summer 2021 Energy UK, again working with Ofgem, looked to ensure the initial consumer protection principles remained for winter 2021-22,and also sought to create additional support for customers[5]. The industry’s priority throughout the Covid-19 pandemic, and this gas crisis, has been to ensure customers can keep their lights and heating on, in what is a stressful time for everyone.

The anticipated price rises, whilst alarming, unfortunately reflect the cost of supplying and providing energy at the current time. Suppliers cannot continue to subsidise energy bills for millions of customers, while also carrying billions of excess costs as a result of this crisis. The UK Government will to need to take action to support customers with high bills. If suppliers are not able to recover their costs, more will fail, adding further cost onto future customers’ bills.

It is, therefore, essential that the UK Government takes action to help keep energy bills down for customers, while ensuring energy suppliers can continue to sustainably operate and supply energy. Taking no action to support customers will leave millions of people worried about how they will pay their energy bills in the coming years, which is causing great concern for industry. National Energy Action estimate that the expected price rises from 1 April will push a further 1.5million households into fuel poverty.[6] There are serious concerns, and recent Resolution Foundation research found that as many as 27% of household customers could be in fuel stress by the end of 2022.[7]

Wider economic impacts

Industry has remained focused on protecting customers, but it’s clear that these issues are much wider than energy alone, and feed into a wider cost of living crisis. One that threatens to put at risk the country’s economic recovery from the covid-19 pandemic.

An estimated £2,000 household energy bill could increase UK inflation by 1- 2% resulting in more than £10 billion a year in additional Government costs, from indexing debt, pension, salary and other payments. Rising inflation puts further financial pressure on household and businesses.

Energy underpins the rest of the economy. Businesses having to renew longer, fixed term contracts under the backdrop of high prices will see these high prices baked in for a number of years, and ultimately have to pass these to consumers. The recent letter, signed by the five economy wide trade associations, CBI, FSB, IoD, MakeUk and BCC calls for urgent action to limit the impact rising bills could have on the economy and business community.[8]

Given the wider economic impact to rising energy bills, it is essential that the UK Government looks to take a holistic economy-wide perspective to keep bills and prices down.

Solutions and options for supporting customers

Energy UK has developed five principles that will help the UK decide on how to act to protect customers from rising energy bills.

• Delivers fair prices for customers
• Supports people in vulnerable circumstances (recognising this group may grow)
• Addresses any economy wide impacts of high energy prices
• Enables the investment in a secure, Net Zero energy system 
• Enables a retail market which is investable, stable and innovating for Net Zero

Building from these five key principles, there are a range of solutions that the Government could put into place to provide support to energy customers.

Spreading SoLR costs

Under Ofgem’s current process, the costs of supplier failures this winter will need to be recovered from customers in their entirety (with the exception of Bulb, subject to the outcomes of the current Special Administration regime), via increased network charges in 2022 and 2023. We believe one immediate action Government and Ofgem should take is to explore how the recovery of these costs could be delayed or smoothed, whilst ensuring suppliers that have stepped up to support customers this winter are not left out of pocket.

While it remains to be seen if and how the mechanism could/will be used, we welcome Ofgem’s recent work with industry to try and facilitate a framework to allow third-party financing of the SoLR levies, particularly given the lack of Government activity in this space. Third Party financing of the SoLR Levies has the potential to smooth the impact of current extraordinary SoLR levy payments on 2022/23 consumer bills.

We note that Government should also be considering such options in connection with the recovery of any otherwise unrecoverable funding required for the energy supply company administration arrangements stood up for Bulb.

Removing VAT from energy bills

5% of a domestic energy bill (20% for non-domestic customers) is VAT - from April 2022 this is expected to be around £90 per annum for a dual fuel domestic customer. Government could help mitigate rising energy bills by, either on a temporary or permanent basis, reducing or removing VAT on domestic and non-domestic energy bills. However, one consequence of this would be around £2 billion in lost tax revenue.

