Business Energy Markets 2004

Transcription

1 November 2004 Prepared by: Nigel Cornwall & Robert Buckley Cornwall Consulting

2 Disclaimer While Cornwall Consulting considers that the information and opinions given in this report and all other documentation are sound, all parties must rely upon their own skill and judgement when making use of it. Cornwall Consulting will not assume any liability to anyone for any loss or damage arising out of the provision of this report howsoever caused. The report makes use of information gathered from a variety of sources in the public domain and from confidential research that has not been subject to independent verification. No representation or warranty is given by Cornwall Consulting as to the accuracy or completeness of the information contained in this report. Cornwall Consulting makes no warranties, whether express, implied, or statutory regarding or relating to the contents of this report and specifically disclaims all implied warranties, including, but not limited to, the implied warranties of merchantable quality and fitness for a particular purpose. Cornwall Consulting Heath Farm Cottage Paston North Walsham Norfolk NR28 0SQ Tel: +44 (0) Fax: +44 (0) [email protected] Cornwall Consulting Report for Energywatch 2

3 Report Contents 1. Executive Summary Approach and Methodology Key Findings Recommendations Market Overview Market Context Competition Concepts Wholesale Energy Delivery Taxes and Levies Competitive Business Electricity and Gas Markets Electricity Market Size Market Segmentation - Supply Market Segmentation - Demand Pricing Developments Gas Market Size Market Segmentation - Supply Market Segmentation - Demand Pricing Developments Supply Chain Issues Wholesale Energy Markets Energy Cost Components Electricity Wholesale Costs Supplier Margin Delivery Charges Obligations, Levies and Taxes Metering and Data Charges Gas Wholesale Costs Supplier Margin Transportation Charges Metering Charges Levies and Taxes Energy Cost Breakdown Analysis Supply Contracts Contract Duration Pricing Structures 49 Cornwall Consulting Report for Energywatch 3

4 All Inclusive Pass Through Indexed Arrangements Electricity Contract Pricing Components Non-half Hourly Half Hourly Gas Contract Pricing Components Indexed and Flexible Pricing Contracts Energy Service Contracts Brokers and Agents Brokers Agents Purchasing Methodologies and Contracting The Energy Supply Contracting Process Larger Users Electricity Gas Public Sector Users Smaller Users Out of Contract Arrangements Competitive Market Dynamics Customer Responses Pricing and Competition Levels Price Levels Supplier Responses Service Issues Energywatch Complaint Information Energy Policy and Regulation Development and Direction Department of Trade and Industry Economic Regulation The Gas and Electricity Markets Authority (GEMA) and the Office for Gas and Electricity Markets (Ofgem) The Electricity and Gas Supply Licences Exclusion of Cross Subsidy Meter Reading and Theft of Energy Information Provision to Customers Information Provision to Ofgem and GEMA Gas Transportation Charges Guaranteed Standards and Payments Codes of Practice Deemed Contracts Supplier of Last Resort 85 Cornwall Consulting Report for Energywatch 4

5 Transfer Agreements The Customer Transfer Programme Gas Production Financial Services Regulation Competition Policy Sustainable Development The Carbon Trust Customer Representation Implications for Business Customers Customer and Other Stakeholder Views The View of the Office of Gas and Electricity Markets Other Stakeholder Views Level of Competition and Assessments of Trading Conditions Smaller Customers Larger Customers Smaller and Independent Suppliers Larger and Integrated Suppliers Key Themes Issues which May Inhibit Competitive Dynamics Smaller Customers Larger Customers Smaller and Independent Suppliers Larger and Integrated Suppliers Key Themes Outlook for Competitive Supply Markets Customers Smaller and Independent Suppliers Larger and Integrated Suppliers Key Themes Broker and Agent Conduct Brokers Agents Comment and Conclusions Context Opinion on Supply Competition to Business Customers Level of Competition Supplier Numbers Level of Offers Recommendations Issues that Inhibit Competitive Dynamics Wholesale Markets Market and Regulatory Complexity Recommendations 141 Cornwall Consulting Report for Energywatch 5

6 Prospects for Competition Recommendations Role of Intermediaries Recommendations 144 Appendix A: Energywatch Complaint Codes by Category 145 Appendix B: Text of Letter Seeking Stakeholder Views 146 Appendix C: Respondents to this Review 147 Cornwall Consulting Report for Energywatch 6

7 List of Tables Table 2:1 Market Access Thresholds for Electricity and Gas Supply Competition 14 Table 2:2: Business Energy Consumption, 2003 and Table 2:4: Business Electricity Consumption in Great Britain 20 Table 2:5: Electricity Generating Capacity in Great Britain Table 2:6: Electricity Generating Capacity in England and Wales Table 2:7: Major Suppliers and their Key Acquisitions Summer Table 2:8: Shares of the Business Electricity Market Table 2:9: UK Business Gas Consumption 27 Table 2:10: UK Offshore Gas Production by Field Operator Estimated Annual Figures 28 Table 2:11: Gas Supplier Market Shares by Volume Table 3:1: Profile Types for Non-half Hourly Metered Business Customers 43 Table 4:1: Headline Characteristics of Typical Electricity and Gas Supply Contracts 49 Table 4:2: Summary of Electricity and Gas Contracts to Business Customers 52 Table 5:1: Customer Approaches to Energy Procurement 69 Table 5:2: Overview of Aggregate Data Requested from Energy Advisors 70 Table 5:3: Average Contract Prices Secured by Energy Advisors Table 5:4: Suppliers Approached and Responding to Customer Request for Quotations 72 Table 5:5: Offers Received Average and per Supplier Responding 73 Table 5:6: Trends in Energy Supplier Activity Average Responses to Requests to Tender from Major Advisors 74 Table 5:7: Summary of Complaints Received by Energywatch from Business Customers November 2003 to May Table 5:8: Main Complaint Types Received by Energywatch from Business Customers November 2003 to May Table 7:1: Summary of Ofgem s Business Market Framework Electricity 95 Table 7:2: Summary of Ofgem s Business Market Framework Gas 96 Table 7:3: Summary of Ofgem s Conclusions on Business Markets Electricity 97 Table 7:4: Summary of Ofgem s Conclusions on Business Markets Gas 97 Table 7:5: Summary of Customer Views 99 Cornwall Consulting Report for Energywatch 7

8 Table 7:6: Summary of Supplier Views 100 Table 8:1: Supplier Exits from Competitive Energy Supply Markets 131 Table 8:2: Regulatory Investigations, Processes and Reviews Triggered by Concerns over Wholesale Gas Prices 138 List of Figures Figure 2:1 Electricity and Gas Price Breakdowns Summer Figure 2:2: Trends in Year Ahead Wholesale Gas and Power Prices 2002 to Figure 2:3: Trends in Industrial Electricity Prices Annual Averages 26 Figure 2:4: Trends in Industrial Gas Prices Moving Annual Averages 31 Figure 3:1: Physical and Financial Flows Embodied in Customer Bills 35 Figure 3:2: Overview of the Electricity Supply Infrastructure in Great Britain 38 Figure 3:3: Supply Chain for the Business Gas Markets - Physical and Financial Flows 44 Figure 3:4: Indicative Cost Components of Business Energy Bills 47 Figure 5:1: Overview of Typical Business Procurement Processes 61 Figure 5:2: Example Timeline as Established in the 1990s for a Formal Tendering Process Undertaken by a Larger Energy User 62 Figure 5:3: Complaints Received by Energywatch from Business Customers by Supplier November 2003 to May Figure 6:1: Overview of Ofgem Objectives and Guidance 83 Figure 7:1: Gas Prices Payable by a Major Industrial Company for Sites in Germany and Italy 103 Figure 7:12: Broker Commissions Paid by a Major Supplier on its Electricity Contracts 126 Figure 8:1: Gas Contract Trading Activity 136 Figure 8:2: Indicative Hedging Positions of Major Integrated Electricity and Gas Suppliers 137 Figure 8:3: Key Gas Cost Markers in Price Setting to Major Customers 137 Cornwall Consulting Report for Energywatch 8

9 1. Executive Summary 1.1. Approach and Methodology 1. This is the first analysis of supply competition in business energy markets since the dramatic turnaround in wholesale prices. The report is designed to provide a comprehensive overview of the functioning of these markets from the perspective of the customer as well as capturing the key trends and developments including the October 2004 contracting round and the outlook beyond. The report is not just a factual description of market scale and stakeholder views rather it is also intended to explain options and choices to purchasers. 2. The business energy markets are complex and fast moving. It is very difficult to gain a view across them because: a. there are a series of sub markets, some with strong regional characteristics (for smaller users), though clearer groupings exist around intensive (in the sense of traditional manufacturing and large scale commerce/retail) users and small and medium enterprises; b. little systematic gathering of data is undertaken by official/representative bodies, c. no established means for measuring the extent of competition is readily available; and d. they can be very dynamic, with changes closely linked to wholesale markets and supplier strategies seemingly varying from contract round to round. 3. Nonetheless, with data from two intermediaries, written responses and verbal responses from customers and other market participants, and a series of more detailed interviews and access to Energywatch complaints data, substantive analysis has been undertaken. Energywatch and Cornwall Consulting would like to express their gratitude to all those who contributed to this process. A list of participants is provided at Appendix C. 4. The analysis has taken longer than expected to conclude given the dynamic nature of the markets involved and as suppliers proved much more interested in contributing their views than we expected. Likewise some on the customer side proved more difficult to engage than expected. We would like to express our thanks to all those that participated in our review of stakeholder opinion, particularly to John Hall Associates and EnergyQuote for their provision of the price and offer data analysed in Section 5. Cornwall Consulting Report for Energywatch 9

10 1.2. Key Findings 5. Customers are experiencing very significant price increases driven by much higher prices in wholesale markets: a. prices for annual fixed rate electricity contracts renewed in 2004 are 30% up on levels struck in ; b. prices for annual fixed rate firm gas contracts renewed in 2004 are 40% up on levels in ; c. prices for annual fixed rate interruptible gas contracts renewed in 2004 are 45% up on levels in ; and d. the consistent rise in wholesale energy prices has resulted in many larger customers opting to buy on short-term pricing mechanisms, rather than their to now normal practice of fixed price annual contracts, as a means of limiting cost increases. This involves a fundamental change to energy buying practices which must be understood and prepared for. 6. Supplier activity varies by sector and negotiating round. At the maximum, larger customers may secure 5 to 6 suppliers to quote for their business, although not all will necessarily submit their most competitive rates. Smaller customers participate in a regional market where competition will typically be driven by the interaction between the gas and power incumbents. Here, there is a significant need for more information and better customer understanding. 7. Whilst there are no up to date official figures, it is estimated that at least 90% of the business electricity market is serviced by seven suppliers (six integrated generator/suppliers plus British Energy). The business gas market is also concentrated, but probably to a lesser extent, than the domestic market. 8. Market risk and volatility have increased markedly, particularly following the change in electricity trading arrangements to NETA in Traded commodity markets have been created, but declining liquidity is making pricing more unpredictable and increasing market granularity. 9. Industry data problems are constraining competition. They particularly affect smaller sites (both single and multi-site), to the extent that some customers are deterred from accessing the competitive market. It is also apparent that some users may not be making the most of their positions; decision making processes can be improved, and better awareness of the 1 in delivered terms before VAT 2 in delivered terms before VAT 3 in delivered terms before VAT Cornwall Consulting Report for Energywatch 10

11 importance of prompt payment will also be likely to secure an improvement. 10. Persistent regulatory change in a fixed price environment is not helpful to suppliers and ultimately their customers, especially at the smaller end of the market where such supply terms are much more prevalent and transaction costs can be significant on a per account basis. There is also a perception that the market structure works against small players in that they are unable to provide enough resource to monitor and influence regulatory policy and the resulting market change. 11. Brokers and advisors fulfil a very important role in bringing the benefits of competition to business customers of all sizes, as they tend to be better informed and resourced than the typical individual user. However, there are worrying signs that some can use market complexity to pursue their own agendas at the expense of their customers Recommendations 12. Business energy markets are complex and much can be done to improve the lot of customers in them. Energywatch can play a pivotal role in this. 13. Wholesale market and regulatory developments are critical drivers in the business supply market. Major customers in particular do not trust the wholesale gas market any more and perceive that policy makers in general are not sufficiently aware or interested in their concerns. Energywatch should ensure customer views on these sectors are well represented to policy makers, including their current desire for a Competition Commission investigation into the sector. 14. In order to improve policy making, there is a need for much more structured and routine information gathering. This should enable clear market segmentation and measurement of competition. In particular we believe national market measurement of competition is not appropriate for the smaller user sectors. Customers will benefit from these changes, and Energywatch should encourage Ofgem and DTI to take action in this area as well as considering whether wider distribution of its own data on complaint would be helpful. 15. In addressing the business market, Energywatch should recognise different customer needs: a. practical assistance to make the best of market conditions; and b. appropriate customer championing in policy fora. 16. Practical assistance includes the provision of better information, its delivery to customers who can utilise it, and the monitoring of general market conditions. Customer championing includes representing to policy makers the interests of business customers, monitoring policy Cornwall Consulting Report for Energywatch 11

12 developments, and informing business customers of their implications. This sectoral good role would seem particularly valuable for medium and non-energy intensive larger users to bring focus to an area where there are currently disparate lobbying channels. It would require a formal mechanism to ensure proper engagement with customers, for example, through the establishment of a business user panel and regular stakeholder briefings. 17. Active consideration should be given to whether customer use of brokerage services can be improved through, for example, an Energywatch-sponsored code of practice. Its intent should be to raise the standard of service offered by all brokers in the market. Cornwall Consulting November 2004 Cornwall Consulting Report for Energywatch 12

13 2. Market Overview As well as being a major feature of the UK economy in its own right, Britain s competitive energy supply industry is essential to the well being of UK business. In 2003, business customers in the United Kingdom spent 9.9 billion on their electricity and gas. That this figure was 10% lower than four years before - despite the introduction of an energy tax 4 which raised in excess 5 of 800 million that year - suggests that they have benefited substantially from competition in the supply of these fuels. However, wholesale energy markets have turned sharply upwards since early Likewise, climate change has emerged to become a key driver of energy policy. This Section presents a headline survey of the British electricity and gas markets from the perspective of the business customer. It is designed to illustrate the role of the business energy customer within the competitive energy markets and the suppliers who serve them. By showing the scale of business electricity and gas requirements defined for the purposes of this analysis as all final use for non-domestic and non-power generation purposes it is intended to demonstrate the importance of the market in supplying them. It also aims to set the scene for later sections of the report, including a survey of recent pricing developments Market Context Today, some 28.4 million 6 electricity and 20.9 million 7 gas customers can participate in competitive energy markets in Great Britain. Of these customers, some 2.2 million are business electricity users 8 and 403,000 9 are business gas users. These markets have evolved since the mid 1980s, often requiring support from policy makers to ensure their successful development. The process of deregulating supply effectively started with the privatisation of the former British Gas Board in The new British Gas plc started life with a legal monopoly serving smaller customers (with demands of less than 732 MWh/25,000 therms a year) and, in effect, a monopoly to larger users despite an erosion of the franchises to 73MWh in The slow progress, in terms of entry 4 The Climate Change Levy (CCL) was introduced from 1 April See Section and Source: Digest of United Kingdom Energy Statistics 2004 Department of Trade and Industry 6 Source: 2002 figures, Digest of United Kingdom Energy Statistics 2004 Department of Trade and Industry 7 Source: 2002 figures, Energy Trends December 2003 Department of Trade and Industry 8 Source: Cornwall Consulting estimate 9 Source: 2002 figures, Energy Trends December 2003 Department of Trade and Industry

14 of new suppliers, prompted various regulatory interventions, including investigations by the Monopolies and Mergers Commission and the Office of Fair Trading, and the company was forced to relinquish market share and release previously contracted wholesale supplies to potential competitors. Ultimately, in 1997, British Gas plc, responding to political and regulatory pressure, broke itself up by splitting the monopoly pipeline and competitive supply businesses which now operate separately as part of National Grid Transco plc and Centrica plc respectively. In parallel, phased removal of the remaining franchise occurred from 1996 to Table 2:1 lists key eligibility thresholds in electricity and gas supply. Table 2:1 Market Access Thresholds for Electricity and Gas Supply Competition Electricity April 1990 over 1 MW qualifying maximum demand April 1994 over 100 kw qualifying maximum demand April 1998 to 1999 all users Gas 1986 over 732MWh annual consumption August 1992 over 73MWh annual consumption 1996 to 1998 all users Electricity privatisation was accompanied by parallel moves to create competition in both the wholesale generation function and supply activities. The first power wholesale market, the Pool, commenced operations from 1 April 1990, when the nation s 5,000 largest users simultaneously gained the right to negotiate a competitive electricity supply contract. This process proceeded with a pre-specified timetable for further market opening, and culminated in a fully open electricity supply market being in place by the turn of the decade. Larger customers, therefore, now have considerable experience of competitive energy supply. Liberalisation has also occurred elsewhere, most notably via the European Union s directives to open electricity and gas markets to competition. 10 For smaller users, markets have not been open as long and competition is not as well established. This distinction is important in that it underlines how business customer issues and needs differ according to customer characteristics. 10 The EU initiative to stimulate electricity supply competition has resulted in two Directives of the European Parliament and of the Council of Ministers concerning common rules for the internal market in electricity. The first, Directive 96/92/EC, was passed in 1996, to be superseded by Directive 2003/54/EC of 26 June In gas, two similar Directives have also resulted: 98/30/EC and 2003/55/EC. Cornwall Consulting Report for Energywatch 14

15 2.2. Competition Concepts Irrespective of how a competitive offer to supply electricity or gas to a business customer is presented, in preparing it, suppliers will assess separately the different costs in the supply chain, namely: energy costs (including wholesale costs, the supplier s costs of servicing the customer, and its margin); charges for using the delivery networks, from production facility to the customer s meter; and taxes and levies. Suppliers secure wholesale energy supplies to match the customer s requirements from competitive traded markets. They will also assess their costs in servicing the account and then factor in a profit margin. In the business sector, they tend to present their offers either as tailored arrangements specifically for larger customers, or as standardised products for smaller users. A breakdown of typical supply costs to smaller and larger users for electricity and gas is shown in Figure 2:1. Figure 2:1 Electricity and Gas Price Breakdowns Summer 2004 Gas - small user Gas - large user Electricity - small user Electricity - large user Energy Delivery Taxes Source: Cornwall Consulting p/kwh Notes on Figure 2:1: Prices breakdowns are Cornwall Consulting assessments intended to be representative of typical prices in Great Britain. They are shown exclusive of VAT for one year s supply for arrangements struck during August 2004 and commencing 1 October 2004 based on delivery charges and taxes current at that date. It is assumed that the large user is entitled to an 80% abatement in the climate change levy as a signatory of a climate change agreement. The Table below shows user definitions. User Billing Annual MWh Max Demand Load Factor Grid Connection Electricity - small user Quarter % Low voltage network Electricity - large user Month 7,884 1,500 60% High voltage network Gas - small user Quarter % n/a Gas - large user Month 14, % n/a Max demand data is shown hourly for electricity (in kw) and daily for gas in (MWh) Cornwall Consulting Report for Energywatch 15

16 From the customer s point of view, an understanding of this cost chain can help significantly in determining the competitiveness of offer prices received. Many business energy customers find it useful to derive a cost expectation before they approach the competitive market, so they can set a realistic view of potential opportunities. The following paragraphs provide a more detailed overview of the different components of the energy supply chain Wholesale Energy The strength of a supplier s position in the competitive market for business customers is determined by its trading skill as much as its own business aspirations. Energy is traded by a multiplicity of means at the wholesale level. There are formal energy exchanges that have been established, typically, for shorter-term trades. Participants can also contract direct with producers and sometimes choose to do so for larger volume, longer-term requirements. Since the start of 2003, there have been rapid increases in wholesale electricity and gas prices, which have been passed through to final customers, as Figure 2:2 shows. The figure plots trends in the year-ahead baseload contract, which is a critical measure from a business customer s point of view, as it provides for the delivery of the same amount of energy every day of the year. The rises it shows marked the end of a two-year period where wholesale power prices had fallen to such an extent that customers were able to make substantial savings, even despite the introduction of the Climate Change Levy. Important factors that have been attributed by some analysts as being behind the surge in wholesale power prices include the steep rises in traded gas and coal prices. Increases in the wholesale gas price, also shown at Figure 2:2, have been attributed to factors including the resurgent world oil market. The link between gas and electricity prices is recognised because of the importance of gas in the British power generation mix 11. Oil is an important driver of gas prices because it determines gas contract prices in continental Europe. The interconnector pipeline from Bacton in Norfolk to Zeebrugge in Belgium has, since 1998, provided the opportunity for British gas to be traded in other European markets, and the corresponding possibility for gas to be imported. 11 According to DTI figures, in 2003, 21 GW (35%) of the 60.3 GW of generating capacity installed in England and Wales was combined cycle gas turbine. Cornwall Consulting Report for Energywatch 16

17 Figure 2:2: Trends in Year Ahead Wholesale Gas and Power Prices 2002 to 2004 Elec (p/kwh) Gas (p/kwh) Jan-02 May-02 Sep-02 Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Electricity Gas Source: Data from Platts, conversions to p/kwh by Cornwall Consulting Aside from trends in related fuel markets, gas and electricity wholesale markets can be influenced by: short-term difficulties at production facilities (e.g. power stations or offshore gas fields); technical difficulties, constraining bulk energy flows (e.g. an outage in interconnection facilities restricting cross-border trade); weather, triggering unexpected demand conditions either in Britain or elsewhere through interconnections with north-west Europe; perceptions of the longer-term demand and supply balances; actions by producers to invest in, or close, capacity; the actions of traders, funds and other market participants; and changes in government or regulatory policy Delivery It has already been noted that competition is established in supplying customers and also in wholesale energy production. The delivery of energy to Cornwall Consulting Report for Energywatch 17

18 the meter is, however, not competitive, as it is felt that this would mean the duplication of wires and pipeline assets which would be both economically and environmentally undesirable. Therefore, a number of companies operate monopoly services moving energy around the country. In England and Wales they include National Grid Transco (NGT), which operates the high voltage electricity transmission system akin to the motorway network and the national gas grid. When the British Electricity Transmission and Trading Arrangements are implemented from April 2005, NGT will become the operator, but not the owner, of the transmission network in Scotland. Additionally, there are 12 regional electricity distribution networks in England and Wales and a further two north of the border operated by various different companies. North of the border, the distribution and transmission networks are owned by two regional companies. NGT owns and operates the British gas network. There are presently plans under consideration to allow restructuring and sale of four of the local gas distribution networks 12 owned by NGT. Network use in the UK is provided on an open access basis. The network owners cannot deny any reasonable request for access and must comply on fair and transparent terms. The charges the companies levy are published and consistent for all suppliers. They are designed to reflect the costs they incur in shipping the energy for each customer through their networks. They are set according to published tariffs which are regulated by the Office of Gas and Electricity Markets (Ofgem), the industry regulator Taxes and Levies Electricity and gas consumption by business users attracts various taxes and levies including value added tax (VAT), the Climate Change Levy and the costs of the Renewables Obligation. Typically, they will be separately itemised on the bill, and further information is provided on them in Sections and At the end of August 2004, NGT National Grid Transco announced the sale, subject to final regulatory approval, of four of its regional gas distribution networks for a total cash consideration of 5.8 billion. The four networks are: the North of England distribution network, to be purchased for 1.4 billion by a consortium headed by Cheung Kong Infrastructure Holdings, and including United Utilities; the South of England and Scottish distribution networks, to be purchased for 3.2 billion by a consortium 50% of which is owned by Scottish and Southern Energy; and the Wales and West distribution network, to be purchased for 1.2 billion by a consortium led by Australia's Macquarrie Bank. Cornwall Consulting Report for Energywatch 18

19 2.3. Competitive Business Electricity and Gas Markets Business electricity and gas markets were the first to see supply competition. Despite the extension of choice to householders, they remain a very important sector of the market. As Table 2:2 shows, two in every three kilowatt hours (kwh) of electricity consumed in the United Kingdom are used by a business customer 13. In gas excluding power station use this ratio is a still significant four in ten. Table 2:2: Business Energy Consumption, 2003 and 1990 (Million Tonnes of Oil Equivalent) Change (%) Business as % Total (2003) Electricity Gas Oil Coal Other sources Total Source: heat supplied basis data from DTI Digest of UK Energy Statistics. Calculations by Cornwall Consulting. Other sources include coke and breeze, other solid fuels, oven gas, heat sold and renewables. Both gas and electricity demand from business users have increased since The majority of this increase has arisen in the commercial and public sectors and, for electricity in particular, whilst demand from heavy industry has declined, reflecting long-term economic structural change Electricity Market Size There are around 2.2 million business electricity customers in Great Britain, ranging in scale from small businesses spending hundreds of pounds a year, to major industrial and retail accounts whose account values range in the tens of millions of pounds. Their needs are met by a supply side which has seen very 13 in this analysis business energy requirements are defined as all final use of electricity and gas for energy purposes (i.e. non-feedstock) which is not attributable to the domestic sector. Cornwall Consulting Report for Energywatch 19

20 significant consolidation, particularly around the time of the change in wholesale trading arrangements (from the Pool to the New Electricity Trading Arrangements or NETA ) in April This supply consolidation has been paralleled by vertical integration with generation, a sector itself now subject to horizontal consolidation, as independent operators withdraw from the market. These developments have also been occurring across Europe s energy markets. Table 2:3 provides estimates of the scale of the business electricity market in Great Britain. Table 2:3: Business Electricity Consumption in Great Britain Number of Meters Consumption (TWh) Spend ( bn) All 2,200, Of which half hourly metered c 100, Non half hourly metered 2,100, Source: Cornwall Consulting estimates based on DTI and Electricity Association data. By volume, DTI figures attribute 50% of the business market to the industrial sector, 35% to the commercial sector, and 9% to the public sector, with the balance from transport, agriculture and other uses. Half hourly metering was a requirement for larger users to switch in the first two phases of market opening, and remains obligatory for over 100kW users. It is also an option for smaller users whose requirements have been pursued in cases where the customer believes the extra cost will be paid back by enabling it to access a more competitive supply arrangement. The electricity to meet customer requirements is mainly produced from 68.4GW of generating capacity located in Great Britain. As Table 2:4 shows, the dominant capacities installed are fired by coal, gas or nuclear energy. Two interconnectors, of 2 GW capacity, link Scotland with England and Wales, and France with England and Wales. Both typically have acted to provide power into England and Wales. Cornwall Consulting Report for Energywatch 20

21 Table 2:4: Electricity Generating Capacity in Great Britain 2002 GW Great Scotland Wales England GB (%) Britain Conventional steam: % Of which: Coal fired % Oil fired % Mixed or dual fired % Combined cycle gas turbine % Nuclear % Gas turbines and oil engines % Hydro natural flow % Pumped storage % Renewables other than hydro % Total % Source: Department of Trade and Industry Generating capacity in England and Wales is owned by more than 20 companies, but more than half is now in the hands of six major integrated energy retailers as Table 2.5 shows Market Segmentation - Supply Supply of electricity to customers, both domestic and business, sits mainly in the hands of six integrated operators which also have a significant presence in the generation market. These companies have built their positions through competing for custom and, perhaps more importantly, acquiring rivals. The first years of the liberalised regime saw 12 regional electricity companies undertaking both local distribution and supply activities in England and Wales, which included dealings in the competitive sector with business users. As Table 2:6 shows, most of these regional suppliers were acquired by their new owners during the period 2000 to Some of the new owners trade using these brand names, while others have adopted new identities. This consolidation has been cited by some customers as the factor behind the perception that there has been a lessening in competition to service their requirements since Cornwall Consulting Report for Energywatch 21

22 Table 2:5: Electricity Generating Capacity in England and Wales 2004 (GW) Nuclear Oil Coal CCGT Other Total Centrica RWE/npower E.ON/Powergen EdF Energy Scottish and Southern Scottish Power British Energy Magnox Others Total Share held by major retailers % 92.3% 64.1% 55.6% 59.2% 53.1% Source: Cornwall Consulting analysis of National Grid figures The six integrated operators supply the vast majority of domestic customers (99% 15 ) and also have significant positions in the business electricity market. British Energy, the nuclear generator, is the only other operator with a significant presence in the business power market (with more than 2% market share by volume) since the early summer 2004 exit of Atlantic Electric and Gas. Ofgem s figures, in Table 2:7, quoted from its 2003 review of non-domestic competition, show that, at that time, the aggregate share of the top six suppliers in the business electricity market was 91%. Since these figures were produced, there have been three further key developments in the business power market: on 24 June 2003 Maverick Energy was placed in to administrative receivership and its supply contracts were assumed by Atlantic Electric and Gas; in Autumn 2003, UK Electric Power announced that it would not be seeking new electricity customers; and 14 major retailers defined as Centrica, RWE/Innogy, E.ON/Powergen, EdF Energy, Scottish and Southern Energy and Scottish Power 15 Source: Domestic Competitive Market Review 2004, a review document, Ofgem, April 2004 Cornwall Consulting Report for Energywatch 22

23 on 28 April 2004, Scottish and Southern Energy (SSE) acquired the contracts of Atlantic Electric and Gas from that company s administrator. In its May consultation on the SSE/Atlantic acquisition, Ofgem noted that, after this change, there would be 13 suppliers active in what it defines as the small non-domestic market (for requirements up to 200 MWh), of which eight have a market share in excess of 0.5%, and 9 in the medium non-domestic market (for requirements from 200MWh to 30GWh), of which seven have a market share in excess of 0.5% Market Segmentation - Demand Customers have different requirements for the electricity they use and, therefore, different needs for the services they demand of their suppliers. They act to segment the electricity market in the sense that they are served by different offerings and delivery channels by suppliers. Smaller customers tend to be targeted by suppliers with standard regionalised products reflecting the different grid access charges between regions and usage profiles. Larger customers will attract site specific offerings based on their usage and individual negotiation. In a fragmented market, with many different customer groupings, there are three discernible sub sectors: small users, mainly quarterly billed (and with non-half hourly metered requirements), of up to 50 MWh annual consumption; medium users, monthly billed requirements (the larger of which will be half hourly metered) ranging from 50 MWh to 10 GWh; and a large intensive user sector of 10 GWh annual consumption or more. The first and third in the list are more clearly definable, both from the customer point of view, and in the way suppliers deal with them. The number of sites owned by a customer also has a bearing; some multi-site users have commented to us that they face particular difficulties in securing competitive supply arrangements due to the administrative complexity which suppliers face in providing quotes and administering their accounts. Depending on the purchase volume, this complexity can become an issue when meter numbers attaching to a contract increase over 20. The ownership structure of their organisation can influence the way customers approach the competitive electricity market. A clearly defined set of EU rules governs public sector, and some private utility, dealings, whereas larger listed private organisations are more likely to establish a dedicated energy procurement and management responsibility than smaller private companies. Cornwall Consulting Report for Energywatch 23

24 Table 2:6: Major Suppliers and their Key Acquisitions Summer 2004 Supplier Trading names Key acquisitions (date) in business market Centrica British Gas, Electricity Direct (2002), Enron Direct Scottish Gas (2001) Scottish Power Scottish Power, Manweb (1995) Manweb Scottish and Scottish and Scottish Hydro and Southern Electric Southern Southern merge 1998, SWALEC (2000), Atlantic Energy Energy, Electric and Gas (April 2004) SWALEC, Southern Electric, Hydro Electric EdF Energy EdF Energy, London Electricity (1998), South Western London Energy, Electricity (1999), SEEBOARD (2002) SEEBOARD, SWEB E.ON E.ON Energy, Powergen (incl. East Midlands) (2001- Powergen 02), TXU Energy (owner of Eastern, NORWEB) (2002) RWE npower npower (incl. National Power, Northern, Yorkshire, Midlands) (2002) Source: Cornwall Consulting research. Table 2:7: Shares of the Business Electricity Market All market Electricity Gas Aggregated share of top 3 64% 49% Aggregated share of top 6 91% 81% Other suppliers 9% 19% Source: Ofgem review of non-domestic competition 2003 Cornwall Consulting Report for Energywatch 24

25 Several suppliers have shared with us their organisational structures which reflect their segmentation of the market. A number pointed out to us that they did not participate across the market as whole. Key points that emerge from these approaches include: smaller, non-half hourly metered, business customers: o tend to be served by standardised regional products administered from national call centres; o are sometimes targeted with combined dual fuel (electricity and gas) propositions; and o sales agents are a key channel to market for smaller customers. large, intensive users: o tend to buy their electricity in a separate process from their gas o attract tailored, fixed period, supply arrangements with some degree of flexibility in terms of supply; and o are managed by supplier key account managers either directly or indirectly through brokers. The customer group we have described as medium is served by suppliers in more varied ways. There is a tendency for larger users in this group to be served in the same way as the intensive users noted above and, similarly, there is a tendency for smaller users in this group to be served in the same way as the small user group. We have used this understanding of the market segmentation in our analysis, most notably in our review of contract pricing and supplier activity contained in Section Pricing Developments Competition in electricity supply has altered the way customers transact for their power. The prices they have paid have varied significantly since the start of the liberalised regime in As Figure 2:3 shows, following initial falls when competition started in 1990, large user prices increased through to the middle of the decade before beginning a long period of decline ending in These price falls occurred because of a variety of factors, including: the tightening of distribution and transmission pricing controls by the regulator, producing notable cost reductions in 1995, 1996 and 2000; the phased reduction of the fossil fuel levy in England and Wales from a maximum of 11% in to 0% today; and Cornwall Consulting Report for Energywatch 25

26 a 40% decline in wholesale power prices following the introduction of NETA in However, wholesale power prices have surged since early 2003, and this development has had a substantial impact on end-user prices. The rates shown in Figure 2:3 exclude the Climate Change Levy (CCL). Adding the CCL s 0.43 p/kwh to rates recorded for the first quarter of 2004 would increase the larger user price level from 2.64 p/kwh, as shown in the figure, to 3.07 p/kwh, which is a price level similar to that current in the year Moreover, the full extent of the wholesale price surge is not shown on the DTI data series as new, much higher priced, contracts are yet to be incorporated in it. Figure 2:3: Trends in Industrial Electricity Prices Annual Averages p/kwh Q1 92Q1 94Q1 96Q1 98Q1 00Q1 02Q1 04Q1 Small Medium Large Source: nominal price data from DTI Quarterly Energy Prices, calculations by Cornwall Consulting. Figures exclude the climate change levy. Cornwall Consulting Report for Energywatch 26

27 Gas Market Size There are around 400,000 business gas meter points in Great Britain 16. Typical spend levels for gas are lower than electricity, reflecting its lower unit costs, but again there is a wide range, from small users spending a few hundred of pounds a year, to major industrial customers and combined heat and power plant operators. Gas suppliers are drawn typically from three types of background: upstream oil and gas producers; electricity retailers; and independent and trading operators. As with electricity, there has been consolidation within the sector. Many of the expanded electricity businesses also have gas supply operations. There also continues to be market entry and exit by other participants, reflecting their commercial priorities. Table 2:8 provides estimates of the scale of the business gas market in Great Britain. Table 2:8: UK Business Gas Consumption Number of Meters Consumption (TWh) Spend ( bn) All 403, Of which firm 401, Interruptible and large loads 2, Source: Cornwall Consulting estimates based on DTI and National Grid Transco data. DTI figures attribute 63% of the business market by volume to the industrial sector, with the balance to other users, including commercial and the public sector. The long-term trend has been for British gas demand to be met from indigenous offshore North Sea fields. DTI s estimate of UK gas reserves at the close of 2003 was 905 billion cubic metres Source: Transco 17 Of this figure, 590 bcm is rated proven and the balance probable. Further possible resources are estimate to be a maximum 336 bcm. Gas consumed in Great Britain in 2003 amounted to 127 bcm. Cornwall Consulting Report for Energywatch 27

28 These are mainly located in the North Sea from where they are brought ashore through four offshore pipeline systems to beach-head terminals for processing and delivery into the onshore gas transportation network. Key producing fields include Bruce, Britannia, the Brae fields, Brent and Elgin. Additionally, the Irish Sea contains the large Morecambe (North and South) and Hamilton fields. Table 2:9 outlines UK offshore gas production by major field operator over the twelve-month period ending May Note that it is common for fields to be in joint ownership and be operated by the largest shareholder. Four of the leading five operators, on this measure, are also participants in the business gas market. Table 2:9: UK Offshore Gas Production by Field Operator Estimated Annual Figures Field Operator TWh Equivalent Share (%) Shell % BP % Conocophillips % Centrica % Totalfinaelf % Marathon % BG % Exxonmobil % Next 10 largest % Remaining % Total 1, % Source: base data from DTI UK Production Data Release 1/9/4, further assessment, calculation and aggregation by Cornwall Consulting. A combination of rising demand and resource depletion is expected to make the UK a net importer of gas in the very near future. This transition marks a major challenge for all those involved in the UK gas supply chain. As UK gas production declines, imports will be required to meet an expected supply gap. Various initiatives have been put forward to bridge this gap, including new pipeline, interconnection and liquefied natural gas projects. Cornwall Consulting Report for Energywatch 28

29 Market Segmentation - Supply Business Energy Markets 2004 It has already been noted that a number of the major producers have a direct presence in the market supplying business customers. Ofgem figures show that the aggregate share of the top six suppliers in the business gas market was 81% in Table 2:10 provides further information and reveals that more suppliers are active in the gas market than in the power market. Table 2:10: Gas Supplier Market Shares by Volume 2003 Volume band (consumption by meter) Market share < 50,000 therms >-50,000 therms Interruptible Over 15% British Gas, Powergen/TXU Powergen/TXU, TotalfinaElf BP Gas, Gaz de France Energy 10% to 15% TotalfinaElf Gaz de France Energy Powergen/TXU, Shell, Statoil, TotalfinaElf 5% to 10% Shell BP Gas, British Gas, Shell, Statoil Up to 5% 21 operators 12 operators 8 operators Source: summary of Ofgem figures Since these figures were produced, there has been one key development. In October 2004, it was reported that BP Gas intended to withdraw from the market serving metered gas users by not renewing established contracts Market Segmentation - Demand The vast majority of business gas customers secure their gas on firm, permanent supply contracts. Larger users consuming more than 5.8GWh (200,000 therms) per year can opt for an interruptible rather than fixed, firm, supply arrangements. Such contracts provide for supplies to be cut to customers on pre-agreed notice. In return, a price discount is available compared with the equivalent firm supply. Interruption is useful for load balancing by both the pipeline operator and the gas supplier. The Competition Commission 18 Source: Review of competition in the non-domestic gas and electricity supply sectors - Initial findings, Ofgem, July See Section 7.1 for further information Cornwall Consulting Report for Energywatch 29

30 commented in that the bulk (over 90 per cent by gas volume) of interruptible contracts provided only for interruption by the pipeline operator, and did not give the supplier the right to interrupt on commercial grounds. The firm/interruptible split is a key factor in the business gas market. As in electricity, there is a scale differentiator as well. Even five years or so after the last phase of market opening, this tends to reflect the last access threshold of 73MWh, with an intensive sector recognised from 10GWh or so annual consumption, and a medium customer group in between. As in electricity, customer ownership and meters accruing to the account are also key factors Pricing Developments Gas prices have cycled significantly since the start of the liberalised regime in 1990, reaching a trough in the mid 1990s and rebounding from 2000, as Figure 2:4 shows. Key price drivers include: a collapse in wholesale gas prices in the Spring of 1995, which saw them halve in a matter of weeks, and provided a major stimulus to supply competition; tighter price controls on transportation charges which lower pipeline costs; and the linkage to continental wholesale gas prices resulting from the physical connection of the British gas market to the north-west European market via the opening of the interconnector to Zeebrugge from the autumn of This resulted in oil prices becoming much more important in British wholesale gas pricing due to their importance in determining continental wholesale gas prices. The first impact of this link was to force wholesale gas prices lower, but particularly since 2003 they have been attributed as a factor behind very substantial price increases. 19 As part of its review of the Centrica acquisition of the gas storage assets owned by Dynegy. Cornwall Consulting Report for Energywatch 30

31 Figure 2:4: Trends in Industrial Gas Prices Moving Annual Averages p/kwh Q1 92Q1 94Q1 96Q1 98Q1 00Q1 02Q1 04Q1 Small Medium Large Source: nominal price data from DTI Quarterly Energy Prices, calculations by Cornwall Consulting. Figures exclude the climate change levy. Cornwall Consulting Report for Energywatch 31

32 3. Supply Chain Issues This Section provides an overview of the supply chains serving business electricity and gas customers. It covers the following aspects: an overview of supply market structures, to give the necessary background to assess business energy customers supply costs; the key cost components of customers energy bills, looking first at electricity, and then at gas; the key features of supply contracts struck in both the electricity and gas markets; and the role of brokers and agents in the business energy market. The overview is intended to provide readers, including customers, with an understanding of how electricity and gas prices are constructed, and comments on how suppliers source their requirements. In so doing, it also highlights many issues in the electricity and gas markets which are addressed in later Sections, especially with regard to the way they may impact customer activities Wholesale Energy Markets In the years since liberalisation, the wholesale electricity and gas markets have evolved towards operating as traded commodity markets 20. Suppliers in both markets are incentivised through market rules to ensure that their wholesale supply / demand positions are in balance. Longer-term trading on a contract basis is significant. Shorter-term OTC 21 and screen-based forward 22 and futures 23 trading markets have developed. The combination of these markets means that both fuels can be traded for future positions, with timescales ranging from within day to several years ahead. In each market, a balancing mechanism run 20 Wholesale electricity trading in Scotland is undertaken on the basis of a regime of administered prices linked to rates in England and Wales. This situation will continue until the introduction of the British Electricity Transmission and Trading Arrangements (BETTA) scheduled for 1 April OTC over the counter trades are negotiated directly, according to standard terms, between buyers and sellers, many with the active involvement of a broker. 22 A forward contract is a cash market transaction in which a seller agrees to deliver a specific cash commodity to a buyer at some point in the future. Unlike futures contracts (which occur through a clearing firm), forward contracts are privately negotiated and are not standardised. The two parties must also bear each other s credit risk. 23 A futures contract is a standardised transferable, exchange-traded contract that requires delivery of a commodity at a specified price on a specified date in the future. Cornwall Consulting Report for Energywatch 32

33 by the grid operator is used to ensure that the many trading positions taken at any one time translate to gas and power flowing through to customers. National Grid Transco (NGT) is responsible for ensuring that the national electricity transmission network in England and Wales is in balance for each half hour, and uses the Balancing Mechanism 24 to fulfil this function, accepting offers and bids for electricity to enable it to balance energy supply and demand across the system. An imbalance settlement process redistributes the cost of any extra power required on the system (or costs for reducing the power on the system) to those generators/suppliers identified as out of balance, by comparing reported contract positions with outturn data. In addition, balancing services use of system (BSUoS) charges are levied by NGT across all generators and suppliers. BSUoS charges are set on a half hourly basis, and recover NGT s costs in keeping the grid in balance, and adhering to technical and safety parameters. These charges are incorporated into energy customers wholesale power costs. In Scotland, the two transmission network owners currently fulfil these balancing functions, although the implementation of BETTA, scheduled for 1 April 2005, will extend the England and Wales trading arrangements, including those mechanisms, to Scotland. The wholesale gas market already operates on a Great Britain-wide basis. As well as long-term bilateral contracting of gas, OTC and OCM 25 (On the Day Commodity Markets) have developed. Shippers, which are licensed to contract to move gas through the transportation pipes, have responsibility for ensuring that they input enough gas to meet their offtake requirements. Their exposure to gas balancing charges is just as important an issue as in electricity, as there can be substantial movements in intra-day traded gas prices. The rules and administrative systems for maintaining both gas and electricity system balancing are complex. In electricity, the process is managed through the Balancing and Settlement Code (BSC) and, in gas, through the Network Code. A variety of parties provide administrative and systems operational services in support of the balancing and settlement processes in both electricity and gas markets. 24 The transmission system operator (TSO) is responsible for managing the transmission network and, in so doing, may anticipate that more energy will be generated than consumed, or vice versa. Unchecked, this would result in system frequency falling or rising to an unacceptable degree. The balancing mechanism provides a means by which the TSO can buy or sell additional energy close to real time to maintain energy balance, and also to deal with other operational constraints on the network. The cash-out or imbalance prices System Buy Price (SBP) and System Sell Price (SSP) applied to imbalances are derived largely as the weighted average prices of these accepted balancing mechanism offers and bids. 25 The on-the-day gas commodity market (OCM) provides a real-time 24 hours a day facility to buy and sell within-day and day-ahead gas at the National Balancing Point (NBP), as well as providing real-time system prices. The OCM is anonymous and fully cleared and allows gas shippers to trade with Transco and each other for short-term within-day gas balancing. Trades conducted on the OCM are used in the calculation of three key prices for the gas trading arrangements, namely the average price SAP, and the marginal prices SMP Buy and SMP Sell. Cornwall Consulting Report for Energywatch 33

34 3.2. Energy Cost Components Business customers charges for electricity and gas consist of a number of cost elements reflecting the separate functions involved from producing the energy to delivering it to its point of use. These different cost components can be categorised into three broad areas: the cost of the energy; the cost of delivering the energy to the customer and associated metering; and applicable duties, taxes or similar. The cost of the energy encompasses the wholesale cost of the power, as well as suppliers fees for balancing, risk and margin. Whilst competition has been introduced into the generation / production and supply sides of the energy markets, the costs associated with transporting and delivering it remain regulated. Ofgem regulates these charges, generally through five-year price control cycles. In recent years, the government has also introduced a number of new environment-related levies and policies, which have added to business customers energy costs. The following paragraphs outline the cost chain for each fuel in more detail Electricity Figure 3:1 illustrates, in simplified form, financial and physical flows in the business electricity market. The solid arrows highlight physical flows of power from generator to meter and the dashed arrows show financial flows. It is worth noting that, given the integrated nature of the physical infrastructure, and given the power flows do not follow contractual paths, it is not possible to trace actual power flows from a particular power station to an individual customer. Both the generation and supply markets are open to competition and customers secure their physical supplies of electricity from a licensed supplier. The operating licences set out conditions that must be followed in conducting business. Amongst the obligations borne by suppliers is a requirement to abide by the terms of the BSC. Cornwall Consulting Report for Energywatch 34

35 Figure 3:1: Physical and Financial Flows Embodied in Customer Bills G e n e r a t o r T rader T ransm ission S u p p l i e r D istrib u tio n D a t a / M e t e r i n g C u s t o m e r Green denotes regulated cost elements Yellow denotes competitive cost elements Source: Cornwall Consulting research Suppliers have a range of options in sourcing their power requirements. They can purchase, for example, from a generator, from another supplier, or from the power exchange (these issues are discussed further in Section 4). It is also possible for customers to become signatories to the BSC. In return for accepting the associated compliance costs, they are able to access financial and physical market participants directly, without the need for a licensed supplier to act as an intermediary. The vast majority of customers who draw power from the public network contract with a licensed supplier for their requirements. Their bills are based on charges that the supplier passes on to the customer, including: the wholesale cost of the electricity; the supplier s margin and administration / management costs to cover elements such as balancing risk and billing; the cost of delivering the electricity, consisting of regulated charges which typically comprise: o transmission network use of system charges (TNUoS), o distribution use of system charges (DUoS), and o losses incurred in delivering the power across the transmission and distribution networks; metering and data charges; and Cornwall Consulting Report for Energywatch 35

36 obligations, taxes and levies. Business Energy Markets 2004 The exact level of prices will depend on the interaction of these different factors, and an assessment of their relative importance is provided in Section 3.3. During the mid 1990s, tighter price controls cut regulated transmission and distribution charges. More recently, new environmental levies and obligations have combined with higher wholesale prices to force delivered electricity prices very sharply higher. There is a very wide range of ways in which suppliers present their offer prices to customers. They range from single rate and standard time of day tariff structures, similar to those used in the household sector, to very complex arrangements where the energy element of prices is directly indexed to rates in the wholesale market. More detailed consideration is given to each element of the cost chain below Wholesale Costs The wholesale cost in the price to an individual customer is usually driven by that user s load profile. It can be thought of as the cost for generating electricity to its requirements at a power station. Generally speaking, in business customers supply contracts where the individual cost components are billed separately, the wholesale cost of power also includes the generator s, and often also the supplier s, share of transmission losses, as well as BSUoS charges. Forward curves are extremely important in supplier pricing, because they reflect the current wholesale price of a good. Independent suppliers must buy at their rates, and integrated suppliers tend to use them for transfer cost allocation. This is at the root of the argument which is advanced from time to time that a supplier selling at prices below the current curve will lose money, even if the market price exceeds production costs. Forward curves are used for marking to market, a discipline used by traders to value their open positions at prevailing market prices. Valuing the portfolio every day will show daily changes in its value and thus whether the trader is making money or not Supplier Margin Suppliers charge a margin to cover factors including their risk exposure to balancing costs, customer acquisition and associated marketing costs, administration / management costs in servicing the account, and their profit. Margin levels can vary significantly, and a particular factor in determining them on an individual level is the supplier s assessment of the customer s credit Cornwall Consulting Report for Energywatch 36

37 standing, including the risk they face of possible late or non-payment. In extreme cases, suppliers may choose not to offer terms. A further factor is the value of accurate demand forecasting in avoiding costs of uncontracted energy and balancing. Customers who are aware of this, and who have a good working knowledge of their consumption profile, can help suppliers, particularly potential new providers, reduce their exposure to such risks, and thus see a direct cost benefit in their prices. Not surprisingly, load profile issues become more significant the larger the purchase volume. Increasingly, suppliers are asking for forward notification from larger halfhourly metered customers of substantive changes in their usage patterns, for example, for a shift change or the introduction of a new production line, including this requirement in their standard terms and conditions of supply Delivery Charges Ofgem regulates transmission network use of system and distribution use of system charges, typically through five-year price controls. Transmission Network Use of System Charges (TNUoS) NGT owns and operates the high voltage transmission system in England and Wales. In Scotland, Scottish Power Transmission Limited (SPTL) and Scottish Hydro Electric Transmission Limited (SHETL) own and operate the transmission systems in their respective regions. Under BETTA, it is intended that the operation of the Scotland and England and Wales systems will be merged under the responsibility of NGT. Figure 3:2 provides an overview of the electricity supply infrastructure in Great Britain. Business customers are charged indirectly via their suppliers for their deemed usage of the transmission network. These charges reflect broad power inputs to, and outputs from, the grid. The vast majority of electricity flows through the transmission system from the generating station to the local distribution network (although there are a handful of extremely large customers directly connected to the transmission network). Charges are levied by NGT, and by the two Scottish transmission network owners SPTL and SHETL. Cornwall Consulting Report for Energywatch 37

38 Figure 3:2: Overview of the Electricity Supply Infrastructure in Great Britain Source: Department of Trade and Industry Cornwall Consulting Report for Energywatch 38