Move policy costs into Government spending

Approximately 15% of a domestic energy bill represents the social and environmental obligations placed on suppliers by government. These costs pay for important programmes like the Energy Company Obligation (ECO), Warm Home Discount (WHD), Contracts for Difference (CfD) and the Renewables Obligation, all of which are essential if we are to meet our legally binding net-zero ambitions. Schemes like ECO also provide essential support to vulnerable customers in helping to improve the energy efficiency of their property, and keep their bills down. It is vital that these schemes remain to provide support customers.

The UK Government could mitigate rising energy bills, either on a temporary or permanent basis, by moving the funding of these policies into general spending. In the short term, we believe this could be achieved by directly compensating customers for the costs of delivering such schemes, for example by bill rebates. A similar approach was used in 2013 and 2014 via the Government Electricity Rebate (GER), to compensate customers for the cost of providing WHD. This would save customers around £180.

Each of these options has previously been shared by Energy UK with the UK Government. The options are not mutually exclusive, in fact a combination of options will likely be needed to best support customers. The order the options are presented in is also not indicative of any preference held by Energy UK.

Wider and additional support

While each of the above actions could, either on their own or in combination, ease some of the pressure on consumer bills, in the face of record-breaking increases and volatility in wholesale prices, they are ultimately insufficient. We believe there is also a need for the UK Government to consider what more it can do to support customers with a global gas price crisis, in particular those customers in vulnerable circumstances

One option to support all households in the short-term would be to spread the costs of the wholesale gas spike over a period of time. This could be achieved by funding a rebate directly on bills now and recovering it via a levy on future bills, once wholesale prices start to fall. Any smoothing of bills would, however, need to consider and take into account the possibility of higher-than-average gas bills continuing for a number of years.

With regards to customers in vulnerable circumstances, one option could be for the UK Government to increase the value of and/or expand the number of households that receive support under the existing energy social price support scheme, WHD. It is worth noting that in 2019’s Energy White Paper, the Government announced plans to expand the scheme from winter 2022/23 by increasing the value of the WHD rebate to £150, and providing the rebate to another half a million households.

Further increasing the size of the WHD would however, place additional pressure on household bills as it is a policy funded via all customers’ energy bills. If pressure on bills is to be minimised, we believe the only sustainable way to fund an expansion of WHD would be by taking it out of customers’ energy bills and into government spending.

Financial regulation and role of Ofgem

Once gas prices have stabilised, the UK Government and Ofgem must turn their attention to working with the industry to enable a resilient and sustainable retail market in future - one where suppliers are not just able to stay in business but can invest and innovate to support customers through the changes Net Zero will involve.   

As a first step on this journey, Energy UK has long called for a more sustainable regulatory and policy environment. As evidenced by the 28 supplier failures since Autumn 2021, there is clearly a need to review whether the right regulatory and financial controls are in place as a sector.  We, therefore, welcome Ofgem’s recently published financial resilience action plan[9] and look forward to working with Ofgem as it seeks to co-develop new stress testing arrangements for energy suppliers. Overall, we recognise and welcome Ofgem’s intention to learn from the ongoing crisis and take urgent action to address any deficiencies in the regulation of the retail market that may have exacerbated the impacts of the crisis on the stability of the market.

Ofgem’s action plan must not, however, simply add new rules to the already extensive supplier licence. Over the past three years Ofgem, via its Supplier Licence Review, has already taken on new powers and introduced a wide range of additional duties on suppliers in relation to their financial health. In light of recent events, it is right to ensure these recently introduced rules remain fit for purpose, but there is also a need for Ofgem to consider its approach in general, and how it is monitoring and enforcing compliance within existing rules and making use of its already extensive powers.

Unfortunately, we recognise the worrying picture painted by Citizens Advice in its ‘Market Meltdown’ report on Ofgem’s approach to the regulation of the energy retail market.[10] Energy UK has long held similar such concerns.

Future of the Default Tariff Cap

Energy UK members hold different views on the principle and design of the current Default Tariff Cap (DTC). We recognise that the DTC has played an important role through winter 2021/22 in helping to insulate millions of domestic consumers from the full brunt of high and volatile wholesale prices.

It is, however, also important to remember the purpose and intent of the DTC. The DTC was introduced to ensure that customers pay a fair price by only allowing suppliers to recover efficiently incurred costs from customers, in response to concern around loyalty penalties. The DTC is not and was not meant to tackle fuel poverty or ensure that energy bills are affordable for customers.

In the short term (for April 2022) this means the cap needs to increase. We believe Ofgem’s primary objective must be to ensure that ensure that the cap from April appropriately reflects efficient supplier costs, and that abnormal costs being incurred due to the current unprecedented wholesale price rises should be recovered before further irreparable damage is done to market stability and competition.

Longer term, we believe there are fundamental structural issues with the current Default Tariff Cap, highlighted by the current market conditions. There are also questions as to whether the underlying objectives of the cap remain correct. There is, therefore, a need for a robust discussion and debate on the potential for more wide-ranging modifications to the GB’s market’s approach to price protection, which should look to address fundamental issues and ensure it remains fit for future market design.

Despite Government’s intention to extend the Default Tariff Cap Act to 2028, we are concerned that there currently appears to be no clear lead on price cap reform, and the roles of Government and Ofgem in relation to one another when it comes to addressing such long-term, structural reform are confused. Collaboration is needed to ensure any price protection is fit for purpose in the current market, as well as in the future. For example, Ofgem is currently exploring actions is can take within the current limits of the Default Tariff Cap Act, however if the optimal fix for the price cap methodology sits outside of Ofgem’s current powers there is a clear need for the Government to lead on overall price cap reform. To date, there has been no indication the Government (via BEIS) is seeking to take on that role.

Market Reform

Energy UK has welcomed BEIS’ intention to refresh its retail energy market strategy and the early opportunity to engage with BEIS through its recent Call for Evidence. We support its decision to take account of the lessons from recent months to ensure that the energy retail market is resilient, sustainable and continues to protect consumers as the whole energy system moves towards Net Zero.

Overall, Energy UK broadly agrees with the vision that BEIS set out in the Strategy, and that at a high level it sets a reasonable foundation on which a future retail market can be successfully built. We, however, had strong concerns that the underlying strategy and the specific policy interventions that BEIS intended to undertake were either unaligned, contradictory or lacking detail/ambition.

For example, its previous proposals to introduce an opt-in switching scheme and trial an opt-out switching scheme were policy interventions that were not fit for the current market, let alone a future market focused on innovation and meeting Net Zero. Instead of continuing the pursuit of increased switching and the proliferation of below cost tariffs to the expense of market sustainability, the Government’s strategy should be geared towards creating a sector that is encouraged through reward to innovate, provide new and better services to customers, and fits in to the wider system’s overall transition to meet Net Zero. Therefore, we welcome and greatly support the decision to put on hold its opt-in/opt-out switching scheme plans. We continue to believe that these proposals should be dropped in their entirety as part of this refresh, and BEIS’ attention should be refocused on developing a framework and policy interventions that are geared towards creating and supporting a sustainable and innovative energy retail market.

Energy UK previously outlined its vision for future retail markets in its 2019 report ‘The Future of Energy: The future retail market and customers’ relationship with it’[11]. In ‘Future of Energy’, Energy UK set out its ambition for “a low carbon energy system that customers see as fair and which delivers excellent service, choice and value for money to all homes and businesses”. The report argues this ambition will entail:

• Maximising competition, investment and innovation to realise the benefits of new technology and data opportunities as the energy system transitions.
• Recognising the successes of the current ‘supplier hub’ model and looking to build on the success of the model.
• Examining the impact of supplier obligations on the future retail market, either through distorting competition or deterring new entrants or innovative offerings.
• Ensuring the regulatory regime evolves to foster innovation, protect customers across converging markets and from harms emerging from new, unregulated services.
• Ensuring customers in vulnerable circumstances can be supported, protected and be viable for market players.
• Ensuring there is no free-riding by market participants or cost burdens falling unduly on specific customer segments.