39 Two TNUoS charging methodologies are currently applied to suppliers in England and Wales by NGT and approved by Ofgem 26, one for half hourly metered customers and the other for non-half hourly metered customers. The charges are revised annually, normally from 1 April. 27 From 1 April 2005 and the introduction of BETTA, a consistent transmission charging methodology is expected to be applied across Great Britain. Half hourly metered customers are charged for their use of the transmission system using the triad methodology. Regional per kw charges are set for each of the 12 demand zones, which align with Grid Supply Point (GSP) groups, in England and Wales. This per kw charge (inflated by the peak distribution loss factor) is applied to the customer s average maximum demand at the times of the three highest periods (half hours) of demand on the national transmission system the triad. These three periods must be separated by at least ten days, and normally occur between the start of November and the end of February on weekday early evenings. Typically, customers are billed on a monthly basis through the year for their TNUoS charges, based on an assessment of their expected triad charges (usually using historic data). Reconciliation of the account then takes place when actual triad times are known, usually on the March bill. A similar charging methodology is used by the two Scottish companies. Non-half hourly metered customers in England and Wales are charged for their use of the transmission system on the basis of their consumption. Pence per kwh charges are set, again based on the demand zones, and are applied to the customer s consumption during the peak demand afternoon period between and hours during the year. Distribution Use of System Charges (DUoS) Distribution use of system charges are applied to cover the costs of moving power from the national transmission system to the customer s meter through the local distribution networks. Charges for each of the 14 distribution network regions in Great Britain are again regulated by Ofgem 28. Distribution tariffs vary regionally, and also according to the voltage level at which the customer is connected. Charges for customers at extra high voltage (typically defined as at voltages of 33kV and above) are usually set on a site-specific basis and, until recently, were not remunerated under the distribution regulatory price control. The structure of DUoS charges varies according to the metering configuration at the site. Typically, DUoS charges consist of a standing charge and a consumption 26 Ofgem approves the underlying principles rather than the detailed tariffs. 27 Additionally connection charges are applicable, though those are levied in the first instance on the physical connected party, typically the local distributor of which are in England and Wales, and which are contiguous with the GSP groups. Cornwall Consulting Report for Energywatch 39

40 charge. The consumption charge may consist of several unit rates, especially for sites where metering records data are for more than one time block. System Losses Customers are charged for the thermal losses that occur as power is moved across both the national transmission and the local distribution networks. These system losses are charged through assessed loss factors. Transmission losses average 1.5% 29 to all volumes injected onto, or taken off, the transmission system, and their costs are split between the generation and supply sectors on a ratio of 45:55. NGT is also subject to an incentive scheme whereby it can keep a share of the savings if it beats an annual target set by the regulator. Distribution loss assessments are published annually by the distribution network operators and are percentage factors which vary by time of day and connection voltage. Distribution losses average around 7%, although they can be as high as 20%. A customer s metered energy consumption is inflated by these loss factors by suppliers in their price setting and billing processes Obligations, Levies and Taxes Since 2001, as part of the Climate Change Programme, the government has introduced the Climate Change Levy and the Renewables Obligation, both of which impact business customers electricity bills. 30 The general thrust of these policy measures is to raise prices to encourage investment by renewable producers and make customers become more energy efficient. Climate Change Levy (CCL) The CCL is a tax applied to the business use of energy, and was implemented from 1st April It is designed to be revenue neutral to business in that the revenue it raises is offset by lower employers National Insurance Contribution. HM Customs and Excise administers the CCL, although it is collected by suppliers as part of customers energy bills. A flat rate tax of 0.43 p/kwh for electricity, and 0.15 p/kwh for gas, is applied to the customer s consumption. Not all business customers pay the full rate of the CCL. A complex range of relief mechanisms has been established to encourage better climate change 29 Peak losses are higher, at about 1.8%. 30 A Fossil Fuel Levy was introduced in Cornwall Consulting Report for Energywatch 40

41 management by industry and tone down international competitiveness impacts. An important example of such a mechanism is the programme of Climate Change Agreements, administered by DEFRA, under which relief of up to 80% from the CCL is granted in return for users signing onto energy management improvement contracts. The level of the CCL is subject to review as part of the government s annual Budget process and, thus far, has been held constant since its introduction. Another example of available relief is the exemption from the CCL for gas used to fuel good quality combined heat and power plant in industrial and commercial applications. Renewables Obligation (RO) Under the terms of the RO, suppliers are obliged to buy a certain amount of the electricity they sell on to customers from qualifying renewable power sources. These generators earn Renewable Obligation Certificates (ROCs) proportionate to their output which they can trade. ROCs have a nominal value of 30/MWh (3 p/kwh), indexed to levels. Suppliers face a financial penalty if they fail to secure sufficient ROCs to meet their RO targets. In its first year in England and Wales (April 2002 to March 2003 inclusive), the RO cost to customers was the equivalent of 0.09p/kWh, based on a 3% target for suppliers. In , the obligation had risen to 4.3% and the cost was equivalent to 0.13 p/kwh. In the current year (April 2004 to March 2005 inclusive), the typical cost is expected to be 0.15p/kWh, based on a 4.9% target. Over time, the level of the obligation is set to increase further. Ascending targets have already been set to The costs of the RO are accounted for in different ways in business customers bills. Suppliers endeavour to pass on to customers their costs in meeting the RO, although there is no legal obligation on them to do so. Value Added Tax (VAT) VAT is levied at the standard rate of 17.5% with limited exceptions, the most notable of which is the 5% rate levied on premises used for domestic purposes but which are owned by business organisations. Cornwall Consulting Report for Energywatch 41

42 Metering and Data Charges Business Energy Markets 2004 Customers must pay for the charges associated with the functions of metering and data services. These services encompass the measurement of energy consumed and the collection and settlement of that data at industry level to enable balancing and settlement, and calculation of use of system charges. Larger customers must have half hourly metering installed. For smaller users, half hourly metering is an option. New rules, effective from 1 December 2004, refine the previous half hourly requirement from a site to a meter system basis. From that date, the requirement for half hourly metering will be based on exceeding 100kW average demand in the three months of highest demand in the previous 12 months, or where the profile implies, or where there is a major change that obviously requires half hour metering. In addition, there will be a choice of either half hour or non-half hour settlement where metering systems no longer qualify as mandatory half hourly (a change of meter is not necessary). Customers should have more flexibility over the circumstances where they are required to install meters. Half hourly metered customers must also ensure that they have the appropriate communications in place to enable the daily downloading of data. Customers in this sector of the market have the ability to appoint their service providers directly. Smaller customers tend not to have half hourly metering and their requirements are settled according to one of six standard industry profiles for the business energy market, as shown in Table 3:1. Non-half hourly metered customers must also have meter operator, data collection and data aggregation arrangements in place, but these are normally provided by the supplier as part of the supply contract. Consequently, in the non-half hourly metered market, charges for these services tend to be included within the energy supply charges, rather than separately paid for. Cornwall Consulting Report for Energywatch 42

43 Table 3:1: Profile Types for Non-half Hourly Metered Business Customers Profile Profile Name Class 03 Non domestic unrestricted 04 Non domestic Economy 7 05 Non domestic Maximum Demand with load factor less than 20% 06 Non domestic Maximum Demand with load factor greater than 20% and less than 30% 07 Non domestic Maximum Demand with load factor greater than 30% and less than 40% 08 Non domestic Maximum Demand with load factor greater than 40% Source: Ofgem s Strategy for Metering A Consultation Paper, March Gas Figure 3:3 shows the key flows in the gas supply market. The solid arrows show physical flows of gas and the dashed arrows the financial flows. Both the wholesale and supply markets are open to competition, but customers must purchase their gas from a licensed supplier or shipper. Suppliers must purchase their gas from shippers (operators licensed by Ofgem to transport gas on Transco s network). Shippers have a range of options in sourcing their gas requirements, for example, from a producer, from another shipper, or from the traded market. Shippers own the gas whilst it is in transportation, and it is they who have the responsibility for daily network balancing. Cornwall Consulting Report for Energywatch 43

44 Figure 3:3: Supply Chain for the Business Gas Markets - Physical and Financial Flows Producer Trader T ran sp o rtatio n Shipper M e te rin g S u p p lier Customer Green denotes regulated cost elements Yellow denotes competitive cost elements Many suppliers are also shippers, but there is no requirement to hold a supplier licence, in order to deal with business customers (from now on, the term supplier is used to describe both gas suppliers and shippers). Charges for using the national and regional gas transportation networks are regulated by Ofgem. Metering services are open to competition. The Climate Change Levy also applies to business users of gas. Customers contract with suppliers for their gas requirements. The charges that suppliers pass on to their customers include: wholesale costs; supply margin and administration / management costs to cover elements such as swing (measure of the ratio between daily maximum and average flow), credit, billing and profit; transportation charges, to cover the movement of the gas over the transportation networks to the customer s meter, with costs for use of the: metering; and o national transmission system; and o local distribution networks; taxes and levies. Cornwall Consulting Report for Energywatch 44

45 More detail on each is provided below and an assessment of their relative importance is provided in Section Wholesale Costs The operation of the wholesale market for gas is competitive. A customer s wholesale gas cost is determined by its load profile, and represents the cost of the gas at a notional National Balancing Point (NBP) Supplier Margin Suppliers add a margin onto the wholesale cost of gas to cover their risk exposure to changes in load and balancing costs. This element can be described as swing, which is a measure of the ratio between daily maximum and average flows. Suppliers also add a margin to cover their administration and management costs and profit Transportation Charges Transportation charges are levied by Transco and regulated by Ofgem, presently under five-year price controls. Normally, these charges are set annually, and change from 1st October each year, although intra-year adjustments can take place, to reflect under or over recovery against price control formulas. Separate charges exist for use of the national and regional networks. A small number of very large industrial customers and power stations are directly connected to the NTS, and are therefore not subject to regional charges. Transportation charges comprise capacity (pence / peak day kwh / day) and commodity charges (pence per kwh), which are applied to each customer s annual usage data. A typical business customer s transportation charges comprise four key cost components: movement of the gas on the NTS (commodity); exit of the gas from the NTS (capacity); movement of the gas over the regional distribution network to the customer s meter (capacity and commodity); and customer specific charges. Cornwall Consulting Report for Energywatch 45

46 Customers transportation charges also vary according to whether the site has firm or interruptible status. Currently, customers with a supply point that has daily metering and an annual consumption of over 5.8GWh (200,000 therms) can take an interruptible service. Interruptible customers avoid the exit capacity charge related to the NTS, as well as the capacity element of the regional charge. In return, the customer contracts to provide interruption rights to the pipeline operator. Changes to the interruptible regime are due to be implemented over the next year as Ofgem pushes plans in support of universal firm access. Customers can also contract for supplier nominated interruptions and receive further benefit in their supply prices Metering Charges Customers must pay for their metering services. Most of this market is open to competition, with suppliers appointing the meter reader. Daily metered sites are the exception, as Transco continues to provide services to these sites under regulated charges. Customers consuming more than 2 million therms per annum are required to have daily meters installed, and customers with a lower consumption can opt to have daily metering. Ofgem estimates that there are some 2,000 daily metered sites. Although the area of metering services is open to competition, Transco is still obliged to publish its full range of metering charges Levies and Taxes The standard Climate Change Levy rate applied to the business use of gas is 0.15 p/kwh. As with electricity users, business gas customers can enter into Climate Change Agreements to recover rebates of up to 80% of the charge. VAT is levied at the standard rate of 17.5%, with the same provisos applying as for electricity (see Section above) Energy Cost Breakdown Analysis The influence of wholesale prices and competition in supply is clearly evidenced by Figure 3:4 below. The wholesale element within business customers electricity bills typically ranges between half and more than twothirds of the total bill (excluding the Climate Change Levy). In the case of gas, it is even more pronounced, the wholesale cost of gas representing more than 80% of the total bill for a larger user (again excluding Climate Change Levy). Cornwall Consulting Report for Energywatch 46

47 Figure 3:4: Indicative Cost Components of Business Energy Bills Electricity - Smaller Commercial Electricity - Larger Industrial Levies and taxes 8% Losses 6% Metering 4% Losses 5% TNUoS 2% Levies and taxes 5% Metering 0% TNUoS 3% Energy 43% DUoS 16% Supplier 1% DUoS 34% Supplier 2% Energy 71% Gas - Smaller Commercial Gas - Larger Industrial Levies and taxes 8% Metering 8% Transport 12% Supplier 2% Metering 1% Levies and taxes 2% Transport 26% Energy 53% Supplier 5% Energy 83% Notes on Figure 3:4 Prices breakdowns are Cornwall Consulting assessments intended to be representative of typical prices in Great Britain. They are shown exclusive of VAT for one year s supply for arrangements struck during August 2004 and commencing 1 October 2004 based delivery charges and taxes current at that date. Supplier element includes gross contribution and balancing elements. It is assumed that the large user is entitled to an 80% abatement in the climate change levy as a signatory of a climate change agreement. The Table below shows user definitions. User Billing Annual MWh Max Demand Load Factor Grid Connection Electricity small user Quarter % Low voltage network Electricity large user Month 7,884 1,500 60% High voltage network Gas small user Quarter % n/a Gas - large user Month 14, % n/a Max demand data is shown hourly for electricity (in kw) and daily for gas in (MWh) Cornwall Consulting Report for Energywatch 47

48 4. Supply Contracts Within the business energy supply market, a range of contract structures has developed. Since the opening up of the markets, annual contracting for both electricity and gas supply at fixed prices has been typical. Also in both markets, there has tended to be a clear distinction between customer types and the contract structures that have been struck. Smaller business customers, and multi site customers with large numbers of relatively low consuming sites, have tended to opt for less complex arrangements than those with larger energy spends. This is particularly the case within the electricity market, where the build-up of charges tends to be more complex than for gas. Table 4:1 below outlines the distinctions between the main contract structures in the electricity and gas markets. A notable number of larger industrial and commercial gas customers have their supply prices linked to the wholesale market and indices derived from it. This is a contracting position that is also now developing rapidly in the industrial and commercial electricity supply market. It is also evident that more varied approaches are beginning to apply in terms of duration of contracts and the timing of procurement Contract Duration Most typically, contracts with a duration of multiples of 12 months are currently struck in both the electricity and gas markets. Longer-term contracts are by no means unusual but have tended to be concentrated within certain market sectors. Two- to five-year contract arrangements have most typically been struck at the smaller end of the public sector, and of the commercial, market. In the case of the electricity sector, this approach particularly involves those in the non-half hourly sector, and, in the case of gas, those sites with an annual consumption of less than 2,500 therms per annum. It is these sections of the market too that are most likely to have signed up to an all-inclusive, fixed price structure. Longer-term contracts are now beginning to be considered more in relation to larger customers, triggered by the change to the electricity trading arrangements and perceptions of a rising market, environmental considerations, and added costs that businesses must now work to, as well as the contraction of the number of providers on the supply side. These changes are discussed in more detail later in this Section. By contrast, mid-market users are still more likely to strike supply contracts annually for both electricity and gas. Cornwall Consulting Report for Energywatch 48

49 Table 4:1: Headline Characteristics of Typical Electricity and Gas Supply Contracts Factor Characteristics Duration Pricing structure Typical supply pricing components Source: Cornwall Consulting Larger users: typically 12 months with 1 or 3 months termination notice, but also 24 months plus duration, particularly for multi-site arrangements longer term contracts may contain price change mechanism linked to wholesale power market and/or inflation e.g. RPI, or some kind of annual review clause Smaller users: rolling contracts, with provision for price changes, are gradually being superseded by fixed price, fixed-term negotiated arrangements; smaller users who have not switched suppliers are supplied under deemed contract terms Larger users: All inclusive Energy only (fixed or variable) plus published costs at pass through Smaller users: All inclusive Larger users: Fixed ( standing ) charge Unit consumption rates (p/kwh) varying by time of day and season Maximum demand charges ( /kw of peak electricity demand) Capacity/availability charges ( /kva of electricity capacity) Smaller users: Fixed ( standing ) charge Unit consumption rates (p/kwh) varying by time of day 4.2. Pricing Structures There are three main types of contract pricing structures within both the electricity and gas markets: all inclusive; Cornwall Consulting Report for Energywatch 49

50 pass through; and Business Energy Markets 2004 indexed arrangements. The broad principles of each structure are summarised below and are followed by more detailed consideration of cost elements as they typically appear on bills. Table 4:2 below presents a summary of key points All Inclusive An all-inclusive pricing structure incorporates rates covering all supply chain cost elements: the wholesale cost of the energy, published delivery costs (distribution and transmission use of system charges and losses for electricity customers, transportation charges for gas customers) and metering and data collection charges. Usually, costs for the Renewables Obligation are included within the electricity supply rates, whilst the Climate Change Levy and Value Added Tax are normally exclusive in both electricity and gas. In this type of contract pricing structure, the supplier makes an assessment of the expected costs for delivery, and the customer pays upfront agreed unit rates (per kwh consumption) for the contract duration, probably in a traditional tariff type structure. The number of unit rates can range up to six but typically either one or two is most common. In gas, such pricing arrangements will include wholesale and transportation costs, with taxes again separately itemised. It is more common for prices to be presented on an all-inclusive price basis in gas, but this does not necessarily mean that changes to Transco charges will be passed through to the customer. Such arrangements are becoming more prevalent in gas. All-inclusive pricing arrangements are most common at the lower consumption levels of the power market, both non-half hourly and small and medium half hourly metered sites. Additionally, for larger electricity and gas customers with many small sites, the complexity of the offer analysis and contract administration tends to encourage the use of simpler pricing structures of this kind. Furthermore, it is also worth noting that the presentation of the pricing structure may not preclude the pass through of cost changes (in both wholesale and published charges) that occur during the life of a supply contract. This is a matter for commercial negotiation. Cornwall Consulting Report for Energywatch 50

51 Pass Through Pass through pricing arrangements are common in both electricity and gas supply contracts for larger users and provide for the separation of billing of published charges (covering distribution, transmission and levies) from the nonpublished commercially negotiable wholesale price for serving the customer. There are a number of variations as to what is, and what is not, included within the energy price of a pass through contract, for example, in relation to electricity BSUoS and transmission charges. Published elements, billed at pass through, will typically include transmission network use of system charges, distribution use of system charges, distribution losses, settlement charges, taxes and levies. A common pass through contract structure in the electricity market is Energy at GSP (Grid Supply Point). A GSP energy price includes the wholesale cost of power, BSUoS and the cost of transmission losses, whilst all other cost elements need to be added on to reach the delivered price. Some pass through contracts may also show separately the supplier s administration/management fee. In gas, transportation and metering charges are billed at pass through for the duration of the contract. In addition, the supplier may separately identify its administration / management costs, as well as although much less commonly its charges for profile variation (referred to as swing). Both these latter elements are usually fixed price cost elements agreed during the contract negotiation. Pass through pricing arrangements tend to be more prevalent in the larger half hourly volume electricity market Indexed Arrangements Indexed pricing structures are now increasingly becoming popular in the larger volume sectors of both the gas and electricity markets. Much of this popularity appears to be forced, as customers seek relief from current high wholesale prices. This type of pricing arrangement also separates the cost of the commodity from the other fixed price components, like the pass through contract. However, the commodity cost element will move according to a formula related to agreed measures of wholesale market prices. Examples of indices used are baseload month and year-ahead indicators published by price reporters and brokers. Such mechanisms allow the customer to make ongoing purchasing decisions throughout the duration of the contract. Cornwall Consulting Report for Energywatch 51

52 The applicable published charges (such as delivery, transportation and metering) are billed at pass through, and other costs, for example the supplier s administration fee and any balancing and risk management charges, are agreed in advance. These arrangements are becoming predominant for larger gas users. In the electricity market, this is an area that is now developing at a fast pace, especially in response to the sharp increases in wholesale power prices. Further detail on the workings of such contract types is provided in the Sections below. Table 4:2: Summary of Electricity and Gas Contracts to Business Customers Electricity Gas Non-half Half Hourly Small Large Supplier Pricing Pricing structure Contract Duration Contract structure Current developments Source: Cornwall Consulting Hour Profile based, often against standard matrices All inclusive, fixed price 24 months plus Standing charge Unit rate Focus on multi-site service issues by some: supplier switching process, multi billing etc. Site specific Site specific / Group pricing for multi site groups Fixed cost of energy, pass through of individual cost components All inclusive, fixed price 12 months 12 months plus Standing Standing charge charge Capacity Unit rate charges 2 plus unit rates For very large customers: flexible pricing products Energy management related, longer-term contracts Focus on multi-site service issues by some: supplier switching process, multi billing etc. Site specific Pass through, indexed arrangements 12 months Standing charge Unit rate Energy management related, longer-term contracts Cornwall Consulting Report for Energywatch 52

53 4.3. Electricity Contract Pricing Components Business Energy Markets 2004 The cost elements seen on typical electricity bills vary, but, broadly speaking, the most common are: standing charges, the frequency of which is likely to reflect the metering and billing arrangements; one or more unit rates applied to kwh consumption, partly determined by metering configuration and also by a customer s ability to load manage; and for larger customers, a capacity charge reflecting their expected maximum off-take from the power network Non-half Hourly In the non-half hourly market, the structure of electricity supply charges has tended to reflect the traditional tariff structure that applied before the whole sector was opened to competition between 1998 and Typically, most suppliers provide all-inclusive, fixed-price quotes for such business on the basis of standard pricing matrices. These matrices reflect the main profile classes for each distribution network region to incorporate the regional variations in delivery charges. Customers and suppliers tend to negotiate on price levels within these matrices rather than on their structures. This approach differs from the domestic market where fixed published prices are non-negotiable. Householder customers choose between competing fixed price offers. Just as in the household sector, metering arrangements determine the tariff structure a customer will secure, with the trading profile class highlighting this issue to competing suppliers 31. A profile 3 customer will, therefore, have a standard unit rate for all hours and all days, whilst a profile 4 customer will typically have an Economy 7 meter, and thus different supply charges for the day and night. At the larger end of the non-half hourly market, monthly-based pricing structures apply. Such sites are billed monthly, typically on either a flat unit rate across the year, or on a two-rate structure with separate day and night unit rates. The extra costs of providing power during peak winter times normally weekday early evenings - can be recovered separately by one of two methods: 31 see Table 3:1. for the definition of profile types Cornwall Consulting Report for Energywatch 53

54 the levying of penal unit rates for consumption (known as Seasonal Time of Day or STOD - arrangements); or the levying of maximum demand charges based on the highest number of units through the meter during the period Half Hourly In the half hourly metered market, the number of unit rates incorporated within the supply contract can vary widely. They tend to be more complex than in the non-half hourly sector, although the commercial freedom to negotiate means that it is not possible to state that particular structures necessarily characterise particular market sectors. Suppliers tend to design their pricing structures with regard to their own risk management and competitiveness priorities, which will change from time to time. As a general rule, there is a benefit to them in having a good working relationship with customers who are able to forecast and manage their load accurately, as it can help reduce the supplier s risk exposure to balancing charges. Some suppliers are now building into their standard terms a requirement for the customer to provide reasonable notification of changes to consumption patterns. Customers tend to select their pricing structure based on their attitude to exposure to high winter charges, and their perception of prevailing traded market prices at the time they strike their contracts. The structure they sign up to tends to be determined by their confidence in their ability to control and manage demand. More complex contract price structures were first developed under the old Electricity Pool, but the dramatic fall in wholesale electricity prices in 2001 after the replacement of the Pool by NETA saw the take-up of such arrangements reduced. However, the subsequent rise in wholesale prices, and the energy management initiatives now being undertaken by business, has led many larger customers to strike more complex arrangements again. Consequently, multi-rate contracts, with up to twelve unit rates, are becoming common again. These will typically specify different unit rates, for nights, weekends, summer days, winter peak (often between hours on weekdays November to February), and other winter weekdays. Generally speaking, STOD structures have replaced maximum demand pricing structures, which are now much less common, with the notable exception of Scotland where traditional approaches endure. Cornwall Consulting Report for Energywatch 54

55 4.4. Gas Contract Pricing Components Supply pricing components in the gas market are less complex than in the electricity market for small and medium users. Gas supply contracts typically comprise: a standing charge: and a consumption charge. In most supply contracts for these customers, the supplier provides a single fixed rate commodity cost (per therm or kwh of energy consumed) for the contract duration. This rate will be based on the supplier s assessment of the commodity cost against the customer s load profile at the time of the contract agreement. Although such arrangements may present a pre-tax price, including transportation and metering costs, these costs may not be fixed for the duration of the arrangement. This is because provision for the allocation of changes to transportation and metering costs will be assigned under the terms of the supply contract Indexed and Flexible Pricing Contracts Procurement arrangements for larger gas customers tend to be more complex. They are more likely to incorporate separate itemisation of transportation and tax elements and a wholesale gas price indexed to the traded market. Indexed (or floating as they are sometimes termed) contracts are typically based around the following structure: fixed fee payments covering administrative and account management, supply margin and peak profile and balancing elements; pass through of published charges and taxes at prevailing rates; and a mechanism whereby the energy price can be agreed from time to time linked to published markers of rates on the wholesale market. Indexed pricing contracts provide customers with the ability to separate out the commodity element of their procurement from other costs. Arrangements for the physical supply of energy are concluded in the same way as for fixed price structures. The wholesale price of energy is related to a particular index or formula basis. A wide range of indices and formulae are used reflecting the differing commercial priorities of individual customers and suppliers. The use of a widely traded index may allow the customer to purchase financial risk management services from a party other than its supplier. Cornwall Consulting Report for Energywatch 55

56 The principle behind such arrangements is that linking prices to wholesale markets allows the customer s price to respond to changes quickly. If desired, it enables the user to undertake a more active role in energy price setting than the annual agreement of a 12 month price fix. In a sharply rising or volatile market, as currently exists, such arrangements can have a particular attraction for customers not wishing to commit to very high fixed price annual rates. They entail a different approach to purchasing for buyers used to setting their price expectations in, say, a fixed annual budgeting cycle. Very often these arrangements are adopted in the context of an overall risk management approach involving the ongoing measurement of the contract position and potential exposure and value at risk. Where properly adopted, this should see energy formally accounted for in the corporate risk management strategy. The customer can then make the decision to agree tranches of its energy requirements throughout the duration of the contract, as determined by the contract terms and conditions. Contracts which incorporate more flexible pricing structures in the electricity market have been slow to develop but are now evolving quickly: one major supplier states it is selling volume equivalent to five times the consumption of Bristol on such arrangements. They have developed later in electricity than gas, partly due to the perceived greater complexity of the traded wholesale electricity market, as well as the low prices of the recent past. In the electricity market, there has been a marked movement towards the development of such contract arrangements at the large end of the sector in the last twelve months given sharply higher wholesale prices. Such arrangements tend to split a customer s requirement into tradable elements (baseload and peak, for example) and a residual element. The tradable element can then be priced at wholesale market related prices in specified tranches for specified periods, throughout the duration of the contract, typically on a monthly, quarterly, or seasonal basis, as nominated by the purchaser. The deadline for the procurement decision is defined within each contract, but might typically be 1-15 days prior to physical delivery. Otherwise, a specified default position applies. Such contracts are now well established in the business gas market. Although take-up of these types of contracts has tended to be most marked at the larger end of the market, it has by no means been restricted to this sector Energy Service Contracts Both gas and electricity businesses and the supply side are responding to new pressures placed upon them, particularly in relation to energy utilisation and the response to climate change policies. The commitments established under Climate Cornwall Consulting Report for Energywatch 56

57 Change Agreements and new costs arising from the Renewables Obligation, the Energy Efficiency Commitment and the impending EU Emissions Trading Scheme, has significantly raised the profile of energy management within larger corporate organisations and amongst intensive energy users. As a result, the supply sector is seeing the development of commercial propositions involving longer-term relationships linking energy management with energy procurement. Customers sign up to supply contracts that can be linked, for example, to funded energy management improvements. This is a significant development on the established practise where supply contract negotiations have been separate from energy management activity Brokers and Agents In view of the increasing complexity of energy procurement and the typically low level of dedicated in-house procurement resource, brokers and agents have established significant positions for themselves as intermediaries between customers and suppliers in the competitive business energy markets. More specifically: brokers offer products from a range of suppliers to their customers and act on the customer s behalf in any negotiation process; and agents sell the products of a particular supplier and act on its behalf in dealing, typically, with smaller customers. As a sector they are very diverse in structure, ranging from sole trader operations to substantial companies employing hundreds of staff. They also differ in terms of the route to market they use, from telephone and doorstep sales to complex electronically facilitated evaluation systems. Both provide an important support service to business customers and their suppliers. Brokers tend to concentrate their activity on medium and larger customers, and agents usually target smaller users. Services of value they provide include: making customers aware of the commercial opportunities available to them from energy supply competition, and providing a convenient route to accessing them; helping their customers keep abreast of market developments so they can adapt their business plans accordingly; offering suppliers a low cost, incentive-based and convenient route to market (they can therefore be particularly useful to non-incumbent suppliers); Cornwall Consulting Report for Energywatch 57

58 facilitating the collection and verification of customer information and data for suppliers to price (or in the case of agents providing such customers with a price on behalf of the supplier), which is a service that is especially important for small sites, whether they are individually owned or part of larger groups; and prompt analysis of complex pricing offers to enable the quick decisionmaking necessary in markets which can be very fast moving Brokers Brokers play a very significant role in the medium to large site energy markets and also have an important position in the small, multi-site sector. Exact estimates of their importance vary. For example, one major supplier estimates that it deals with more than 200 brokers in the medium and large electricity market. Another supplier estimates that brokers control the purchasing decisions of at least 70% of the half hourly electricity market. Our experience, in undertaking this analysis, suggests these are reasonable assessments. Perceived complexity and uncertainties in the market arising from price volatility and supplier failure have encouraged many customers to use the services of brokers, and they can act to stimulate competition on behalf of their clients. Their fees are commercially negotiated and payable in a variety of ways, including fixed rates, a share of savings (whereby the broker is entitled to a percentage share of the money it claims it will save the customer as a result of its activity) or a commission, more usually payable by the successful supplier. Some suppliers have commented that the level of broker remuneration can sometimes be greater than the margin they achieve. Brokers are less utilised by the largest customers, who tend to have specialist energy knowledge and skills of their own. They also tend to be more prevalent in the electricity sector than gas, reflecting the relatively higher unit cost of power and the perceived simplicity of most gas offers Agents Agents have been used by many suppliers of gas and electricity to attract and win new business customers. Sales approaches which they use include doorstep selling and telemarketing, and, usually, they are remunerated on a results basis. Paying commission on delivery of signed contracts is a typical way that this Cornwall Consulting Report for Energywatch 58

59 might be achieved and this mechanism has proved attractive to new entrant suppliers looking to develop a business, as well as to more established operators. Agent fees can be significant, and there is a tendency for them to seek upfront payment rather than phased remuneration over the life of the contract. This approach is believed to have arisen as a result of non-payment of full commission by suppliers exiting the market. Cornwall Consulting Report for Energywatch 59

60 5. Purchasing Methodologies and Contracting This Section provides an overview of purchasing methodologies used by customers in the business energy market, and reviews their experiences in dealing with their suppliers. It covers the following issues: an explanation of typical buying processes, identifying key distinctions between different customer types, as well as recent developments; an overview of supply chain aspects, focusing on the link between wholesale and retail markets, and the implications of this for both the supply industry and business customers; and a review of the nature of competition, including price, supplier activity and service levels. It is designed to provide a contextual framework for the analysis of participant views which follows in Section The Energy Supply Contracting Process Energy supply arrangements between suppliers and their non-domestic customers are contractual, commercial relationships as for any other product businesses may purchase. There are a wide variety of contract arrangements within the energy supply markets, though twelve-month, and rolling, contracts, subject to an agreed termination period, are the most commonplace. The type of arrangement already in place generally determines how non-domestic customers purchase their energy, as most contracts will include within them the termination requirements, for notification of intent to terminate as well as expiry. As already highlighted, customer awareness of the ability to negotiate for contracts is high in the larger business sector but can be much less so for smaller users. Whilst there are variations in the structure of contracts struck and the level of switching activity according to customer types, common approaches to energy contracting have emerged for smaller and larger users. Buying processes for larger users have been established for longer, and are more complex Larger Users Buying processes for larger customers initially developed as they responded to the various opportunities available to them to ensure that a switch of supplier could be undertaken in a timely and orderly manner. Whilst these processes are Cornwall Consulting Report for Energywatch 60

61 complex and can be time consuming, they are generally well understood by participants on both sides of the market and also by the advisors serving the sector. There are, however, tensions and strains within them that have emerged as a result of a discernible trend which we have observed to reprice major user contracts in response to changes in wholesale markets as price volatility has grown. In 1990, it was a requirement that eligible, over 1 MW, electricity customers had half hourly metering installed, and that notification of switching was registered with the settlements agency four weeks in advance of the contract anniversary date. This starting point tends to mean that the period immediately prior to expiry is typically the time when most customers strike their contracts. With churn rates relatively high in the sector, from the supplier point of view, the scale and nature of their operation serving larger users can change quite profoundly over this period and between one contract round and another. In contrast, sometimes suppliers opt for wider commercial reasons to compete less aggressively in particular rounds, which will have a substantial influence on market shares. In recent times, for example, both Powergen and EDF Energy elected to do this whilst their assimilations of TXU and Seeboard were being concluded. Partly through the involvement of advisors and brokers, but also as a consequence of central reconciliation and settlement methods that have developed, a series of processes have developed which are applied, in various different ways, by or on behalf of larger customers. These processes are summarised in the diagram shown in Figure 5:1. Figure 5:1: Overview of Typical Business Procurement Processes Data collection & verification Tender preparation & dispatch Analysis of responses Negotiation Contract award Cornwall Consulting Report for Energywatch 61

62 Differences in the approaches to, and time required for, each of the functions shown in Figure 5:1 arise because of short-term market conditions, the complexity of the customer s requirement, and the chosen route to market. As will be discussed in Section , this presents a key challenge to buyers responding to wholesale market conditions, which have become very much more volatile over recent years. The scale of this challenge is evidenced by Figure 5:2. It shows an example timeline for larger users undertaking a formal tendering process based on the practice which developed in the 1990s. A key driver of the timing is administration of the supplier change process. In the electricity market, such registration can be undertaken within 5 working days, although, to ensure a timely process, 15 working days is the general minimum. In the gas market, 15 working days is required for registration, although a number of suppliers specify that they need longer than this, sometimes as much as twice this time. Figure 5:2: Example Timeline as Established in the 1990s for a Formal Tendering Process Undertaken by a Larger Energy User Data Tender Tender Analysis of Negotiation Contract Collection Preparation Despatch Responses Award Week 1 Week 4 Week 6 Week 8 Week 8 (to 12) Week 12 (to 15) Week 13 to 16 Contract Start The development of the wholesale electricity and gas markets into commodity markets, and the close links between them and contract supply pricing to nondomestic customers, now mean that many fixed price offers are only valid on the day they are made. Moreover, during periods of extreme wholesale price volatility, offers can be extremely hard to come by, if at all. Such time pressures have a significant impact on the negotiation process for larger business customers. They must now be in a position to organise competing, valid offers, analyse them, and negotiate their supply contracts within very short time-spans, vastly shorter than Figure 5:2 implies. This very important consideration is discussed in more detail later in this Section and has been a major factor in the rise of intermediaries serving the sector. Cornwall Consulting Report for Energywatch 62

63 Electricity The bulk of medium and large customers now hold supply contracts with a 1 October renewal date. The development of electricity contracting rounds was a result of the process of opening the supply market to competition. In the early 1990s, the majority of contracts in the eligible competitive market were negotiated with a 1 April contract commencement date (reflecting that the market became competitive on 1 April 1990), and most contracts at this time were for 12 months. This timing meant that most contracting activity was undertaken in the first quarter of the year. However, against a background of sharply rising Pool prices in the early 1990s, some users opted for 18 month fixed price contracts, commencing on 1 April, as these offered a one-off price advantage compared with an annual arrangement from the same date. This preference arose because such an arrangement incorporates two summers of expected low wholesale costs against one higher priced winter period. Furthermore, in 1993 many larger customers undertook 18 month contracts as a means of avoiding the renewal process in April 1994, when the 100kW to 1MW sector of the market was due to open. This subsequently created the second major annual contracting round of the year for 1 October contract renewals. This trend was repeated to a certain extent in the run-up to 1998, when the small business and domestic sectors of the market were due to open to competition, although slipping from their original implementation month of April to a staggered phase-in. Now the major negotiation round for business electricity supply contracts is for October renewals, followed by April, with much more limited activity for July and other dates. In the main, customers have tended to continue to opt for 12 month supply arrangements, although longer-term contracts are more common for larger users buying for high numbers of smaller, sub 100kW sites. Longer-term, typically two-year, but some much longer, contracts were also more common across the spectrum of customers at the time of the sharp fall in wholesale electricity prices in As a result of these developments, in recent years the bulk of negotiation activity has taken place in the third quarter of the year for October contract renewals, and in the first quarter of the year for April contract renewals Gas In the gas market, the majority of large user contracts also now have a 1 October contract renewal date, again reflecting general trends in development. There is, though, more variation in contract start dates compared to electricity. This difference largely reflects the longer developed and more mature nature of Cornwall Consulting Report for Energywatch 63

64 the traded wholesale gas market. As a result, non-domestic customers have exercised more flexibility in their gas supply contracting, for example, opting for shorter-term pricing arrangements, and competitively contracting for sites added to their portfolios as and when acquired. Just as in the electricity market, however, the majority of gas supply contracting activity is undertaken in the third quarter of each year Public Sector Users Public sector organisations are subject to EU procurement rules for their energy purchasing. The rules apply to qualifying public authorities (including, amongst others, government departments, local authorities and NHS Trusts) and certain utility companies operating in the energy, water, transport and telecommunications sectors and include a spend threshold. In order to comply with EU procurement rules, they must amongst other requirements, place a tender notice within the Official Journal of the European Communities (OJEC) and comply with certain minimum timescales for posting the notice and for receiving suppliers pricing offers. The public sector is characterised by a wide variety of purchasing channels and groups. Purchasing groups and consortia are an important feature and can offer important advantages in terms of knowledge and consolidated buying power to public sector users. These groups operate on a sectoral or regional level, serving, for example, local government users in a particular area or a distinct sector, such as higher education or the health service. To an extent, their activities are similar to the services provided by advisors and brokers, some of which also compete to serve public sector users. The EU procurement rules can be interpreted very differently by public sector buyers. In some interpretations, they can effectively mean that the tendering and negotiation process for public sector organisations takes longer than for other comparable energy requirements. A rigid interpretation can also mean that customers are not able to take quick decisions outside the appropriate point in the process. This inflexibility can cause difficulties for users buying in a rising, volatile market, for example, and, indeed, suppliers have been known to factor risk premia into their prices should they need to hold them open for longer periods of time. Cornwall Consulting Report for Energywatch 64

65 Smaller Users The electricity and gas markets for smaller users are relatively new. Full gas retail competition commenced from 1996 and the electricity market for all business users was opened up sequentially over the period However, markets have now been open for a minimum of five years and the small business energy market has established dynamics of its own, different to other business markets. Suppliers publish standard terms of contract. However, in theory, all are negotiable, as all aspects of the business sector are no longer subject to supply regulation. These standard terms are generally applied to the smallest customers, and schedules vary according to trading profiles and payment mechanisms. Suppliers access such customers through a variety of channels including doorstep sales agents, direct promotion and telesales. From the customer point of view, although conceptual awareness of competition can be high, practical knowledge about where to source competing offers and interpreting those acquired can be lacking. Whilst advisors do serve the small user sector, internet resources, which are a feature of the domestic market, are not as established for smaller business customers. Retail pricing for small and medium sized customers in the small non-half hourly metered electricity sector tends to be less responsive to day to day changes within wholesale markets and more to general trends. Use of profiling means that these customers tend to be thought of by suppliers as more predictable in terms of demand usage. This situation, along with the large number of sites within this sector of the market, and the considerable potential for variation in delivery charges (pricing offers in this sector of the market are typically all-inclusive), means that suppliers are likely to develop standard offer matrices. Whilst major users are generally pro-active in their dealings with their energy suppliers, this is less so for small customers. This context puts the onus much more on suppliers to lead product and contract development. A typical example of this is the current trend for small business customers to be migrated to fixed term contracts by their suppliers. Indeed, multi-year contracts now tend to be more common for smaller users than elsewhere in the energy markets. Within such arrangements, there is likely to be the scope for suppliers to adjust prices from time to time, and defined notice periods for termination and switching are usually stipulated. Traditionally, tariff prices to the small and medium sized business sector were revised from April each year. More recently, however, partly due to the increase in distribution companies changing their delivery charges at different times of the year, and also due to the increasing links between wholesale and retail prices, such changes have begun to occur at varying times through the year. Cornwall Consulting Report for Energywatch 65

66 Out of Contract Arrangements Business Energy Markets 2004 An important feature of fixed period supply contracts is the pricing arrangement that will supersede the agreed schedule of rates should no new contract be in place. These rates apply once an account moves out of contract and on to deemed terms offered by the supplier which incorporate prices at a premium to contracted rates. This premium is justified on the grounds that the supplier will still be responsible for wholesale settlement of the energy used by the customer, even though its formal contract has expired. The out of contract situation, it is argued, exposes the supplier to short-term energy purchase commitments which may be very expensive and the supplier requires protection against this. Overrun rates vary considerably by supplier and, in some cases, can be penal Competitive Market Dynamics The introduction of competition in energy wholesale and supply has comprehensively changed the relationship between electricity and gas customers and their suppliers. This change is most visible for larger users where new contract structures, competing operators and price signals have emerged. In this section, the dynamics of the competitive electricity and gas markets are assessed, and we look at how they impact customers across the sector. The Sections that follow provide an overview of price trends, and customer responses to them, with specific consideration of: changes in competitive energy prices, both wholesale energy and pre-tax delivered; levels of supplier activity within the market, both in terms of headline numbers and offer patterns; and customer concerns and complaints about the service they receive from their energy suppliers. Regulatory separation of the different business functions within the energy supply chain ensures that cost visibility is a feasible, if complex, task for end users. The wholesale markets in both electricity and gas have created published price markers and indices which suppliers use as the starting point for their retail pricing strategy, regardless of the way they may be sourcing or purchasing their energy requirements. Methodologies for energy sourcing differ by supplier as well as by customer type. As we have seen, these arrangements incorporate price markers or indices linked to wholesale market measures produced by a wide range of reporters, exchanges and brokers including Platts, Petroleum Cornwall Consulting Report for Energywatch 66

67 Argus, Heren Energy, Spectron, the UK Power Exchange and the International Petroleum Exchange. In the larger sectors of both gas and power markets, suppliers tell us that they will typically back out retail contracts with matching wholesale arrangements wherever possible. As a result of this, retail pricing at the large end of the nondomestic sector is extremely sensitive to, and reactive to, pricing developments in the wholesale markets. Pricing offers for large business customers are now extremely time sensitive, and virtually all suppliers now operate a within-day validity period within their offers. Even then, most offers include clauses that these prices could be subject to change. Whilst within-day pricing is most typical, some suppliers can hold their prices open for longer but might expect to factor in a price premium for doing so. At times of extreme pricing volatility in wholesale markets, many suppliers tend to retain the option of withdrawing all their customer offers with immediate effect, and may well not re-quote until they perceive some element of stability has returned. Use of such safeguards has been seen recently in both the electricity and gas markets in the wake of the publication of the conclusion to Ofgem s gas price probe Customer Responses Activity by non-domestic customers in their energy supply contracting is dictated by a number of issues, primarily by the size of the business and the level of energy spend, at an absolute level, and also as a proportion of total costs. Most larger and many medium non-domestic customers are now more active in their energy procurement in the sense that they will engage professional support if they do not carry out the role themselves. Typically, the larger the organisation and/or the greater the spend on energy, the more resource is put into the procurement process and energy management. Large organisations with a high spend on energy are likely to have at least one energy procurement and management specialist. At the other end of the scale, a small commercial site is unlikely to devote much resource to energy procurement, with the level of energy spend and the potential cost benefits available being thought not to justify it. For these users, perceived market complexity and poor service from suppliers can also act as deterrents to accessing the competitive market. These factors, along with the type of business, are also important in influencing the approach to risk that is taken. Large organisations that consume a significant amount of energy, and thus have focused procurement resource, may be more interested in more flexible purchasing and risk-sharing 32 see Section Cornwall Consulting Report for Energywatch 67

68 arrangements than the fixed price annual contract. The level of in-house energy expertise is important here, as awareness of site consumption, demand profiling and utilisation, and an ongoing commitment to the procurement process, are required. Conversely, sites with a low energy spend, whether part of a single or multi site portfolio, tend to prefer fixed prices, as do those working to a strict budgetary regime, for example public sector organisations. The close link between wholesale and retail pricing, and the operation of the wholesale energy markets as traded commodity markets, means larger customers are beginning to change the way they buy their energy. Increasingly, these customers are moving away from treating the procurement process as a one-off exercise undertaken at a set time each year. Many are now closely tracking market developments and prices, and using this information to decide when and how to strike their contracts. For example, when wholesale electricity prices fell to very low levels in the summer of 2002, some customers entered multi-year contracts, some as far forward as Others closed their April 2003 renewing contracts at this time, up to six months ahead of then standard timings. Due to the volatile nature of the wholesale markets and the short validity period of most pricing offers, the procurement process for medium and larger customers can now entail several approaches to the market for offers before customers make their final contracting decision. Also as a result of this, some customers are considering less standard contract lengths, for example, shorterterm contracts when they feel wholesale markets are particularly high. Conversely, others, sensing a rising market, have entered into longer-term contracts. Customers are also considering alternative means of procurement, and the use of indexed and flexible pricing products as discussed in the previous Section. At the moment, however, twelve-month, fixed price supply contracts still dominate the non-domestic markets. Even so, these changes are presenting suppliers with many new challenges as they seek to meet customer needs in an efficient manner. As we will see, they are meeting these challenges in a variety of ways and with differing levels of success. Table 5:1 provides an overview of different types of customers and the approach that they may be taking to their energy procurement, both now and looking ahead. For the purposes of the information, multi-site and public sector customers have been grouped because of several shared characteristics. Cornwall Consulting Report for Energywatch 68

69 Table 5:1: Customer Approaches to Energy Procurement Business Energy Markets 2004 Customer type Observations Small site Energy spend low, both at absolute level and as proportion of total costs. Energy procurement of low priority Little action taken may have switched supplier once, for example, as a result of doorstep approach If switched, likely to have agreed a long term (2+ years) or rolling contract Dual fuel supply possible Larger Industrial Multi-site, commercial, public sector Energy intensive site, energy spend high. More active energy procurement /management strategy Employee(s) responsible for energy procurement and usage. Monitoring markets closely, and taking more flexible approach to timing of negotiations Use of market information provider(s) to support activities and perhaps outsourcing of data cleansing, tendering and negotiation Consideration, if not take-up, of indexed gas and, increasingly, electricity if not energy only plus pass through Separate tendering and negotiation of electricity and gas supplies, and likely separate service providers, on 12 month contracts Has working relationships with suppliers to minimise costs e.g. notification of load profile changes for balancing. Perhaps exploring longer-term relationships e.g. linked to energy management, risk management, carbon abatement Energy spend may appear high in value terms but could be low in relative terms. Energy procurement / management activities are more resource intensive due to large number of sites Use of market information provider(s) to support activities and perhaps outsourcing of tendering and negotiation Longer term (24 months), fixed price contract arrangements, especially for small sites Separate tendering and negotiation of electricity and gas supplies, and likely separate service providers. EU procurement processes may apply. Service issues a key consideration within the supplier selection process and can influence the decision Perhaps exploring longer-term supplier partnerships, based around quality services accurate and timely billing etc. Cornwall Consulting Report for Energywatch 69

70 Pricing and Competition Levels Business Energy Markets 2004 Concerns have been expressed to Energywatch by customers about the levels of response they obtain from suppliers when they approach the electricity and gas markets. These complaints originate from across the market, although arguably more from larger users noting the very significant supply-side consolidation that has taken place since These customers have also expressed strong concerns about the price increases they have faced over the last two years. As was noted in Section , although wholesale electricity prices plunged to very low levels during 2001 and 2002, they have subsequently increased very significantly. We have also highlighted the surge in wholesale gas prices over In order to provide a context against which the various participant views are assessed in Section 7, Energywatch approached four leading independent advisors, which act on behalf of energy customers in arranging supply contracts 33. They were asked if they could provide aggregate data arising from their activities in 2002, 2003 and 2004 concerning offer and pricing levels according to the matrix set out in Table 5:2. This matrix reflects a simplification of the high level market segmentation outlined in Section 2. Table 5:2: Overview of Aggregate Data Requested from Energy Advisors For each fuel Volume by contract Customer ownership Electricity > 10 GWh Public sector Firm gas < 10 GWh Private sector Interruptible gas EnergyQuote and John Hall Associates provided responses and the results from them have been analysed, with summary findings and comment presented below. The data received resulted from contracts placed by the two advisors. The data covered an average purchase volume of 7 TWh of electricity (mainly concentrated on the half hourly sector), 4 TWh of interruptible gas, and 2 TWh of firm gas per year over the three years in question. The quantities vary by year, reflecting changing advisor activity and, more importantly, the adoption of twoyear or more contracts by customers effectively limiting available brokerage 33 Energy Information Centre, EnergyQuote, John Hall Associates and Utilyx Cornwall Consulting Report for Energywatch 70

71 volumes in later years. There was a notable trend towards two-year or longer contracts by customers during 2001 to Data coverage is biased towards the private sector rather than public. However, a number of useful insights can be drawn concerning competition to larger customers, particularly those outside the public sector. As these advisors build a business position based on involving a wide number of suppliers in their contract enquiries, we believe that the comments below can be taken as reflecting the business energy markets at their most competitive Price Levels Electricity prices have risen very significantly between 2002 and The average price for contracts struck in the data sample for 2002 was p/kwh, inclusive of all costs, save for VAT and the Climate Change Levy. In 2004, this average level had risen by 51% to p/kwh. This figure records fixed price annual contracts struck in 2004 to the end of September and is, therefore, likely to understate the magnitude of the price increases faced by customers striking their contracts after that date, given the continuing increase in wholesale power prices. For firm and interruptible gas, the averages are p/kwh and p/kwh respectively for The 2004 figure of p/kwh for firm gas is 36% higher than this, and the interruptible figure of p/kwh is 44% up. It is worth noting that 2003 levels were lower than 2002 for both firm and interruptible gas, reflecting a marginal weakening in the wholesale market over that period. Table 5:3 provides an overview of price levels recorded from this data sample. Table 5:3: Average Contract Prices Secured by Energy Advisors (p/kwh) energy total energy total energy Total Electricity Firm gas Interruptible gas Notes total includes all costs excluding metering where separately charged, climate change levy and VAT. energy the residual left after deducting all published and assessable grid access charges and losses from total costs Source: energy advisors This analysis confirms the claims made by larger customers of the very significant cost increases they have faced over the last two years. Whilst possible Cornwall Consulting Report for Energywatch 71