Building on the Future of Energy’ report we have also previously identified a range of key issues/barriers that we believe any robust retail strategy would need to consider and provide a steer on:

1. What outcomes do you want to see? – e.g. Energy customers and retail markets are likely to be more diversified as consumers make more and different decisions about how they engage and use energy. Customer outcomes are, therefore, also likely to be more differentiated. What is/is perceived as fair?
2. The long-term financial sustainability and investability of the sector – Nearly 50 suppliers have exited the market over the past 3 years, with remaining challenges in profitability for many in the sector. Concerns need to be addressed to ensure enduring and future retail propositions are built on solid financial foundations and that the sector can attract investment needed to innovate and drive the transition to Net Zero. This includes considering the implications of reformed charging regimes and changes designed to influence customer behaviour. Questions remain unanswered about the long-term future of the Default Tariff Cap and the appropriateness of placing such a high level of financial risk upon suppliers on behalf of the rest of the value chain.
3. The appropriate regulatory framework – With the continued transition to a smarter, more flexible energy system there are risks that new innovations and services, designed to benefit customers and reach Net Zero, will either not be captured appropriately by the regulatory framework, or obstructed from coming to market. We have already seen a sharp change in the way many customers engage with their energy, but this is limited by the current rigid framework. A flexible and adaptive regulatory framework is needed that is capable of delivering the Government’s vision for Net Zero, providing consumers and industry with the right price signals, ensuring equal consumer protection when interacting with any market participant, whilst also limiting barriers to competition, investment and innovation.
4. The role of customers and the retail market in achieving Net Zero – Retail energy markets will be at the forefront of enabling customers to decarbonise their homes and transportation and assisting customers with using energy more efficiently. Consideration is needed as to how we support markets in engaging with different customer groups in Net Zero and what support and advice is needed, including for those who don’t want to proactively engage or change behaviours.
5. The roles and responsibilities of industry and Government in supporting customers in vulnerable circumstances – Questions around the provision of support for customers in vulnerable circumstances or fuel poverty are of growing importance, especially when we consider the new challenges being raised by the decarbonisation of heat, or the emergence of new, currently unregulated, business models, services and products. A balance needs to be developed between the responsibilities of industry and the Government in supporting such customers in the future market.

There is a fundamental difference between today’s world and one in which the energy retail market maximises its contribution to net zero. This it that in the net zero world, consumers use – and even generate - electricity in a way that minimises greenhouse gas emissions and minimises the need for grid reinforcement. Such changes would include: (a) shifting consumption – e.g. to periods of high wind; (b) reducing or eliminating consumption; and (c) on-site/in-home production and use of storage. There are a number of preconditions that will enable consumers in the energy retail market to maximise their contributions to Net Zero, and BEIS should ensure that these are also considered within its strategy. These include the successful rollout of smart meters, the successful implementation of market-wide half-hourly settlement (MHHS), and the proliferation of Time of Use tariffs across the market following the implementation of MHHS.

Any refreshed retail market strategy (and subsequent policy development) may stop short of what is needed if it is developed in isolation from the wider energy system. Achieving Net Zero successfully and at the lowest cost to consumers will require changes across the whole energy system.

As a result, the retail market and its future framework should not be seen as a standalone entity. In developing its refreshed strategy, it will be important for BEIS to collaborate with other Government departments and ensure that also it is able to drive necessary change across the energy system as a whole, whether that’s network charging, deployment of electric vehicles and low carbon heating, or the future power market design. The underlying drive of its strategy refresh workstream should be that the retail market and its framework both now and in the future is aligned with the wider system’s drive towards Net Zero.

February 2022