72 reasons for these price increases, and their wider implications, are discussed in Section 7.2.1, there is a very close correlation between trends in annual forward wholesale prices and the energy components of major user gas and electricity contracts. If anything, it understates the magnitude of price increases in 2004, as many customers waited until as late in the year as possible before striking contracts. They did this in the hope that rates would fall. Unfortunately, this has proved not to be the case and some have been facing price increases of an order of magnitude greater than implied by Table Supplier Responses One means to assess the level of competition is by measuring the level of supplier response to customer requests for quotations. Anecdotal evidence from larger customers has suggested that the level of competition for their business is declining because fewer suppliers are providing them with offers, and some of these are not competitive prices. The independent energy advisors were asked to provide aggregate information on the number of suppliers they approached, and response levels to their requests for quotations for each of the last three years by fuel and sector as set out in Table 5:2. Summary figures of this data are also presented in Table 5:4 below and they suggest that: the number of suppliers active in the business electricity market has reduced from 19 to 10 over the last two years; the number of suppliers active in the business gas markets has reduced over the same period, but to a much lesser extent; suppliers do not respond to all requests to quote that they receive; and supplier response levels have fallen slightly over the period. Table 5:4: Suppliers Approached and Responding to Customer Request for Quotations (p/kwh) appr. resp. appr. resp. appr. resp. Electricity Firm gas Interruptible gas Source: energy advisors Cornwall Consulting Report for Energywatch 72

73 Whilst the number of suppliers responding is one means of assessing the level of competition, another is to consider the number of offers received from those suppliers. Multiple offers may be held to represent intense competition between a relatively low number of suppliers. The data shown in Table 5:5 may appear to support this point of view, because it shows that the typical customer is receiving at least four offers from each supplier responding to its request for a quotation. However, the comments made above about the importance of wholesale markets in customer pricing need to be borne in mind. Suppliers can make, and withdraw, offers very quickly depending on wholesale market conditions. Furthermore, customers do not necessarily close a contract on the first occasion they approach the market, if they are of the opinion that they will secure a better rate on another occasion because they expect the wholesale price to be lower. Table 5:5: Offers Received Average and per Supplier Responding (p/kwh) offers per sup offers per sup offers per sup Electricity Firm gas Interruptible gas Source: energy advisors Suppliers participate in different sectors of the business electricity and gas markets and few are active across all at any one time. Therefore, customers can expect different suppliers to respond to different requirements, generally segmented by volume. Accordingly, levels of competition can vary across the business energy markets, as the participant views summarised in Section 7 strongly underline. In this context, a key distinction appears to exist in the business electricity market. Supplier activity appears much more concentrated on the larger volume market (defined, for these purposes, as contracts of more than 10 GWh of annual consumption). Table 5:6 suggests that, whilst a similar number of suppliers respond to customer requests for quotations in the small and large markets, those active at the higher end are twice as active as those at the lower end. This situation may arise because pricing systems are more dynamic for larger users, reflecting the greater importance of individual pricing in this sector. It may also reflect commercial strategies of the suppliers which enable greater levels of competition per se for these users. Cornwall Consulting Report for Energywatch 73

74 Table 5:6: Trends in Energy Supplier Activity Average Responses to Requests to Tender from Major Advisors - electricity contracts < 10 GWh Suppliers approached Suppliers responding Offers received Offers per supplier responding electricity contracts > 10 GWh Suppliers approached Suppliers responding Offers received Offers per supplier responding Source: energy advisors 5.3. Service Issues Competition in energy supply has enabled customers to negotiate for their supplies on the basis of price and their perceptions of the service they will obtain from their new operator. There is a strong perception, particularly from suppliers, that competition remains very much a price-based activity for customers who do not, therefore, fully value service. From the customer point of view, dealings in the competitive energy markets can be accompanied by service problems with their suppliers. These problems can occur for many reasons, either specific to the individual supplier, or reflecting the wider market situation. They can also impact on different sectors to different extents, as is noted in more detail in Section 7.2.2, even to the point of acting as a deterrent to some customer participation in the market. Supply competition requires complex information systems on the part of suppliers, both at the front office customer service level and in back office settlement and trading functions. These systems reflect their interpretations of the trading regime and tend to have evolved as market rule changes have been implemented. Standard accreditation and testing procedures are in place to ensure timely communication between wholesale buyers and sellers, and a Cornwall Consulting Report for Energywatch 74

75 rigorous testing regime is in place with which new entrants have to demonstrate compliance before they can commence trading. From time to time in the development of competitive energy supply markets in the UK, difficulties arising from such complexity appear to have been compounded. This complex trading environment has sometimes been cited by suppliers and some believe has reached a point where it is discouraging new supplier entry. An example of this is the introduction of new settlement arrangements from 1998 to support the abolition of the electricity market access level from 100 kw maximum demand Energywatch Complaint Information Energywatch handles complaints from business as well as domestic customers concerning their dealings with suppliers. Information on them is stored by Energywatch in a database which defines more than 40 complaint types 34 across four broad categories: the sales process; metering issues; the supply relationship, mainly billing and payment issues; and the transfer process. As a part of this analysis, a brief review of summary data of complaints from business customers received by Energywatch between November 2003 and May 2004 was undertaken. It shows that, over the seven months in question, 7,795 complaints were received by Energywatch from business electricity and gas users in Great Britain. These represent complaints by consumers who have been unable to get a satisfactory resolution from their energy supplier. Whilst this data should not necessarily be deemed representative of business customers concerns about the service they receive from the energy suppliers, as Table 5:7 shows, it does reveal some points of note: more complaints were received about disputes concerning established supply relationships (61%) than any other source issue; twice as many customers have complained about issues involved in the switching process (23%) than in the way they were sold to (11%); and issues with metering form a small, but notable proportion (5%) of business customer complaints. 34 see Appendix A for a full listing of Energywatch complaint code references Cornwall Consulting Report for Energywatch 75

76 This headline review tends to suggest that more customer concerns are generated by the independent actions of suppliers rather than more industrywide structural issues, that unresolved billing and payment complaints represent nearly 60% of all complaints received, and that mis-selling is no longer a significant issue in the business market. Table 5:7: Summary of Complaints Received by Energywatch from Business Customers November 2003 to May 2004 Number Share (%) Sales % Metering % Supply 4, % Transfer 1, % Total 7, % Source: Cornwall Consulting analysis of Energywatch data. Consideration of the individual complaint categories defined by Energywatch serves to underline the points made above, as Table 5:8 shows. Energywatch also collates complaint data by supplier involved. Whilst Figure 5:3 presents a summary of this information, care needs to be taken with its interpretation. Absolute complaint numbers may reflect the scale of the supply businesses involved rather than any tendency to provide better or worse customer service, triggering fewer or more complaints to Energywatch. A review of the information presented in Figure 5:3 reveals the following: the six companies with the most customers 35 are all amongst the ten companies for which Energywatch received the most complaints during November 2003 to May 2004; and a handful of smaller suppliers attracted similar level of complaints despite having very significantly fewer customers. 35 E.ON/Powergen, npower, British Gas, Scottish and Southern Energy, Scottish Power and EdF Energy Cornwall Consulting Report for Energywatch 76

77 Table 5:8: Main Complaint Types Received by Energywatch from Business Customers November 2003 to May 2004 Issue Type Proportion Disputed account Supply 36.1% Sales Misinformation Sales 7.6% Estimated bills/consumption Supply 6.5% Frequency/Infrequency of bills Supply 5.3% Refunds Supply 4.6% Transfer in error due to incorrect data Transfer 4.1% Problems arising from contracts Transfer 3.7% Billing problems with old Supplier Transfer 3.6% Supplier objection to transfer under contract Transfer 2.8% Inaccurate Meter Reading on Transfer Transfer 2.3% Source: Cornwall Consulting analysis of Energywatch data. Figure 5:3: Complaints Received by Energywatch from Business Customers by Supplier November 2003 to May ,500 3,000 2,500 2,000 Key: integrated energy retailer other major electricity and/or gas producer 1,500 1, Source: Cornwall Consulting analysis of Energywatch data. Cornwall Consulting Report for Energywatch 77

78 6. Energy Policy and Regulation This Section sets out the policy and regulatory framework within which business energy supply markets operate. Creating competition in energy markets both supply and wholesale has been a major feature of national and EU energy policy for the last 15 years or so. It is argued that, through competition, the objectives of lower prices and better services to customers can be better delivered. Despite the UK now having implemented competitive energy markets, policy makers also believe that account of customers interests needs to be taken at the policy level and, as such, both the Department of Trade and Industry (DTI) and Ofgem are tasked with safeguarding them. As sustainable development has become an ever more important priority, so the role of the relevant government department, DEFRA (the Department for the Environment, Food and Rural Affairs) has increased. In this Section, an overview of energy policy is followed by a summary of the regulatory framework in so far as it impacts business energy customers. A key aim is to demonstrate the increasing importance of sustainable development on energy policy, and thus market evolution and competition. This influence is already having a notable impact on energy prices and services to business customers, and its significance on all sectors of the market is expected to increase. Business customers, therefore, need to be aware of these conflicting pressures in setting their own development and operational plans as new opportunities and risks arise. Different aspects of energy policy are important and feature different bodies. They can be broadly broken down into six areas and aspects relevant to business customers are considered in more detail below: development and direction; economic regulation; financial services regulation; competition policy; sustainable development; and customer representation. Cornwall Consulting Report for Energywatch 78

79 6.1. Development and Direction The current energy policy framework is built on the concept that competitive markets are better than monopolies in serving customers. As highlighted in Section 3, supply competition involves the provision of services from a number of functions, some of which are competitive (e.g. generation and metering services) and some of which are natural monopolies (e.g. distribution and transmission). Some regulation is necessary to protect monopoly customers to prevent abuse by dominant players, including ensuring that new entrants are not unfairly discriminated against, and to deal with any remaining market distortions. Regulation is also used to deliver specific government policy objectives, be they economic, social or environmental. Examples of such initiatives that currently apply are the Renewables Obligation and the Climate Change Levy. In this competitive regime, policy makers need to work closely with a wide variety of participants to ensure that their objectives are achievable and ensure that market dynamics work in desirable ways. In its written material, much reference is made by the DTI, as lead government department, to a partnership approach being essential to bring the dynamism of the market into delivery of Government policy Department of Trade and Industry The DTI s Energy Group is responsible for a diverse range of matters, from offshore development to social protection against fuel poverty. The Department s overall objectives are defined in its Public Service Agreement with government. The current agreement covers the period , and Target 4 within it addresses energy specifically. Reproduced below, it states that the DTI is tasked to: Ensure the UK ranks in the top 3 most competitive energy markets in the EU and G7 in each year, whilst on course to maintain energy security, to achieve fuel poverty objectives; and (Joint target with DEFRA) improve the environment and the sustainable use of natural resources, including through the use of energy saving technologies, to help to reduce greenhouse gas emissions by 12.5% from 1990 levels and moving towards a 20% reduction in carbon dioxide emissions by Cornwall Consulting Report for Energywatch 79

80 In terms of how it interprets this target, on its website 36 the DTI Energy Group states that: Its role is to set out a fair and effective framework in which competition can flourish for the benefit of customers, the industry and suppliers, and which will contribute to the achievement of the UK's environmental and social objectives. These include the alleviation of fuel poverty, and maintaining the security and diversity of the UK energy sources. February 2003 s Energy White Paper 37 was a notable development in energy policy in that it set out, for the first time, a long-term vision, combining environmental, security of supply, competitiveness and social goals. It followed November 2000 s Climate Change Programme, which sets out national emissions reduction targets, and measures aimed at achieving them. The Energy White Paper includes more than 130 commitments, and its four energy policy goals are quoted below: to put ourselves on a path to cut the UK s carbon dioxide emissions - the main contributor to global warming - by some 60% by about 2050 with real progress by 2020; to maintain the reliability of energy supplies; to promote competitive markets in the UK and beyond, helping to raise the rate of sustainable economic growth and to improve our productivity; and to ensure that every home is adequately and affordably heated. The Sustainable Energy Policy Network (SEPN) has been established by government to ensure the delivery of the Energy White Paper commitments. This cross-departmental approach is necessary because it is believed that the scale of the task to deliver environmental, security of supply, as well as competitiveness goals means it cannot be achieved by any one government department, and requires close integration across departments and on a much wider scale. SEPN is a network of policy units from across government departments, the devolved administrations, regulators and key delivery organisations that are jointly responsible for delivery. The Secretary of State for Trade and Industry formally launched SEPN in June It published its first annual update in April SEPN is directed by a Ministerial Group which itself is advised by a Sustainable Energy Policy Advisory Board of senior, independent experts and stakeholders Creating a Low Carbon Economy - First Annual Report on Implementation of the Energy White Paper, which is available at: Cornwall Consulting Report for Energywatch 80

81 6.2. Economic Regulation Whilst DTI develops and implements government energy policy, the Office for Gas and Electricity Markets (Ofgem) is responsible for the economic regulation of energy markets. According to the DTI, 39 its current priorities for gas and electricity markets are: underpinning UK gas supplies for the medium and longer terms through liberalisation of the gas sector within the EU; ensuring adequate competition among competitor countries and transit states; extending to Scotland the new electricity trading arrangements (NETA) - introduced in England and Wales in 2001 as the British Electricity Transmission and Trading Arrangements (BETTA); encouraging an effective implementation of the EU s Barcelona agreement on electricity market opening; ensuring that satisfactory up to date emergency plans are in place; and encouraging the gearing up of electricity networks in Great Britain to help deliver the environmental benefits offered by renewable or CHP embedded generation while continuing to provide security of supply and low prices. In a number of these areas, Ofgem is responsible as the economic regulator The Gas and Electricity Markets Authority (GEMA) and the Office for Gas and Electricity Markets (Ofgem) When the electricity and gas industries were privatised, independent economic regulators were established: the Director General for Electricity Supply (heading the Office of Electricity Regulation) was established by the 1989 Electricity Act, and the Director General for Gas Supply (heading the Office of Gas Supply) was established by the 1986 Gas Act. Their key functions centred on the issuing and enforcement of operating licences for market participants covering supply, generation, transmission and distribution functions, subject to ensuring certain policy objectives were fulfilled. The economic regulatory structure was overhauled by the Utilities Act It established a new regulatory body, the Gas and Electricity Markets Authority 39 Cornwall Consulting Report for Energywatch 81

82 (GEMA), which took over the responsibilities previously held separately by the Director General of Electricity Supply and the Director General of Gas Supply. The principal objective of GEMA, in carrying out its functions, is to protect the interests of consumers, wherever appropriate, by promoting effective competition in the generation, transmission, distribution or supply of electricity and gas. GEMA is under a duty to carry out its functions in the manner which it considers is best calculated to meet its principal objective, having regard to: the need to secure that all reasonable demands for electricity and gas are met; and the need to secure that licence-holders are able to finance their activities which are the subject of legal obligations GEMA is also required to carry out its functions in the manner it considers best calculated to secure a diverse and viable long-term energy supply, and to have regard to environmental impacts. Ofgem, therefore, operates under GEMA s direction and governance. It exercises its responsibilities through a combination of competition law, licence requirements, price controls and other consumer law. It states that it divides its work into four areas; making gas and electricity markets work effectively, regulating monopoly businesses intelligently, securing Britain's gas and electricity supplies, and meeting its increased social and environmental responsibilities. Figure 6:1 provides an overview of Ofgem s role. Whilst explicit controls on gas and electricity supply prices were removed in 2001 and 2002 respectively, Ofgem has dedicated teams which are intended to ensure that effective competition develops through extensive market monitoring and investigations as required. In terms of supply, the business customer market is significantly less regulated than the domestic sector. This is evidenced by some sections of supply licences only taking effect if the supplier is supplying domestic customers The Electricity and Gas Supply Licences The Electricity Act 1989 provides for the licensing of electricity suppliers. The Gas Act 1986 provides for the licensing of gas shippers and suppliers. The licensing of suppliers under the Acts is now applicable on a Great Britain-wide basis, and the licences themselves contain standard conditions for all suppliers. There is also now no distinction between suppliers selling in to or outside their traditional regions. Obligations under these licence conditions relevant to suppliers in the industrial and commercial markets are summarised in the paragraphs below. Cornwall Consulting Report for Energywatch 82

83 Figure 6:1: Overview of Ofgem Objectives and Guidance Ofgem's principal objective is to: Protect the interests of present and future consumers wherever appropriate by promoting effective competition In meeting the principal objective Ofgem must have regard to: Ensuring all reasonable demands for electricity and gas (where economically viable) are met; Securing that licence holders are able to finance their obligations; The interests of special customers including the sick and disabled, the elderly, those on low income and those in rural areas; and The interests of other utility consumers. Subject to the principal objective Ofgem is required to: - Promote efficiency & economy - Protect the public from dangers - Secure long term energy supply Ofgem must have regard to: the effect on the environment of activities connected with power generation, transmission and distribution and the conveyance of gas through pipes Ofgem must also have regard to: Social and environmental guidance issued by the Secretary of State Source: Ofgem Exclusion of Cross Subsidy As a condition of their licences, suppliers are bound not to give any crosssubsidy to, or receive a cross-subsidy from, any related business. In practice, for example, if a supplier makes losses repeatedly over a period of time which might appear to be the result of a cross-subsidy from another part of its business, this would tend to suggest a breach of this condition. However, such a circumstance would very likely be extremely difficult to prove in practice. Cornwall Consulting Report for Energywatch 83

84 Meter Reading and Theft of Energy Gas licensees must provide information, as reasonably requested by a gas transporter, to enable it to meet its licence requirements to develop and operate a safe pipeline system and detect and prevent the theft of gas. Electricity licensees and their agents must take all reasonable steps to detect and prevent theft of electricity, damage to and interference with electrical plant, meters and lines. Gas and electricity suppliers also have an obligation to ensure that meters are read, and inspect them for damage, interference or deterioration at least once in every two-year period during which they service a customer Information Provision to Customers The supply number (electricity) and meter point reference number (gas) must be provided by licensees to customers either annually or with or on each bill. Suppliers must provide their customers with a telephone number for safety purposes to report gas escapes or electrical dangers. This must be provided when the customer first signs a supply contract and then annually or with, or on, each bill Information Provision to Ofgem and GEMA Licensed suppliers are obliged to provide GEMA at any time, and in whatever form it requests it, with any information it may reasonably require, or as may be necessary for the purpose of performing its statutory duties. From time to time, Ofgem monitors aspects of the suppliers businesses, including customer numbers, market share and prices Gas Transportation Charges Gas licensees, which supply gas to customers on a gas transporter s pipeline network, must give the transporter a binding undertaking to pay its charges in the event that its shipper is terminated from the Network Code of the transporter, and no other arrangements come into force. Cornwall Consulting Report for Energywatch 84

85 Guaranteed Standards and Payments Business Energy Markets 2004 Licensees must pass on guaranteed standards payments received from either gas shippers or transporters, or electricity distributors, to the relevant customer Codes of Practice Licensees must prepare Codes of Practice covering: procedures with respect to site access, i.e. the principles and procedures that they will follow in respect of any representative requiring access to a customer s premises including compliance with statutory Rights of Entry powers; and efficient use of gas / electricity, i.e. guidance for customers on energy efficiency, including the provision of a telephone enquiry and advice service. This is primarily targeted at domestic users Deemed Contracts Licensees must prepare deemed contracts. Where there is no contract explicitly agreed between a customer and the registered supplier of a premises, the deemed contract terms apply. There is no duty to supply non-domestic customers Supplier of Last Resort In the event that one supplier ( A ) loses its licence to supply (by becoming insolvent or having its licence revoked for some reason), the Authority can direct any other licensee ( B ) to become a Supplier of Last Resort for some or all of the customers of A. This mechanism is allowable provided that it will not significantly prejudice the ability of B to continue to supply its customers, and fulfil its contractual obligations for the supply of electricity. Use of it has not yet happened to date. Ofgem, from time to time, asks licensees if they wish to be considered as a potential Supplier of Last Resort in the event that this was to happen. Once the process begins, other licence requirements come into play regarding information to be given to customers and prices that will apply. Cornwall Consulting Report for Energywatch 85

86 Transfer Agreements There are certain supporting transfer agreements which provide more detail behind the processes and operational elements of the general terms set out in the licences. In the England and Wales electricity market, the Master Registration Agreement (MRA) is a multi-party agreement that all licensed electricity suppliers and distribution network operators must sign. It governs the interactions between them when customers change supplier and provides for the governance of the Data Transfer Catalogue. The process governing the transfer of electricity customers is set out in the MRA. In the non-domestic electricity markets, currently, a supplier is permitted to block the proposed transfer of a customer supplied on negotiated (i.e. not deemed) terms on the grounds of debt or insufficient contract-termination notice. If a customer is supplied on deemed terms, the incumbent supplier can only object to a transfer if: the new supplier has contacted the old supplier and both have agreed that the customer has been registered in error; or the transfer concerns a site with related meter points, and the new supplier has not correctly applied to register all the meter points at the same time. In the gas market, the details of the process for transferring a customer are set out in the Network Code of each relevant gas network operator (transporter). In the non-domestic gas market currently, suppliers can object to a proposed transfer on the grounds of outstanding debt and insufficient contract termination notice. A code of practice exists between gas shippers to ensure customers are not financially worse off as a result of poorly administered, but legitimate switches The Customer Transfer Programme Customers have a very clear interest in knowing that a switch of supplier has taken place as expected and that they can also expect billing to continue smoothly over that change. Energy liberalisation has been accompanied by some significant issues in this area which, have materialised over the early years of experience in the use of transfer systems, and associated data. The supply industry is now seeking to collectively address these issues through a dedicated programme. In the course of our research we made contact with the Customer Transfer Programme (CTP). It is tasked with improving customer experience of switching energy suppliers and facilitating the improved systems and processes Cornwall Consulting Report for Energywatch 86

87 working for supply-side participants. It is considering the domestic and nondomestic sectors separately due to potential differing customer expectations: for example - business transfers of supplier differ from those for householders in that they are timed around contract renewal dates, as opposed to needing to be undertaken within a target timeframe. The CTP is expecting to produce consensus driven changes to industry codes and governance so that its key objectives can be met. A range of critical success factors is under development to measure performance in the business switching process and they are expected to provide an input into the ongoing monitoring of the success of the switching process. Non-domestic customer expectations were established in CTP Stage 1, through an industry wide survey and discussions with end-customers, customer representative bodies, suppliers and other industry parties. The CTP Stage 1 Critical Success Factors for the delivery of an improved customer experience have been reviewed in Stage 2, in addition to referencing other material and research. The CTP continues to take confidence that it is seeking to address the key non-domestic customer concerns over the transfer process Gas Production Ofgem is responsible for the economic regulation of all aspects of the electricity and gas supply chains with one notable exception, gas production. This activity is subject to a licensing regime overseen by the Oil and Gas Directorate of the DTI. The Directorate's overall aim is to maximise the economic benefit to the UK of its oil and gas resources, taking into account the environmental impact of hydrocarbon development and the need to ensure secure, diverse and sustainable supplies of energy to UK businesses and consumers at competitive prices. In guidance to potential new field developers, the DTI states that it will consider the following policy objectives when assessing proposals: ensuring the recovery of all economic hydrocarbon reserves; ensuring adequate and competitive provision of pipelines and facilities; and taking proper account of environmental impacts and the interests of other users of the sea. Offshore operators supply information to Transco and the DTI on gas supply to improve UK security of supply. In November 2003, UK gas terminal operators agreed to standardise and enhance the information they provide to Transco regarding their maintenance programmes, and planned and unplanned outages, Cornwall Consulting Report for Energywatch 87

88 that can affect the supply of gas. In March 2004, UK Offshore Operators Association (UKOOA) members, representing over 95 per cent of total UK gas production, agreed to increase the flow of additional, longer-term information to Transco to help with its ten-year planning process. UKOOA members have also agreed to Transco providing aggregated information to the wider market Financial Services Regulation Competition in energy markets has stimulated the development of a wide range of trading mechanisms and arrangements, some of which involve the use of financial instruments. There is an increasing inter-relationship between the oil, gas and electricity markets, how they are traded, and overlap between the participants in each. The development of sophisticated expertise by some companies in these areas has also led to the growth of advisory and management services. Markets in coal, weather and emissions have also emerged. Aspects of energy trading which involve financial instruments are subject to regulation by the Financial Services Authority (FSA), which in March issued guidance for energy market participants in what is a highly complex area. The vast majority of energy purchases by customers, being physical supply arrangements, do not involve financial instruments, and are, therefore, not subject to FSA regulation. Energy exchanges, which offer trading facilities for gas- and electricity-related investments, are subject to regulation by the FSA, and their contracts are qualifying contracts under the Financial Services Act. Likewise, some large users are buying energy on index-related mechanisms which can be managed with the aid of financial instruments sourced from non-physical market participants as well as other energy suppliers Competition Policy Markets characterised by scale players or complex monopolies can be examined by the Office of Fair Trading (OFT) (the functions of the Director General for Fair Trading (DGFT) were transferred to the OFT, and the Office of the DGFT abolished, under the Enterprise Act). Ofgem has concurrent jurisdiction in relation to the electricity and gas sectors. The OFT may make a reference to the Competition Commission to establish whether a monopoly situation operates, or may be expected to operate, against the public interest. A scale monopoly situation is defined as existing where a single company (or group of interconnected companies) supplies or acquires at least Cornwall Consulting Report for Energywatch 88

89 one-quarter of the goods or services of a particular type in all or part of the UK. A complex monopoly situation is defined as existing where a group of unconnected companies, which together account for at least one-quarter of the supply or acquisition of a particular type of goods or services, engage in conduct which has, or is likely to have, the effect of restricting, distorting or preventing competition. The enforcement of the Competition Act 1998 is carried out by Ofgem, concurrently with the OFT, where the agreement or conduct relates to commercial activities connected with the generation, transmission, or supply of electricity and the transmission, distribution and supply of gas. This distinction, taken in conjunction with DTI responsibility for offshore production of oil and gas, effectively means that Ofgem has no formal powers over the offshore gas production industry Sustainable Development As environmental and climate change concerns have increased over recent years, regulations have been introduced to encourage better environmental management by energy customers. Specific examples include: the Renewables Obligation; the Climate Change Levy; and the EU Renewables and Emissions Trading Directives. More detail on the Renewables Obligation and Climate Change Levy has been provided in Section The trading of permits to produce greenhouse gases by combustion processes such as electricity generation essentially enabling the consumption of fossil fuels is intended to be one of the key mechanisms by which international commitments to reduce their emissions will be met. Under the 1997 Kyoto Protocol, the European Union pledged to cut greenhouse gas emissions by 8% on 1990 levels over the period 2008 to The UK has a 12.5% reduction target from Kyoto, and the 2000 Climate Change Programme also adopted a 20% CO2 national target. An EU wide emissions trading scheme (ETS) is due to commence from 1 January One of the supporting mechanisms for the Climate Change Levy facilitates the voluntary trading of emissions permits on a UK national basis. There has also been a separate but linked scheme, which allowed major customers to participate in an auction process for greenhouse gas savings. However, the EU scheme brings a major change of approach as well as a broadening of scope as it is mandatory for all generators above 20MW. The UK scheme allows relative targets (i.e. linked to production) and focuses on final Cornwall Consulting Report for Energywatch 89

90 users. The EU scheme is based on absolute capped carbon dioxide emissions and encompasses energy producers in its first stage from 1 January A second phase to the scheme is intended to run from January 2008 to The ETS is a cap and trade system where allowances are awarded free to participants including generators, according to historic emissions. Fewer allowances will be allocated in this way over time in line with targets for reducing emissions. Participants, therefore, face the choice of investing in abatement measures or buying additional permits to meet any shortfall. Penalties for failure to comply are severe: 40/EU Allowance (EUA) in Phase I, rising to 100/EUA in Phase II. Market prices for the first phase of the scheme stood around 9/EUA in mid October Their low levels have been attributed to perceived lax permit allocation plans tabled by many EU member states The Carbon Trust Government has created the Carbon Trust, an independent, not-for-profit, company, to operate alongside business, public bodies and the research community in helping achieve its sustainable development targets. The Trust offers advice on energy management, helping organisations to minimise their Climate Change Levy liabilities and promoting investment in low-carbon technologies. The most notable Carbon Trust initiative from the perspective of the business energy user is arguably the Action Energy programme Customer Representation Energywatch was established by the Utilities Act 2000 (the legislation that also set up GEMA) as the Gas and Electricity Consumer Council. An independent, publicly funded body, its purpose is to protect the interests of customers of gas and electricity by: providing advice and information to consumers, public authorities and other persons; investigating consumer complaints; and monitoring customer issues, developing proposals to improve market functioning from the customer s point of view. Cornwall Consulting Report for Energywatch 90

91 Perhaps Energywatch s most important power is its newly acquired ability to seek a competitive investigation into energy markets it perceives may not be acting in customer interests. Following the coming into force of the Enterprise Act 2002 (Bodies Designated to make Supercomplaints) Order 2004 in July 2004, Energywatch now has powers to make a supercomplaint about behaviour which may be damaging to customer interests. Technically, a supercomplaint is defined as a complaint submitted by an authorised customer body alleging that any feature, or combination of features, of a market in the United Kingdom for goods or services is, or appears to be, significantly harming the interests of consumers. It is intended to act as a fast track system under which market features that are significantly harming customer interests can be brought to the attention of the Office of Fair Trading (OFT) and, in the case of the energy markets, Ofgem. The regulator to whom the supercomplaint is made must respond within 90 days and explain how it will deal with the supercomplaint. Whilst the power to raise a supercomplaint relates solely to domestic consumers any reference by energywatch under these powers could also embrace a wider market perspective including the impact on business consumers. In terms of servicing business customers, Energywatch has recently established a Business Services Team with the specific objectives of: managing information on consumer experience in a way that makes it easy to spot patterns of behaviour and types of complaints that point to areas where change is needed; understanding levels of consumer satisfaction and customer service across all suppliers, to help direct and prioritise change actions; focusing attention on those suppliers who generate patterns of complaints and dissatisfaction that indicate the need for change, thereby encouraging them to share information and agree change targets that will improve their customers experience, and ensure that business consumers get the standard of customer service that they deserve; taking to task those suppliers who persist in taking advantage of small business consumers, for example, through aggressive and misleading selling and over enthusiastic credit control; defining a dedicated service for business consumers where they can come for advice, complaint escalation and resolution and delivered through Energywatch s existing regional and national offices; and ensuring that consumers have the information they need to engage responsibly and knowledgeably for their energy supply, and accepting that fuel has to be paid for, while likewise pressing suppliers to accept that they need to work harder to understand the needs of their consumers, and configure their processes and attitudes accordingly. Cornwall Consulting Report for Energywatch 91

92 6.8. Implications for Business Customers Since 2000, the national energy policy framework has changed considerably. There is still a significant commitment to competitive markets, but now in a much broader policy context, including environmental, security of supply and social aspects. For business energy customers, this has some significant implications. As noted in Section 3.3, environment-related charges are now a significant proportion of business electricity costs in particular, and can be expected to increase over time. There is much official encouragement for companies to improve their environmental and energy management through better reporting, with official guidance accreditation schemes and incentives. Cornwall Consulting Report for Energywatch 92

93 7. Customer and Other Stakeholder Views In its statutory role representing the interests of energy customers, Energywatch is in contact with users from across Britain s electricity and gas markets. Until very recently, the business sector has not been a primary focus for Energywatch, though awareness has been maintained of sector issues. Since the start of 2003, concerns from business customers about the state of competition for their electricity and gas requirements have increased. Smaller users concerns have centred on access to competing offers and their interpretation, billing and service standards, and the conduct of some sales processes. Larger users have expressed disquiet over similar issues augmented by some significant criticism of wholesale market prices and structures. Part of the rationale for undertaking this review has been to investigate such concerns and identify areas where Energywatch might act to secure improvements on behalf of business customers. We have, therefore, been keen to engage with market participants to understand their perspectives on the business electricity and gas markets and assess from them: perceptions of the level of competition in supply to industrial and commercial customers, both across the sector as a whole and also with consideration to key subsectors where it may be stronger or weaker than elsewhere; views on issues in the market that may act to inhibit competitive dynamics along with suggestions for how improvements can be made; and views on how competition in supply is likely to develop over the next two years given the continuation of the current environment. We approached around 150 customers, customer representative groups and trade associations, customer advisors, energy suppliers and other bodies. The initiative was also highlighted on the Energywatch website and end users were also invited to contribute their views via this route. In total we received feedback from 53 organisations, of which 29 were customers. Some 21 interviews were undertaken with market participants, of whom 14 were suppliers and 6 were from the customer side. We also talked to Ofgem. The interviews were undertaken during the period May to August We received a variety of different perspectives. Many of them used Ofgem s 2003 review of the sector as their baseline. Accordingly, this Section takes Ofgem s position as its starting point in reviewing participant views of energy supply competition to business customers in It builds from there by presenting a summary of views concerning each of the issues highlighted above. Cornwall Consulting Report for Energywatch 93

94 7.1. The View of the Office of Gas and Electricity Markets In July 2003, Ofgem published a review 42 of the industrial and commercial gas and electricity supply markets. The study followed customer concerns that competitive pressures may be weakening. It reviewed Ofgem initiatives in facilitating competition, particularly in the area of supplier switching, as well as demonstrating that, in its opinion, the British business markets for electricity and gas are more competitive than those elsewhere in the EU, and that this has provided benefits for users. In the document, Ofgem reported that customer concerns with service quality, levels of competition, problems with switching and data quality prompted its review. It included a comparison of competition on a European level which concluded that it is more established in Great Britain and that this has worked to the benefit of customers. We approached Ofgem to obtain its views on how business supply markets might have evolved over the last year. Ofgem informed us that the review still represented its current views. A considerable portion of the document is devoted to the establishment of a framework designed to provide the structure within which Ofgem can manage its Competition Act (1998) powers. Ofgem concludes that gas and electricity are separate markets: the former a Great Britain-wide market, the latter split between Scotland and England and Wales due to historic differences in wholesale power trading. Table 7.1 and Table 7.2 summarise the Ofgem market frameworks for gas and electricity. Ofgem also reached judgements on the nature of competition between suppliers in each sector and also on customers typical behaviour and requirements. Overall, the conclusion was that the gas market is more competitive than electricity, and that more complex administrative and balancing requirements may have a role in individual market concentration. Generally though, Ofgem was satisfied at that time that sufficient competition exists. Table 7:3 and Table 7:4 summarise Ofgem s conclusions on competition in business energy markets, highlighting some key quotes, which we believe imply structural limits to the further development of competition. 42 Review of competition in the non-domestic gas and electricity supply sectors - Initial findings, Ofgem July 2003 Cornwall Consulting Report for Energywatch 94

95 Table 7:1: Summary of Ofgem s Business Market Framework Electricity Customer Type Key Market Characteristics Small Annual demand up to 200 MWh (approx 12k spend) Electricity as support to business rather than input to process Non daily metered accounts, majority quarterly billed Low spend levels mean standard supplier offerings competition around brand as well as price High volume back office systems required by suppliers Medium Annual demand from 200 MWh to 30 GWh (approx 1m spend) Electricity as key input to business processes Monthly billed accounts, all but smallest half hourly metered Bespoke offerings often with disaggregated (energy + pass through) pricing Account management is key supplier attribute Few barriers to new entry Large Annual demand from 30 GWh Electricity fundamental to process operation Bespoke arrangements likely to embody risk management tools possibly involving customer input Scale of customer volume confers some degree of buyer power and possibly restricts supplier activity Robust forecasting, trading and balancing systems required by suppliers Source: Cornwall Consulting summary of Ofgem Review of competition in the non-domestic gas and electricity supply sectors - Initial findings, July 2003 Cornwall Consulting Report for Energywatch 95

96 Table 7:2: Summary of Ofgem s Business Market Framework Gas Customer Type Key Market Characteristics Small firm Annual demand up to 50,000 therms/1.47 GWh (approx 20k spend) Electricity as support for business rather than input to manufacturing process Low spend levels mean standard supplier offerings competition around brand as well as price High volume back office systems required by suppliers Close links with medium firm market Medium firm Annual demand from 50,000 therms/1.47 GWh upwards Interruptible (excl. generators) Process and space heating requirements Bespoke terms including indexed prices available most likely to larger daily metered sites Robust forecasting, trading and balancing systems required by suppliers Minimum eligibility threshold of 200,000 therms/5.86 GWh p.a. lower transportation costs than similar firm loads with potential for lower wholesale costs Process use is primary requirement demand process rather than temperature driven Bespoke terms including indexed prices are standard Sophisticated buyers whose purchase volumes give them a degree of power Few suppliers active as operating regime seen as more onerous than firm Source: Cornwall Consulting summary of Ofgem Review of competition in the non-domestic gas and electricity supply sectors - Initial findings, July 2003 Cornwall Consulting Report for Energywatch 96

97 Table 7:3: Summary of Ofgem s Conclusions on Business Markets Electricity Customer Type Average Energy Price ( /MWh) Market Concentration Ease of New Entry Defining Quote Small 41 High Difficult It is reasonable to expect that concentration in this market may therefore not substantially alter over time. Medium 27 Higher than Small Large 20 Higher than Medium Easier than Small and Large Difficult analysis of this potential market suggests new entrants may be able to enter this segment more easily this has the features of a market where a limited number of suppliers can compete for the business of a relatively low number of customers. Source: Cornwall Consulting summary of Ofgem Review of competition in the non-domestic gas and electricity supply sectors - Initial findings, July 2003 Table 7:4: Summary of Ofgem s Conclusions on Business Markets Gas Customer Type Average Energy Price (p/therm) Small firm 36 ( 12.3/MWh) Medium firm 24 ( 8.2/MWh) Interruptible 21 ( 7.2/MWh) Market Concentration High Moderate Moderate Ease of New Entry No specific reference, but 8 new entrants to gas market noted since (2001 = 3, 2002 = 4, 2003 =1) Defining Quote As with the small non-domestic electricity market, issues of scale are seen as relevant to the ability of suppliers to operate in this segment. the relatively lower shares of the top three suppliers and the number of suppliers operating in this market [suggest] it is moderately concentrated, with new entrants succeeding in building market share. where customers in this market switch supplier, substantial changes in supplier market share are expected. Source: Cornwall Consulting summary of Ofgem Review of competition in the non-domestic gas and electricity supply sectors - Initial findings, July 2003 Cornwall Consulting Report for Energywatch 97

98 7.2. Other Stakeholder Views The recent upturn in wholesale power and gas markets has caused customer supply prices to increase very significantly. Nothing is more likely to focus customer attention than price rises. It has also meant major changes in the approach of suppliers to the market, to which many have already adapted, and of customers, where progress has, arguably, been slower, and the interaction between the two. In such an environment, data discrepancies and service failures are likely to prove more costly and, consequently, good service should have more value. In the following paragraphs, we summarise the views received from market participants on the issues where we sought their input. We received these views either in the form of written submissions in response to an initial written request, or through interviewing key market participants. Often these interviews were undertaken on a confidential basis. The views are presented by participant group followed by a summary of key themes; in some cases, where they concern the conduct of other market participants, we have included representative responses from those parties. There is one significant exception to this: many respondents from all sides of the market expressed views to us about the conduct and role of brokers and advisors acting as intermediaries between customers and suppliers. This subject is addressed separately at the close of this section. Our observations and comments on the issues raised are included in Section 8, along with the recommendations from this review process. Table 7:5 and Table 7:6 present a summary of participant views Level of Competition and Assessments of Trading Conditions Smaller Customers The feedback obtained from smaller electricity and gas customers tended to focus on the practical issues around sourcing and switching competitive suppliers, and on the administration of supply contracts. This feedback was obtained direct from users and also from groups including trade associations representing smaller sites. Cornwall Consulting Report for Energywatch 98

99 Table 7:5: Summary of Customer Views Nature of competition Recent changes Issues/improvements Future expectation Small customers Large customers Lessening, lots of trade names but fewer real participants Complicated needs expertise and timing Suppliers can be overly aggressive in debt collection Reducing as independents exit and larger players merge More competition in larger than smaller site markets Data issues inhibit competition for multi-site users Service is generally poor Suppliers obfuscate the market Debt management is becoming more intrusive Billing is extremely problematic Administrative systems are a mess and objections to transfers are increasing Extreme concerns about wholesale markets, esp. gas Too much consolidation has been permitted Information on choice and education about it should be made easier to find Improve transparency of tariff information and bills Improve data flows and billing Conduct of sales agents should be addressed Contract terms - clear and fair and made apparent by sales rep Cooling off periods should be introduced Lack of regulatory focus on real issues (i.e. wholesale markets) Too much regulatory activity in areas of questionable benefit (e.g. RGMA, DN sales) More competitive wholesale markets Conduct of brokers Without improvements market will get more difficult for customers struggling to deal with rising prices Consolidation will continue, competition will decline Some customers will close Wholesale gas market needs to be looked at properly if retail competition is to survive

100 Table 7:6: Summary of Supplier Views Business Energy Markets 2004 Nature of competition Recent changes Issues/improvements Future expectation Independent suppliers Integrated suppliers Diminishing rapidly; the big are big enough - the beginnings of oligopolistic behaviour Works well in intensive sector Customers buy on price little allowance for service Major integrated players are very reluctant to offer wholesale product Competition is by and large working well Competition is generally price and not service driven Some issues in data, Scottish electricity and residual monopolies can impact competition Customers locked in on 2-5 year contracts with narrow exit windows Transfer objections going up Wholesale trading is more difficult with reducing counterparties inhibits operations Some customers have adapted the way they approach the market but others need to catch up Wholesale market liquidity is declining and this can effect ability to compete for some customers Increased objections triggering more customer complaints Predatory pricing by producer backed suppliers Conduct of brokers Regulatory burden Conduct of some brokers Excessive regulatory change is a burden to competition as it can impose extra and unforeseen costs Transfer pricing and wholesale market liquidity 5-6 large suppliers with minimal switching and choice for customers Service and innovation will be low Supply margins will be 2-3 times now Consolidation and exit amongst brokers/agents Products could look very different especially for the larger customer Prices will carry on increasing Environmental issues will push prices up further, Energy services may ameliorate cost increases Security of supply has to be funded Cornwall Consulting Report for Energywatch 100

101 Representative groups tended to present a broader picture of the electricity and gas supply markets. The picture presented by them can be characterised in the following points: customers have a low level of knowledge of the opportunities open to them from energy supply competition; overall there has been a reduction in competition since 2000 as consolidation has reduced the number of active suppliers in the market. The use of different brands by some of the major suppliers can confuse customers and leave them with the perception that there is more competition in the market than there actually is; small business users have difficulties obtaining and evaluating offers from competing suppliers, given a perceived non-comparability of terms and a general lack of transparency; awareness and understanding of the recent shift to fixed term contracts is low, leading to a greater tendency to contract disputes around invalid transfers; whilst individual supplier performance can vary, the energy supply industry collectively is not good at billing its customers and administering their contracts. One major trade association told us that this can unfortunately lead to heavy handed treatment of customers often correctly disputing erroneous bills. Whilst it recognises the importance of credit control to energy supply companies, it believes such instances are damaging to the reputation of the industry as a whole and should be minimised; and mis-selling is an issue for some customers and deters their participation in the market. Individual users tended to cite particular perceptions reflecting their own circumstances. Examples included access to the difficulties in securing access to competing offers, re-sale energy charges levied by landlords, lack of accurate billing and a perceived reduction in the number of suppliers competing in the market. A particular issue emerged concerning public house tenancy changes where new licensees have apparently been wrongly told that they are responsible for the previous tenants bills Larger Customers Larger customers, both individual organisations and their representative groups, expressed considerable concern about the functioning of a number of aspects of the competitive energy markets. These aspects ranged along the supply chain from wholesale markets, especially gas, to billing and contract administration issues. In terms of the level of competition, one representative group told us that it does not believe that the markets for electricity and gas

102 are truly competitive citing a very significant reduction in suppliers (it claims from 18 to 6) over a very short period of time, and vertical integration about which we should be very concerned. The practical effect of this change is, according to this body, that customers struggle to secure sufficient offers to generate competition to supply their requirements. Even if offers are made, they may not cover the entire portfolio of a multi-site customer. We asked suppliers for their perspective on the multi-site issue. Whilst responses varied, they tended to incorporate the following points to the effect that customers as well as suppliers can acquire reputations (good and bad): customers should provide good data to quote on, preparing a response to a multi-site tender has a resource cost to suppliers, and even a well prepared request can take a full day s time for a pricing team; customers should make sure they pay promptly according to the payment terms of their contracts and not late; some purchasing practices (specifically including sealed bid tenders) do not permit suppliers to offer their most competitive propositions; and, perhaps most notably, customers should be prepared to switch. Suppliers quickly learn which is a serious enquiry and which is market testing. Market testers should not expect lots of offers! Some major customers directly attribute their perception of reduced competition to the entry of major European utilities. This reaction is because they feel that such large companies do not treat the British market as a priority and are, therefore, not particularly interested in servicing customers in this country. More widespread concern is expressed about vertical integration, as, it is argued, operators with their own energy production and retail businesses do not need to participate actively in wholesale markets, even though they need the prices produced in these same wholesale markets as the basis for their supply contract offers. Some customers question this price basis pointing out that they feel wholesale energy markets produce prices that do not correspond to fuel production costs. For example, one manufacturer told us that one of the problems is duration of any quotations, these seem to be valid for less than one day. It is highly unlikely that the suppliers cost of production is so volatile to necessitate this short duration of quotation. Therefore, one has to question market dynamics and the lack of action by Ofgem to bring stability and to stop unjustified price increases. The volatility as well as the price levels that recent wholesale market conditions have brought is subject to concern to customers, especially those with operations across Europe. One major industrialist provided us with data on delivered gas prices in Germany and Italy. It wished to highlight to us the broad stability the oil-indexed contract price mechanisms applicable in both countries bring to prices. It is also worth highlighting the downward trend observable for both Italian and German prices in 2004 compared with 2003 Cornwall Consulting Report for Energywatch 102

103 and contrast that with the British experience illustrated in Section , where average gas price increases of 40% plus are shown. Emphasising this point the customer concerned told us that the expected prices for 2005 (which have been based on a sensible view of the appropriate indexation factors) are below where forward UK wholesale (and I emphasise wholesale) prices have been. If anyone had suggested this to us 12 months ago we would have laughed at them!!!! Figure 7:1: Gas Prices Payable by a Major Industrial Company for Sites in Germany and Italy p/kwh equivalent German Site Italian Site 1 Italian Site 2 Source: a major industrial company. Data is presented on a pre-tax basis i.e. inclusive of gas and transportation costs prices are based on projections of appropriate indexation formulas. One customer group made the point to us that one way to judge the level of competition is by assessing the differences between the quality of service offered by suppliers. It felt that these differences are very few, and that some suppliers do not even reach the basis of an acceptable service. Another major public sector buyer told us that, whilst it had managed to find some suppliers which can provide acceptable levels of service, the performance of the majority of suppliers remains substandard in key areas including registrations, billing and account management. It informed us that, in assessing tenders, it tried to measure service aspects through questionnaires, visits, references, and wherever possible testing sample bill formats and registration reports. It uses its conclusions from this analysis to support its policy of awarding contracts on the basis of best value rather than awarding business to the lowest priced offer. It also noted that, even so, in its experience, there is a strong risk of paying a premium but still receiving substandard service. Cornwall Consulting Report for Energywatch 103

104 Whilst customer experience varies across the sector, a small number of suppliers were consistently quoted by larger customers as being associated with better than normal levels of service. These suppliers are Shell Gas Direct, Elf Business Energy and British Energy. No supplier was quoted as offering consistently bad service to its customers: some attracted praise and criticism in equal measure. Some customers have established service level agreements with their suppliers defining terms such as the timeliness and accuracy of registration and billing. To have force, customers say, these agreements should include penalty payments in the event of service failure, but they find it very difficult, if not impossible, to secure such terms. Another measure of the level of competition which customers quoted to us is the confidence which they feel in changing supplier. Whilst the switching process appears to function reasonably for many larger customers, some multi-site contract customers informed us that they feel it presents a significant barrier to their benefiting fully from competitive energy markets. They told us that poorly administered switches of supplier and subsequent billing difficulties in the past had left them with very significant account issues to be settled, sometimes involving disputes with former, as well as new, suppliers. These difficulties seem particularly concentrated on the public sector. A number of public sector buyers told us that perceptions of switching problems acted as a deterrent to their wanting to switch. Some also stated to us that they felt such issues deterred suppliers from competing for their business and attributed them as the key factor behind their struggle to attract sufficient bids for a competitive procurement process. They also seem to influence directly those customers willingness to switch. A major public sector purchaser told us that it did not normally switch energy suppliers for less than a 5% saving, because its experience taught it that a transfer was likely to cost it at least that in extra transaction costs. Others quoted differentials of a similar scale. Our feedback suggests that this is predominantly a gas issue but it can also feature in electricity as well. We also heard anecdotal evidence that some suppliers are routinely objecting to all transfers away from them, and that this is becoming a feature of both gas and electricity markets. What customers perceive to be tenuous excuses presented to them for blocked transfers include outstanding debt in circumstances where a supply company has not yet drawn an established standing order Smaller and Independent Suppliers Representatives from smaller and independent suppliers (i.e. companies not held in common ownership with producing assets, either gas or electricity) were particularly keen to engage with Energywatch as part of this review and put across their views on market issues. They advanced the argument that a healthy competitive market is evidenced by a diverse and viable supply side. For the reasons listed below they do not believe this to be the case: Cornwall Consulting Report for Energywatch 104

105 the recent departure of independent suppliers including Maverick, Atlantic Electric and Gas and UK Electric Power is practical evidence of declining competition. There are fewer suppliers for customers to choose from; the commercial pressures on smaller suppliers and the difficulties of competing with diversified scale players are such that more can be expected to exit the market, especially given the propensity for sudden, unexpected and expensive to implement changes to trading rules; in general, the major suppliers are retaining customers and not acquiring new ones; there is low awareness amongst smaller customers of the opportunities open to them (including the fact that smaller independent suppliers can compete for their business) and accessing them properly, with more resource being expended on customer rights when things go wrong; competing on price with producer-backed suppliers can be an issue. Independent suppliers of both gas and power tend to set their pricing according to the wholesale curve every day. It is perceived that some of the majors adhere to this principle less rigorously which allows them a commercial advantage; major suppliers appear to be attempting to lock in their customers after a sale through blocking strategies like early termination and long notice clauses in contracts. These strategies seem particularly commonplace in the SME sector; and outside of a small niche market based around renewables, customers tend to buy on price, yet most issues that arise are connected with service. In such a low margin environment, it is extremely difficult to fund innovation in service. Therefore, there is pressure for the bodies like Energywatch to set customer service expectations, so depriving suppliers of a valuable opportunity to differentiate their offerings. Smaller suppliers generally perceive that competition works best in the intensive sector where they perceive customers to be at their most pricesensitive. Several claimed that this sensitivity is such that that they could not earn a viable commercial return from dealing in it. One smaller supplier told us that it did not serve larger customers because: the multi-site and meter sector is expensive to serve and this complexity leads to a greater tendency to debt write offs which really hurt in a low margin business; a lot of middle tier customers use brokers who are paid commission. It is unclear in whose interest they act as they are paid commission. [we] try not to deal with commission brokers. Instead [we] use associates to promote [our] products; and Cornwall Consulting Report for Energywatch 105

106 credit is impossible to fund the credit/working capital requirements inherent in serving larger volume accounts. Presently [we have] posted 10% of annual turnover in security credit. A large supplier which does serve this sector made a comment which appears to put some useful detail on this prognosis: very large users have unique and highly specialised requirements which many suppliers may not be equipped to deal with. This market is very complex and the systems needed to support market participation are a major sunk cost to any company looking to serve this segment. For this reason, we believe that many suppliers do not target large users. Another smaller supplier explained to us that it had recently cut back its own sales activity and is now active in 25% of the market it used to be in. From an independent supplier s point of view, it believes that selling into a falling market is easier than a rising one as customers are less likely to switch if savings are not significant. It commented further that most group customers do not move supplier, as currently available savings do not justify the effort, even to the extent that 4-5% savings will be turned down. Overall, the perception from this sector of the market is that competition is diminishing rapidly. One operator told us that the big are big enough and there appears to be the beginnings of oligopolistic behaviour emerging. For example the dropping of sales agents is happening, as there is now no reason for them to exist [because major suppliers are not seeking to grow sales]. Customers are being locked in on 2-5 year contracts with narrow exit windows, which many won t remember. Captive markets are being created. The role of small suppliers like [x company] is to keep the big guys honest this is becoming progressively more difficult Larger and Integrated Suppliers Participants from this sector of the market put forward very strong opinions on the nature and intensity of supply competition to business energy customers. Generally, they argued that the level of competition in supply to industrial and commercial customers is intense across the entire sector. Their reasoning for this assertion included the following: the very low level of margins achievable from supplying business customers (quoted by one major operator as 0.02 p/kwh for electricity to major users. Another told us that it is widely accepted, that returns are tight in this market segment. One other supplier told us that part of the reason for low margins is the existence of distressed players with significant upstream positions in both the gas and electricity markets); commercial conditions in certain sub-sectors precluded their active participation in them. Only three suppliers told us they were active across the business gas market, for example; Cornwall Consulting Report for Energywatch 106

107 the relatively low levels of market share by volume held by suppliers. One told us that there are currently no suppliers with a market share greater than 23% in the I&C gas market and 33% in the I&C electricity market recent very high wholesale prices encouraging customers to undertake more active purchasing rather than simply accepting renewal offers; and the importance of major users as an alternative channel to the traded market for major producers (both power generators and gas field operators). In support of its arguments about the competitive nature of the business energy markets, one major supplier active across wide sectors of the electricity and gas markets told us the following: we believe we are typically competing with up to 6 competitors for all significant accounts; in the period Q2 to Q4 03 in the I & C sector [we] lost business to 11 competitors (where customers were prepared to disclose the winning supplier). In Q1 04 we lost business to 8 competitors; and [we try] to quote for all business put to [us] and [are] only limited in [our] ability to do so by [our] internal resource capability. Some suppliers made reference to official reports and investigations, including those by the National Audit Office 43 and Public Accounts Committee 44, as well as Ofgem s 2003 market review. Some told us that they perceive the smaller customer market to be less competitive for gas and electricity than for larger users. Various reasons were cited for this distinction including difficulty of accessing unknown smaller users compared to higher profile major users, levels of customer knowledge and awareness, relative administrative simplicity for suppliers and the influence of energy brokers and advisors. One particularly pointed out to us its view that brokers had the skills and resource to chase offers for customers, which individual buyers may find more difficult. It told us that this situation gets worse as we get closer to the expiry dates, as the market generally gets very busy and difficult. Suppliers don t have the resources to deal with vast numbers of customer enquiries. Not surprisingly, given the above points, price is widely felt to be the key, if not always the only, driver of customer decisions. One supplier told us that occasionally it can win customers on the basis of bad service from its rivals and good service can also help retain customers. However, it says experience has taught it that good service is not a consistent enough factor on which to build a viable business. Whilst we heard much about larger users in 43 The New Electricity Trading Arrangements in England and Wales, 44 The New Electricity Trading Arrangements in England and Wales, Second Report, 16 December Cornwall Consulting Report for Energywatch 107

108 particular not valuing service from their suppliers at all, a major supplier to the larger industrial sector told us that good customer service was the critical factor in it winning and retaining customers. This situation arises because it serves a sector where most pricing is driven from published wholesale marker prices and suppliers are, therefore, competing on small administration/service margins and so service levels become very important. It argues that, in its sector, levels of service are very tailored to customers and do win business because suppliers cannot compete on price (because they are passing through published rates), so reputation and quality of service are key. The above remark reflects the widespread expectation that as prices are driven from the wholesale market as monitored by price reporters, there should be some consistency in offer levels. Some suppliers expressed bemusement at their perceptions of the pricing strategies of some of their rivals, best evidenced by the quote below concerning the larger site electricity market: [our] analysis shows that, in recent quarters, [we were] 3-4% behind on price when [we were] unsuccessful in obtaining contracts. This is a very wide margin in a market that is based on a traded market producing widely disclosed prices. Similar concerns were expressed by some suppliers at the perceived actions of some rivals in the gas market. One told us that the large volume site (firm and interruptible) market is driven by the strategic priorities of the major producers rather than supply competition no-one makes any money in supplying this sector, it is being cross-subsidised by producers treating it as a part of their overall trading strategies. We asked suppliers with an important presence in this sector of the market for their views of allegations like this. The responses we received emphasised that they operated as stand alone businesses in their own right and that there was no scope for aggressive pricing on a sustained basis because their selling prices rates are referenced to market indices and their company position is marked to market daily. Therefore, were prices to be offered to customers at less than market rates, they would take a direct loss, which they would not be able to sustain. Several suppliers did, however, note that, over time, they expect non-price factors to become more important in customers decision making. A few observed that they were seeing this trend start, as customers demand accurate and timely billing and account management services. Others commented that they expect pressure to improve energy management to translate through to demand for energy services bundled with energy supply contracts Key Themes From the diverse views and opinions our respondents expressed, a number of key themes emerge on the level of competition in the supply of electricity and gas to business customers in Great Britain. Likewise, some important differences of opinion appear to highlight issues which should be of concern Cornwall Consulting Report for Energywatch 108

109 to the wider market and to policy makers. Considering the issues on which a broad, if not absolute, consensus of opinion appears to exist, we might draw the following high level conclusions about the level of competition: wholesale energy markets are the key driver of prices offered to business customers; structural change in the wholesale sector has a direct bearing on the competitive supply market; supply margins (as a proportion of the bill) tend to fall the larger the customer s requirement; some sectors of the market are more complex and costly to serve than others; price is the key factor behind customer switching decisions; the standard of service offered by suppliers can vary considerably and by sector for individual operators; suppliers target their activity in the market; very few are active across all sectors at any one time; and there are fewer suppliers active in the market in 2004 than in previous years. It is worth noting at this point that all respondents bar those from the larger suppliers feel that business energy markets are becoming less competitive Issues which May Inhibit Competitive Dynamics On the following pages we summarise the views put to us on factors in the market which may serve to limit the workings of competition, together with opinions on how some may be addressed. As in Section 7.2.1, they are presented according to source. Reflecting the position on the level of competition, unsurprisingly smaller customers and their representative groups tended to focus on matters that would directly improve their participation in the market. Larger customers and suppliers tended to raise more issues relating to regulatory policy and market structure. Cornwall Consulting Report for Energywatch 109

110 Smaller Customers Smaller customers and their representatives are keen to ensure that the market works better from a practical perspective. Amongst the suggestions they raised are: information on choice and education about it should be made easier to find; suppliers should be encouraged to improve their registration and billing operations, with information on individual performance readily accessible; mis-selling is an issue and can be reduced as the conduct of sales agents should be improved through a code of practice, as has been the case in the domestic sector; efforts should be made to ensure competing tariffs are comparable; consumer protection measures should be improved at the point of sale contract terms should be clear and fair and made apparent by sales representatives at the point of sale. Cooling off periods may be worth introducing; and bills should be made clearer. In particular, they should show all elements the climate change levy should appear on all bills as a separate line item Larger Customers Whilst larger customers are keen to improve the working of the market from a practical point of view, they are just as much, if not more concerned, by structural and policy issues, especially those connected with wholesale energy markets. In this area, there is sometimes a correlation of views between larger customers and their suppliers, especially concerning issues around regulation and market structure. Arguably, the two most significant areas of concern to larger customers at present are wholesale prices, especially gas, and the transfer process. Concerning the latter, one public sector user group told us that this is clearly a barrier to competition, with many consumers avoiding the tendering process in order to stay with the incumbent supplier and even if they do tender, they still look for reasons to stay with the incumbent. Some customers told us that difficulties in the transfer process often heralded the start of major problems with billing. One user group told us that, in its opinion, inaccurate billing often stems from bad estimates and that some customers will not change suppliers until they have recovered monies owing to them, a process it argues can take an inordinate amount of time. Frequent industry rule and cost changes were also cited by users as a major factor behind the billing problems they experienced, but Cornwall Consulting Report for Energywatch 110

111 perhaps the most important single factor raised by customers was supplier systems integration. Suppliers have acted to integrate and combine billing systems on completing the acquisition of their rivals. This process appears in several cases to have been problematic and more time consuming than expected. For their customers this situation has often led to practical difficulties in managing their accounts as bills are either not submitted at all or submitted inaccurately. These difficulties appear to have been concentrated on the major integrated suppliers: all bar Scottish Power have acquired rival suppliers serving the industrial and commercial sector since For example, one major retailer told us that, since its supplier was formally absorbed by an acquiring company in October 2003, it had not received an accurate bill. It states that this is due apparently to a lack of training and a lack of communication between the staff of the two suppliers. We asked the suppliers for their perspective on this issue and their responses are summarised in the following Sections. On the subject of wholesale prices, one manufacturer told us; not enough UK gas, or storage, or true competition. Therefore, [there has been a] price increase of 40% [which is] totally unacceptable to industry. Others made the point very forcefully that any continuation of delivered energy prices at 2004 levels for a sustained period of time would lead to capacity cutbacks. Furthermore, they made it clear that they did not trust any market that they perceived to be so opaque. There is a widespread perception amongst larger customers that offshore gas field maintenance is somehow planned to manipulate the market. Their concerns are clearly also familiar to their suppliers and are encapsulated in the following description from one of these companies as the phrase that the market is where it is because it wants to be cannot reflect a truly competitive market and the linkage between oil and gas; and [in turn] gas and electricity is often cited as the reason for price movements, particularly upward movements. Whilst this is true, the linkages are often broken and no reflection can be made. This linkage can be difficult to comprehend in some cases, as UK gas deals are not linked to oil deals, as is the case in mainland Europe. Another supplier told us that customer scepticism about the wholesale gas market hinders supply competition because one effect is that, if customers don t believe the prices, they delay signing contracts or take short term deals, meaning that a bad situation could be much worse if we have a difficult winter. This is happening now. Large customers and their representatives have lobbied for a wide-ranging regulatory investigation into offshore gas markets. We asked some of these organisations for their reasons for taking this stance. They told us that such an investigation was now necessary because: British electricity and gas prices have moved significantly above those of key peer nations, giving industry a cost disadvantage against its rivals; Cornwall Consulting Report for Energywatch 111

112 there is an absence of local drivers that might cause price increases in excess of general price drivers elsewhere; and they are unable to rationalise, even remotely, reasons that might justify the magnitude of the price increases they are facing because the offshore market is very opaque. Other issues inhibiting competition from the larger user s perspective include market complexity. One user group believes this increases suppliers operating costs reducing their ability to make a fair profit. Examples of such market complexity quoted by it and other larger users include the introduction of competitive gas metering, the fragmentation of the price control on Transco s gas network charges, and the possible sale of some regional gas distribution networks by NGT. Other issues to emerge consistently from our research include customer perceptions that: the high cost of entry to the market and of compliance for suppliers may explain subsequent exits and consolidation; a lack of resources on the supply side to quote, administer and bill contracts is hindering competition; diminishing agent competition and reducing performance are resulting in heavily restricted choice in meter reading, data aggregation and collection; the declining number of suppliers available is also lowering service standards as customers have less discretion in who they choose to deal with; and the lack of meter readings for small sites is making competition more expensive. This situation is argued as being worse in gas and has meant that many customers use their own meter read data in their tenders. However, this is resource intensive. Many large users are very frustrated at what they perceive to be a muddling of regulatory priorities. One major user group told us that generally this is regarded as not always being in the consumer's interest, but rather a theoretical economic plan which is not always pragmatic and adds to the complexity of the systems. Others observed that there seems to be a political tension in regulation between Ofgem and the DTI which is hindering the investigation they would like to see in to the offshore gas market Smaller and Independent Suppliers Smaller and independent suppliers typically expressed concerns about the workings of the supply markets and argued that a number were directly Cornwall Consulting Report for Energywatch 112

113 inhibiting their ability to compete. Many of these concerns can be traced back to wholesale market structures and current dynamics in that sector. The typical, but by no means exclusive, view smaller suppliers wished to relay to us is that, due to consolidation in the wholesale sector, either by integration or contract, freely traded power available to small suppliers is becoming more difficult to source. They attribute vertical re-integration as the main driver behind falling wholesale market liquidity. One small supplier told us that it had six counterparties with which it could normally expect to trade electricity. Another told us that it had three. Furthermore, they argue that the traded market is becoming more granular, with trading moving towards power station lots and not smaller tranches more suited to independent suppliers. In the half hourly market, we were told, there is very little trading as the larger players seek to retain necessary flexibility to meet demand fluctuations in their own generating portfolios. One told us that it feared that very soon all marginal plant will be in the hands of vertically integrated companies so that small players would not be able to buy shaped products on the wholesale market. One independent supplier with recent experience of both gas and power markets told us that, in its opinion, the situation is worse in the gas market. Liquidity is such that small players cannot cover expected times of high, volatile prices as there is no diversity of players willing to provide it. It alleges that gas is being held back from trading to be released back to spot at times when there are electricity peaks. One smaller supplier informed us that it believes the major integrated players are very reluctant to offer wholesale product to suppliers. It claims that a number have told it the reason for this is that the small supplier competes with the retail business of the integrated operator, but this has never been put in writing. The failure of independent generators and their acquisition by existing scale players also means there is much less free capacity to buy from. Even where smaller suppliers can negotiate a wholesale arrangement, they note what they perceive to be a general tightening of credit terms, which, they argue, acts to squeeze them unfairly from the market. We asked for further detail on this claim and were given the following response by one supplier. It told us that in the early summer of 2004, it had received an offer to provide week-ahead purchases of half hourly load shape to a typical value of 20,000 to 60,000 from the trading arm of a major integrated supplier. This offer incorporated the following terms: an 8,000 per month facilitation fee payable for maintaining the relationship (i.e. whether or not any business is transacted between the two parties); a cash deposit, depending on mark to market values, initially proposed at 300,000; and payment by the supplier on the day ahead of the week of trade. Cornwall Consulting Report for Energywatch 113

114 The supplier told us that, in order to transact in the business electricity market, it believed an operator needed to have a working capital facility (covering industry credit, agent commissions and short-term wholesale trading) of at least two and a half times the monthly turnover of that account, assuming no serious issues with the customer. In its opinion, the typical half hourly customer will not break even in cash terms for at least 18 months, whilst in the non half hourly sector, it might expect to break even in cash terms in just under a year. Moreover, this situation leads it to the conclusion that, whichever sector a stand alone power supplier operates in, in order to grow it needs more and more working capital because the business at any one time will not be cash generative. This creates, in turn, an incentive to chase the large market where profits are slimmest, but turnover is greatest, to secure cash. Therefore, in its opinion, the key determinant of the competitive electricity market is the financial strength of the main players rather than innovation and service. For these reasons, this particular operator expects minimal new entry and the exit of most remaining independent electricity and gas suppliers. It concludes with the opinion that the integrated suppliers are using their terms of trade (including rules on the credit status of those with whom they will trade) as a key tool in maintaining their positions, whilst talking up the need to protect themselves from the possible failure of other larger suppliers. The failure of a small supplier would probably have minimal impact on them, yet these operators must post cash security while their integrated rivals can use posted letters of credit, backed by credit ratings drawn from strong positions in capital intensive activities like generation and distribution. Smaller and independent suppliers also expressed concerns about the increasing stickiness of the customer transfer process. Following a change in the electricity Master Registration Agreement, suppliers can now object to a customer leaving if it has an outstanding debt of more than 28 days. One operator told us that this change had seen the rate of objections to transfer increase from around one in ten to three in ten, and that it had employed a new team to help resolve these issues. It contended that it believed certain suppliers were routinely objecting to all transfers regardless of whether a legitimate reason to object was put forward. Subsequent contact with other suppliers from both this and other backgrounds yielded some common names of operators alleged to be acting like this. Smaller suppliers also complained about the service they obtained from agents in the supplier hub process, particularly meter readers serving the non-half hourly (NHH) sector. They claim poor performance directly inhibits their ability to bill and serve their customers properly. One supplier, which targets the non half hourly market, informed us that it had data issues for 25% of new customers and 10% of its existing portfolio of customers. Another told us that it was able to bill around 88% of its NHH accounts on actual annual read data against a meter reading performance threshold of 97%. It claimed that only one meter reading agent was achieving this level at the present time. Cornwall Consulting Report for Energywatch 114

115 In some regions, it claims performance is worsening. It told us that it typically uses the successor business to the local electricity supply company s metering business for NHH meter reading services. Small suppliers claim they suffer from worse performance than their larger rivals. A key member of a relevant industry work group acknowledged this as the biggest open secret in the industry and pointed out that the major suppliers would be the largest customers of the agents and, therefore, it might not be surprising that they concentrate on them as opposed to smaller suppliers. In one instance, the successor business has indicated the intention of withdrawing access to the services of its metering provider to other suppliers. The issue of regulatory change is also one that was raised by operators from this background. A consistent claim of a lack of resource to keep up with industry changes was the main argument made, with the inference being that there are too many, and some are of questionable benefit. One supplier told us that it would have objected to some BSC modifications had it been aware of their full implications. It also claimed that the practice of rebalancing transmission charges (both the PLUGS change of April 2004 and the expected BETTA change of April 2005) puts unmanageable price risks into the market. It stated that the introduction of the PLUGS methodology to transmission use of system charges from 1 April 2004 had cost it the equivalent of one percent of its gross margin. If it is assumed that the operating margin is typically five percent, this change alone would equate to one fifth of its gross profit. Another supplier told us that it believes there is a lack of understanding by the regulator on commercial issues. An example of this is the commercial impact of changes to the MRA which do not always seem to have been thought through. The right to object change noted above puts the onus on the new supplier to prove the intent to switch and, effectively, acts as a deterrent to switching, in its opinion Larger and Integrated Suppliers Reflecting their general view that overall the competitive market is working to the benefit of customers, the concerns expressed by larger suppliers tended to reflect specific rather than general issues. We quote in full the response from one major integrated supplier. The gas and electricity markets are still strongly influenced by the thresholds and consumption levels used to introduce competition. These influence systems and processes, and act as pricing delineators for the natural monopoly providers. Against this scenario, it is unlikely that new suppliers entering the market would be able to constrain incumbent suppliers prices. System requirements necessary to participate in the energy supply markets, especially those required for electricity, are highly technical and complex. Its is, therefore, unlikely that a new entrant would be able to sustain unusually low prices long enough both to cover its start-up costs and be profitable. Cornwall Consulting Report for Energywatch 115

116 The difference in market conditions between England and Wales, and Scotland also inhibits competitive dynamics, more particularly in the electricity market. Key issues continue to include the extensive use of radiotele-switched meters, the wide dispersal of customers and the purchase of power direct from competitors. The prevalence of dynamically radio-teleswitched meters, which are remotely switched by the distributor, reduces our ability to forecast usage for such sites and so lowers our ability to cost and price these sites. There are also some issues around having to buy power from our direct competitors at an administered cost. We have seen very aggressive win back pricing in-area from both the major Scottish competitors to an extent not seen in the domestic market. We look to these anomalies being addressed by BETTA with when it is introduced. We did receive a counterview on the nature of competition in Scotland from another major supplier. It told us that, in its opinion, balancing arrangements were more lenient in Scotland and trading systems were less complex, making it easier for rivals to compete than south of the border. One supplier particularly made a point of bringing default tariffs to our attention. These are the arrangements which apply in the event that a customer contract expires and is not replaced. We were informed that the supply licence requires the licensee to ensure that the terms of its deemed contracts are not unduly onerous. Yet there is a wide disparity in the default tariffs of suppliers, suggesting that different approaches are being taken to setting them. This can result in huge uncertainties over the additional costs to customers if they fail to switch supplier at the end of their contract, and is not aligned with the objective of orderly markets. When considering service and billing issues, larger electricity suppliers pointed out to us that the Customer Transfer Programme 45 is tasked with improving the customer switching experience for both domestic and business customers. They expressed their support for the Programme, including the belief that it would lead to improvements in the service they would be able to offer their customers. Some larger gas suppliers were more sceptical of the Programme, holding the view that, whilst improvements might be possible and desirable in the business sector, any solutions designed to achieve them should be proportionate and verifiably cost effective. Such statements highlight a notable difference in perception about the value of an accurate bill between some larger suppliers and other market participants. Customers and smaller suppliers seem to regard this as a standard, essential element of the service. On the other hand, more than one larger operator told us that it is developing what it perceives to be a premium market position around timely and accurate billing of its customers, suggesting that they perceive other suppliers do not feel these factors are important. Larger suppliers also expressed strong opinions on the nature of the regulatory structure hindering supply competition. The argument here is that 45 CTP see Section Cornwall Consulting Report for Energywatch 116

117 persistent regulatory change creates unnecessary risks and costs for energy providers and their customers and closely resembles that put forward by some smaller suppliers noted above. One major gas supplier told us that it sees itself as a supplier to the industrial and commercial sector and not domestic. It is frustrated that the domestic agenda is affecting it more and more driving the need to change systems and monitor and react to unnecessary regulatory changes for their target market. Another company from a similar background stated that it needed to allocate half of its IT operating expenditure to modifying its billing and administration systems in response to industry code changes. It argued that much of this expenditure is unnecessary and is crowding out investment in enhanced customer services. Furthermore, it claimed that persistent regulatory change makes its operations more expensive and can cause it difficulties with its customers. It cited as an example what it argues is a much more complex price control regime on Transco which is causing it to change its pipeline prices more frequently. This is: making it impossible for [us] to assess the costs of transportation as fixed when preparing prices for customers; causing [us] to pass on this price risk to customers; upsetting customers when they are on the end of unexpected price changes; and causing [us] unnecessary hassle and cost in managing these upset customers. Another informed us that it needed to spend one third of its annual budget on metering services to adapt its system to take account of the recent change in gas metering arrangements. It argues that such changes act to squeeze suppliers out of a low margin business. Another major supplier told us specifically that its experience suggests that, whilst competition may seem less apparent (with many customers struggling to obtain more than three quotes for their tenders), this has not prevented competition from working in favour of [business] customers. Indeed, we continue to find that customers exert strong pressure when we quote for business. The lack of tender responses is, in our view, a direct result of the degree of vertical integration that Ofgem has allowed and the complexity and risks associated with operating as a supply-only company in the market. Both of these factors serve as a deterrent to new entry. On a related theme, the same company told us that it is certainly the case that the introduction of competition in agent services has increased complexity without any apparent corresponding net benefit. In our experience, customers either don t understand or are not interested in the arrangements in this area. Moreover, the savings available between the various data aggregator and data collection combinations are outweighed by the burden imposed on suppliers in terms of system requirements and cost. Similarly, the out of area distribution arrangements have imposed an Cornwall Consulting Report for Energywatch 117

118 additional and unwelcome cost on suppliers without tangible benefit. The drive for competition in these areas has led to an unnecessary increase in the costs and complexities of operation and is, in our view, one of the reasons why the market is seeing very little entry by new suppliers. The view that persistent regulatory change, and the structures that have been established to support it, can run counter to competitive markets is also one that was expressed by some representatives drawn from the integrated energy retailers. Whilst acknowledging that they could provide the resources necessary to keep abreast, and influence, structural developments, they expressed the opinion that not all market participants were able to and, in an environment where some individual changes may be sponsored by companies seeking a particular advantage, this may not necessarily be a good thing. The competitiveness of both wholesale gas and power markets was questioned by major suppliers of both gas and power. Sometimes their concerns closely mirrored those noted from smaller, independent suppliers above. In order to put these in context, we were keen to understand how suppliers, which are part of an integrated business, source their wholesale power. The response we received from one integrated business with a stronger position in electricity than gas production is typical. It told us that as a pure retail business it sells products and services to customers but does not purchase directly from the wholesale market. It sources wholesale market cover from its related trading business for both gas and electricity and receives the same prices and terms as are offered to others. Another supplier told us that its brief is to obtain the best commercial terms it can for its equity energy from the markets it trades in. Customer requirements are sourced by equity or traded resources depending on the commercial judgment of traders at the time. The electricity supplier cited above claimed that oil producers have an important advantage in the gas market as they can choose where to put their margins. They have traditionally regarded gas as a by-product of oil, so this may also influence their attitudes to the competitive gas market from time to time. [We feel] that players with gas production assets may have an advantage in the longer-term as flexibility becomes increasingly important (and this is provided free by gas field ownership). Another supplier with a similar background told us that large producer-owned suppliers have a different perspective on the gas market than retail businesses. They consider the wholesale and major industrial sectors as different channels to market and, in its opinion, sometimes can look to move product in to the industrial sector without unduly influencing the wholesale price. Another company from a similar background informed us that it was unable to buy wholesale gas for the coming winter even at current [July 2004] very high prices, even though official assessments say there should be plenty of gas available. It argued that this position suggests these assessments are wrong, or sellers are deliberately withholding gas from the market in the Cornwall Consulting Report for Energywatch 118

119 expectation of receiving higher prices later. It claimed it had anecdotal evidence of other players facing similar issues, and we had this view repeated when we asked another participant independently. Similar arguments were aired by gas suppliers about the wholesale electricity market: one with a presence in electricity supply claimed that power generators act in a similar way. We received a different perspective from larger suppliers of gas and electricity on objections to customer transfer to counter those from smaller suppliers. One such company told us that one area where the business market has developed is in relation to the ability of the incumbent supplier to object to customers wishing to switch. Changes to the Gas Licence and the Master Registration Agreement now put the onus on the supplier to agree contract terms with customers that define the circumstances in which a valid objection can be raised. We perceive this as a maturing of the market and have supported Ofgem in this area. One point to note, however, is the increasing likelihood to suppliers enforcing termination agreements on customers seeking to move before the end of a contract and that this could see an increase in complaints to bodies such as Energywatch Key Themes As with the responses concerning the level of competition, a number of key themes emerged concerning issues that may be inhibiting competition. These included: strong opinions from non-equity (production asset holders) that wholesale energy markets are not functioning in a proper competitive manner; supply markets are expensive to enter and expensive to operate in as credit requirements have increased after the exit of Enron and failure of TXU Europe; there is an excessive burden of regulatory change and much of this change is of peripheral benefit, if not a cost, to suppliers and their customers; more customers are finding difficulties switching supplier now that suppliers have a right to object to switching in their contracts (although opinions differ on whether this is a good or bad thing for competition); poor performance of agents in meter reading and data collection functions is causing difficulties to suppliers administering their customer accounts; and poor data, and other difficulties in the switching process, is acting as a barrier to customer participation in the electricity and gas markets. Cornwall Consulting Report for Energywatch 119

120 Outlook for Competitive Supply Markets Business Energy Markets 2004 We asked participants how they perceive the markets supplying electricity and gas to business customers may develop if there were no major changes to market structures and energy policy. The purpose of our questioning was to elicit views on the confidence of participants about their own roles in the market and thus to gauge a general perception of the vigour of supply competition and indeed the wider energy economy Customers Larger customers and their representatives are generally fearful that the reduction in competition that they have noted recently will continue. There is recognition and support for changing energy policy priorities including the Climate Change Programme, even though there is also a widespread expectation that it will lead to substantially higher bills. A user group informed us that it believes the market will be challenged as signals to new investment have to come through and also somehow more innovation in services and products for business customers. Users tended to argue to us that government should push an overtly procompetitive policy agenda to keep wholesale costs competitive to make extra costs related to other energy policy objectives more affordable. Some customers perceive that new nuclear build may be the only route to balance rising energy demand and the desire to restrain greenhouse gas emissions, although this is by no means a universally held opinion. One user group told us that government s dash to renewable energy [is] very noble but unachievable, wind is not the entire answer. Nuclear should be considered. Another group put a different perspective on matters with the remark that the prevaricating over the nuclear issue will certainly lead to a run down of the industry and, possibly, even its demise. Because British Energy is active in the [business energy supply] market, this will be another provider who either curtails or ceases its supply. Security of supply issues are very important to business users: one customer group informed us there is also a concern from [our] members that we have an ageing energy infrastructure which needs upgrading. In terms of the recent wholesale price wholesale rebound, customers told us, in the words of one user group, that there was always an awareness that there would be a correction to very low wholesale prices, but the scale of it is very surprising. The financial distress of BE and TXU was evidence of this since then, security of supply, the blackouts, terrorism and the Middle East have combined to make the markets very jittery. It argues that one important consequence is a notable change to the way that many larger users buy their energy and this could have an important bearing on the future development of competition. Whilst some [larger customers] may have the Cornwall Consulting Report for Energywatch 120

121 time and knowledge to manage arrangements like this properly, there is concern that many others will not understand fully what they are taking on. An equal concern is that there are relatively few suppliers capable of administering such arrangements properly and, even then, given their complexity, they cannot properly deal with all interested customers. 60% price increases (at the expiry of 2 and 3 year contracts) mean people are considering these contracts when grasping at anything to offset what they might perceive to be threats to their organisations continued operation. In these circumstances, suppliers are trying to push customers in to longer-term contracts (3-4 years). This is one comment that suggests that larger customers are pessimistic for the future of supply competition. Another user group told us that it believes competition is likely to stagnate and that it is unlikely that there is going to be an influx of new suppliers. Originally, Europe was expected to provide some new competition: the sad reality is that Europe now own the majority of the English companies and so are unlikely to want to compete with themselves. Against this background, it claims that Ofgem, and indeed Energywatch, have got to understand the dynamics of the changes that they call for, and, however good intentioned, must make sure they do not rebound on the consumer and complicate issues still further Smaller and Independent Suppliers According to one independent supplier, the market in two years time will be characterised by: 5-6 large suppliers with minimal switching and choice for customers; service and innovation will be low; supply margins will be 2-3 times current levels; there will be consolidation and market exit amongst brokers and agents; and products could look very different, especially for the larger customer, as suppliers try to differentiate themselves. Another supplier told us bluntly that Wingas may well be the last company to enter the industrial and commercial gas market, Atlantic will probably prove to be the last independent of any scale in the domestic sector. Entry may be limited to the [daily metered] market (or half hourly in electricity). One small supplier claims that the absence of reasonable competition in supply will deter investment in new generation and that, as a result, policy makers should take far more interest in securing what it sees as viable competitive markets. Independent generation projects will not be financed if no route to market can be seen for their output. Such projects will probably Cornwall Consulting Report for Energywatch 121

122 seek long-term power purchase agreements with an incumbent supplier as part of their project financing. Major incumbents will not want to buy from independent projects as they will want the equity returns for their businesses. The argument continues further that incumbents will look at their own supply/demand balance as they will not want to precipitate major change and risk a price war by bringing significant volumes of new power to market all at once. They might, therefore, not respond quickly enough to changes in the overall demand supply balance. With no new build, and more environmental obligations restricting output from the existing generator fleet, it contends that nationally we could be looking at supply shortages. We might reasonably expect that demand peaks could be in summer and overall the energy swing will be much bigger. Particular pinch points in the wholesale market at the moment occur for covering February and September/October (when there is an interaction with gas), and these could represent the times when future supply problems may be most likely. Another small supplier told us that in a competitive market, it is not good that suppliers without gas or electricity production assets cannot survive and further consolidation would only bring about an anti-competitive environment and, ultimately, could return the market to the pre-privatisation generators and major oil and gas offshore companies. It sees the scale of regulatory change restricting new entry and squeezing competitors from the market and quoted us two examples: the DN sales and issues around Renewables Obligation Certificates (ROCs)/Levy Exemption Certificates (LECs) and the EU Emissions Trading Scheme. Another told us that great care needs to be taken with regard to the exit capacity regime. It argues that Ofgem s favouring of a three year ahead bidding process means that suppliers will have to take positions based on their expectations of their businesses in three years time. This may well encourage them to offer longer-term contracts, which may not necessarily be in the customer s best interests. But perhaps the strongest concerns were expressed about the interactions of wholesale markets and government policy on competition in supply. The paragraph below is quoted from a submission received from a supplier active in both gas and power markets. One of our main worries is not in the downstream gas activity in terms of competition, where the margins of suppliers are really a small part of the gas cost, but the commodity price evolution, transparency and control of market prices, lack of liquidity (May 2004 was the least liquid month in three years for gas) and storage cost control. Field suppliers of gas and generators of electricity hold the market control through the availability of the commodities. Vertically integrated players are potentially able to price very low, and in some cases, below the market commodity price when tendering for supply contracts. Cornwall Consulting Report for Energywatch 122

123 Larger and Integrated Suppliers Business Energy Markets 2004 A succinct summary of larger suppliers expectations for the future is provided in the following comment made to us by one of their number: Whilst we do not anticipate that the market conditions will change that significantly over the next two years, it is our belief that a greater focus will be given to the supplier/customer relationship. Customers will increasingly be more demanding in the level and standard of service they require. For example, increasingly we find that non-domestic customers prefer account managed services. Another response addresses the same issue when it told us that it expects supply margins to stay very thin going forward and, as such, the company is not in a position to widen its range of products and services although this is its long-term strategy. Another informed us that "there is a need for the industry to build credibility by moving from a purely price fighting regime to a customer service and reputation based sector. This could be supported by developing business standard service measures similar to those already in place in the domestic market. This theme was further developed by a major gas supplier which told us that the market needs to mature on both customer and supplier sides. The focus on haggling over 0.1 pence per therm of supplier margin is counterproductive given the key competitive value is when a customer buys not who from, given the prime importance of the traded gas market in driving the end user market. Overall the perception from these participants is that the energy industry as a whole is in a period of transition at the end of an energy surplus and there is a growing recognition that security of supply and environmental objectives need to be funded. Future price increases would hurt smaller players and hinder the development of a product and service range. Moving forward, product offerings would be different, and will probably include more sophisticated service elements. As such energy services may ameliorate the absolute cost increases for customers Key Themes It is more difficult to draw out a consensus view about the future direction for the electricity and gas markets supplying business customers. However, the following points can be drawn out: current market conditions and structures are not encouraging to new entry: the number of independent suppliers in particular is likely to fall rather than rise; wholesale market marker rates are to become ever more important in pricing to business energy customers; Cornwall Consulting Report for Energywatch 123

124 there is a widespread perception that energy prices will rise to fund investment in environmental improvement; energy supply arrangements for larger users are likely to evolve and become more complex: elsewhere less change is expected and there are fears that competition for smaller users could lessen somewhat; and larger suppliers are seeking higher margins from their customers to justify investment in service improvements Broker and Agent Conduct During our research, we contacted some intermediaries to gain their perspective on market developments. We also received some significant comment from both customers and suppliers on them and the role they play in the market. We outlined the role intermediaries can play in the market in Section 4.6 where we note that brokers source offers from a range of suppliers, whilst agents sell the product of a particular supplier on its behalf. To some extent, comment from suppliers may arise from intermediaries securing better terms for their customers and sharpening competition. However, there was a consistency and scale of comment from both customer and supplier sides and we present a synthesis of this below Brokers Brokers play a very prominent role in the business electricity and gas supply markets. There are no official measures of the scale of this role, but suppliers, customers and intermediaries themselves maintain their own estimates. Several shared these with us. One major supplier told us that brokers control 70% of electricity purchasing decisions. Another informed us that it has dealings with more than 200 brokers in the business sector and standards vary widely. In 2003, 30% of its customers (17% of its portfolio by volume) were acquired through third party consultants. It notes that this activity tends to be concentrated in the below 10GWh market (mostly below 3GWh). This view was confirmed by a smaller supplier informing us that, in what it terms medium business electricity (accounts spending between 10,000 and 200,000 per year), brokers probably determine 80% to 90% of buyer decisions. It believes they have less influence below, and above, this level as larger customers may have their own energy buyers, and smaller users are more suited to direct sales. Overall, the perception amongst market participants on demand and supply sides is that there are very many brokers active in the market, with very variable standards of service. Many brokers are true to their customers Cornwall Consulting Report for Energywatch 124

125 but some take advantage of them by securing arrangements which are more advantageous to themselves than their clients. There is some resentment amongst suppliers at the levels of commission charged by brokers where they feel these are not properly disclosed to customers. These fees are typically estimated at between 250 and 1,000 per meter point per transaction (i.e. arrangement of a supply contract), although figures can range some way above and below this band. Suppliers claim even typical fees can be at least equivalent to, if not several times, their own margins from the supply contract itself. There is a variety of ways in which the brokers can collect their fees. Firstly, they can be sourced from either customer or supplier. They can be levied on a fixed fee basis, as an oncost to the energy price, or as a share of the savings the broker believes its actions have achieved for the customer. The complexity and lack of transparency in broker fees is a cause of concern. Leading on from this is a questioning of the integrity of operation of at least some brokers. One major supplier commented that in the domestic market, some internet brokers have demonstrated that their advice is linked to their commission, so they do not always recommend the cheapest contract. [We have] also fallen foul of brokers switching deals for commission rather than looking for the best deal for customers across the domestic and SME markets. Particular concerns were expressed by another that broker fee arrangements are generally opaque to customers (in general, fees are added to the final negotiated prices and can be considerable, often being greater than the margin achieved by suppliers). It told us that it believes 45-50% of customers using brokerage services have arrangements which are funded by commission payments from the winning supplier, and further informed us that some brokers took commission from suppliers and did not disclose this to their customers. Furthermore, some of these brokers promote their services as free to the customer, it claims. Figure 7:2 plots the commissions paid to brokers by a major electricity supplier on its portfolio of contracts. Cornwall Consulting Report for Energywatch 125

126 Figure 7:2: Broker Commissions Paid by a Major Supplier on its Electricity Contracts Source: a major supplier Amongst customers and indeed brokers themselves, there is an awareness that broker conduct and service standards can vary very considerably. An organisation representing energy purchasers informed us that it would support any form of investigation, perhaps leading to the development of a licence or code of practice for such operators. Whilst some customers have complained, many buyers don t know about supplier commissions or don t want to admit a mistake. Furthermore, it expressed concern about consultants taking advantage of the lack of knowledge of many buyers in this specialised area. One drew our attention particularly to its view that fees should be by free negotiation with customers and should not be hidden from the customers. This is particularly so when a consultant is taking a fixed sum from customers and also taking undisclosed commission from suppliers. Other concerns expressed about some broker conduct included: some brokers apparently do not allow suppliers to contact their customers directly and this may be detrimental to customers; a lack of written agreements between suppliers and consultants may inhibit the relationship between brokers and their customers; some brokers are advising customers to subscribe to financial products to manage their energy prices, which they may not be authorised to do; some are not disclosing the extent of their approach to the market and their evaluation methods; and Cornwall Consulting Report for Energywatch 126

127 there are suspicions that some are arranging contracts for customers based on their own commissions rather than the customer considerations of price, service and other relevant criteria Agents Whilst brokers operate independently in the market on behalf of end user customers, agents act on behalf of suppliers to sign up new supply contracts. Like brokers, they also earn fees on a transaction basis, typically per signed and registered contract. Their fees are subject to commercial negotiation with suppliers and we have been told that they can range from 50 to 150 per account per year. We were told by suppliers that their use of sales agents is not as widespread as before. Reasons cited for this change include: rising prices mean the margins are not as large as they were for a customer to switch from tariff to contract; smaller suppliers claim their larger rivals are not looking to acquire new customers as they were previously. They are, however, wanting to sign longer-term contracts (fixed prices, attractive in a rising market) and can afford to pay upfront commission for such deals; and the new Master Registration Agreement rules, allowing supplier objection to contract switches in some circumstances, have made switching a more difficult process. One small supplier commented to us that, as agents market conditions have toughened, so their behaviour has worsened even though there are now fewer suppliers seeking to do business with them. It informed us that it has to put more resource in to managing agents than before. It believes regulators including Energywatch should be careful about enforcing measures to improve agent conduct as any heavy-handed action could force them out of the market all together. This would, in its opinion, be a bad thing as agents are an important force for small suppliers, as they bring in new customers and are rewarded on a results basis. Cornwall Consulting Report for Energywatch 127

128 8. Comment and Conclusions 8.1. Context In the course of this analysis, we have undertaken much research into the structure and workings of the markets supplying electricity and gas to business customers. We have also taken the opportunity to engage with some key stakeholders to gain an on the ground view of these markets. We have actively sought views on areas where improvements may be made to their functioning which would result in direct benefits to business customers small and large. In this Section we present our conclusions on the nature of business supply competition as its stands in the second half of We suggest some areas of concern, some possible remedies both at a policy level and where Energywatch may wish to engage more directly, with a view to improving the position of business energy customers in competitive supply markets. This Section breaks down into three parts: conclusions on supply competition to business electricity and gas customers; some suggestions to market participants customers, their suppliers and policy makers on how competitive markets may be made to function better for business customers; and some measures that Energywatch may wish to consider adopting, again with the objective of making competitive markets work better for business customers Opinion on Supply Competition to Business Customers Overall, we believe the market supplying electricity and gas is neither a single whole nor that highly segmented. Moreover, it is a sector which it is very difficult to characterise as a single whole because: it is more a series of sub markets delineated by fuel, some with strong regional characteristics (for smaller users), though a clear grouping exists around intensive (in the sense of large scale manufacturing and commerce/retail) users and small and medium enterprise (SMEs); suppliers can deal with the same customer groups in different ways, most notably in the mid-market sector; little systematic gathering of data is undertaken by official/representative bodies; Cornwall Consulting Report for Energywatch 128

129 no established means for the measurement of competition is readily available, meaning that judgements need to be made from assessments of activity and opinion; and trading conditions can be very dynamic, with changes from contract round to contract round and quick pass through of increased wholesale prices. The business electricity and gas markets share a number of common characteristics: they provide a service whose provision at competitive prices is fundamental to customers business viability; they are complex to administer and rely heavily on accurate flows of data; they are very closely correlated to wholesale markets, both in terms of price direction and participants; customers and many suppliers are typically active in both; and they are subject to political scrutiny and intervention. These characteristics go a long way to explaining why the market is neither a single entity nor that highly segmented. Customer issues do vary generally by the scale of purchase requirement, but, arguably, the most important factors impacting business electricity and gas supply markets are from further up the supply chain. We believe that the downstream impact of upstream issues goes a long way to explaining our opinions on the three key factors we isolated in Section 7: the level of competition in supply to industrial and commercial customers; issues in the market that inhibit competitive dynamics; and prospects for competition. In the paragraphs below we consider the implications of these aspects in more detail. We conclude each with some specific comments and recommendations for Energywatch to consider. The recommendations have been drafted against the baseline understanding that the business energy markets are somewhat fragmented, with distinctive small business and intensive groupings. As a result, customer issues are different across the market and levels of competition vary. Therefore, we believe that focused Energywatch policies and activities should reflect the customer needs that arise from this situation. Primarily, Energywatch (and from what we can gather other regulatory bodies and policy makers) needs to keep up to date on market conditions and use this awareness to fulfil roles which focus on tactical assistance for smaller users and a sectoral good information and lobbying role for larger users Level of Competition We believe there are two distinct but related issues that need to be considered when assessing the level of competition currently for supplying Cornwall Consulting Report for Energywatch 129

130 gas and electricity to Britain s businesses. They are the number of suppliers active in the market, and the level of offers that customers can expect to receive from them. It is very apparent to us that licensed suppliers do not correspond to active suppliers. Ofgem produces a Business Electricity Supply Contact List containing the details of 38 licensed electricity suppliers and a similar list for gas covering 56 licensed gas suppliers. Our research informs us that very few of these are active at any one time. On the other hand, it is also evident that competition can secure some customers multiple offers from suppliers for their requirements. We consider each of these two aspects below Supplier Numbers We believe that an important insight into the state of competition in a market can be gained from an understanding of the number, and health, of suppliers operating in the market. Table 8:1 shows that there have been at least 11 supplier exits in the last four years, commencing with the failure of Independent Energy in the autumn of All bar one of those, the trade sale of Electricity Direct, can be argued as being forced, including two cases involving the failure of international parent companies (TXU Europe and Enron), to ) and five cases of smaller independent suppliers exiting the market. There are also three instances of gas producers exiting from the business supply market. As we noted in Table 2:6, between 1995 and 2002 there was significant consolidation of the privatised electricity companies in Great Britain as 14 regional suppliers and two generators reduced to five integrated generator suppliers (plus the successor company to the privatised British Gas supply business). We believe this evidence of market exit and consolidation goes at least some way to substantiate the concerns expressed by customers about declining competition for their requirements and by small suppliers about the general market environment. As we note in Section and consider further in the following Section, independent suppliers told us that they felt the costs of the trading regime fall disproportionately upon them, causing them to have higher operating costs and price risk which directly impacts on the prices and service they are able to offer customers. Cornwall Consulting Report for Energywatch 130

131 Table 8:1: Supplier Exits from Competitive Energy Supply Markets Supplier Date Comment Independent Energy 2000 Company failure with contracts procured from its administrator by npower. Enron Direct 2001 Trade sale to Centrica after failure of parent company Amerada 2002 Supply operation acquired by TXU Europe. Electricity 2002 Successful trade sale to Centrica. Direct TXU Europe 2002 Company placed in administration; contracts acquired by Powergen. Exxon Mobil 2002 Company s gas supply contracts acquired by TotalFinaElf. Maverick Energy 2003 Company placed in administration; contracts assumed by Atlantic Electric and Gas. UK Electric Power 2003 Company withdraws from market by refusing to renew contracts with customers Shell Gas Direct 2003 Exit from the power market on commercial grounds by a leading supplier of gas to business customers. Atlantic Electric and 2004 Company placed in to administration ahead of sale of contracts to Scottish and Southern Energy. Gas BP Gas Marketing 2004 Reported to be letting gas supply contracts lapse rather than renew. Source: Cornwall Consulting research Level of Offers Larger customers and their representatives argued to us that they are observing a decline in the number of suppliers quoting for their business. These concerns were particularly expressed by multi-site and public sector customers. Smaller users and their representatives informed us that they often struggled to secure competitive offers at all and then had difficulty in their evaluation. Our research via brokers (in Section ) concluded that Cornwall Consulting Report for Energywatch 131

132 even customers serviced by informed and active intermediaries have experienced: the number of suppliers trading in the business electricity and gas markets reducing significantly over the last two years; suppliers participating in different sectors of the business electricity and gas markets with few being active across all at any one time; and suppliers making more offers per customer now than in 2002 reflecting the primacy of posted wholesale prices in driving their activity. It is arguable that informed, active customers are at least as capable of attracting similar levels of supplier interest in their business as intermediaries. However, by no means all customers meet these criteria. Our research suggests to us that the combination of fewer suppliers and much faster moving wholesale markets yields a market environment where there is much more selection by suppliers of the accounts they wish to secure. In this environment, customers need to be aware that their behaviour can directly impact the success of their market approach. Such issues may explain the difficulties which some customers have in securing competitive offers. Some formal buying processes and attitudes do not appear suited to competitive energy procurement, notably more rigid interpretations of EU procurement rules by some public authorities. Suppliers are extremely reluctant to submit fixed price offers for large financial values timed for evaluation weeks, or even days, in advance. If and when they do, they will likely incorporate a significant risk premium. Likewise, some customers have suffered because their internal decision making processes are neither flexible nor quick enough to respond to competitive offers, which can have validity periods measured in minutes. It is apparent that data problems outside their control are causing some multi-site customers to be extremely reluctant to switch their suppliers. Unfortunately, this anxiety is often detectable by potential competitors, meaning that they can struggle to secure competitive offers as bidders suspect they have minimal chance of reward for their efforts. Whilst some customers may be able to do more to convince of their winnability, it is arguable that a malaise of general industry data problems and poor service from some suppliers is directly inhibiting competition. Worse, it would appear that a situation could arise where a supplier offering poor service has little incentive to improve, as this deters its customers from switching and enables it to charge higher prices as a result. When considering the small customer sector, we believe there has been a notable shift in the competitive strategies of the integrated electricity and gas suppliers recently. We suspect that the key focus of these operators is now retention of existing accounts rather than active acquisition of new customers. Our reasons for holding this view are that a number have introduced new terms and conditions of supply to all customers, including legacy accounts Cornwall Consulting Report for Energywatch 132

133 (i.e. those that have never switched supplier). These new terms typically incorporate defined rights to object to transfer (for the first time for nonswitchers), and follow the change to the central Master Registration Agreement 46 (which governs electricity transfers) facilitating objections to transfer. Moreover, two integrated suppliers are seeking to extend the right to object to transfer to electricity legacy customers served on deemed terms. We believe this switch to retention for the small business sector is also evidenced by declining use of sales agents by larger suppliers. Even though there have been mis-selling issues in both domestic and small business sectors, we believe the active use of sales agents by a supplier is a powerful statement of its attitude to the acquisition of new customers. Against this background, we sympathise with customers buying for smaller sites who are struggling to secure competitive offers for their requirements and, as noted in Section , we believe Energywatch can take actions to improve their situation Recommendations In this context, it is recommended that Energywatch consider the following measures designed to improve the competitive position of business, customers either directly or indirectly, through encouraging supplier participation: 1) Energywatch should establish a readily accessible information resource where smaller (e.g. quarterly metered) customers can secure ready access to competing suppliers and their offers so that they can secure an improvement in the cost and/or terms of their supply: a) this resource should include practical assistance on understanding and evaluating offers (including, as appropriate, a standard request for quotation information) and the preparations customers need to undertake to secure the best chance of a successful outcome (in our opinion, it should not provide a calculation engine as Energywatch should not ordinarily become directly involved in the customer/supplier relationship); b) once in place, Energywatch should proactively encourage the use of this resource through direct engagement with small businesses and indirectly via their representative bodies such as trade associations and local business development groups; c) Energywatch should work with other energy stakeholders so that the resource can be used to communicate the wider energy policy agenda, including the Climate Change Programme and its possible impact on relevant users; and 46 In September 2004 Ofgem launched a consultation on whether suppliers be allowed to the same rights object to the transfer of electricity customers on deemed contracts that they currently have with those customers with which they have negotiated arrangements. Cornwall Consulting Report for Energywatch 133

134 d) Energywatch should measure use of the resource to determine its effectiveness and possible further development; 2) Energywatch should encourage suppliers to include basic contract information on each bill including that concerning anniversary dates, duration of current pricing structure and details of any termination window so that customers can see clearly when and how they may be entitled to move; 3) Energywatch should work with Ofgem, DTI, suppliers and customers to agree quantifiable measures of the level of competition in business energy markets, and a mechanism for their production and public circulation 47 ; a) in the absence of timely agreement on the above, Energywatch should collect and analyse data on the nature of competition to business energy customers on a regular basis and publicise the results. It is recommended that this information include at least the following: numbers of suppliers active in the market by major sector and aggregate market shares of the leading players; and 4) Energywatch should investigate further default and out of contract pricing policies used by suppliers to determine their competitiveness. Likewise Energywatch should monitor standard terms of supply for electricity and gas from major suppliers and highlight those it feels may not be fair to customer interests; 5) Energywatch should oppose any regulatory changes which might serve to inhibit customer switching Issues that Inhibit Competitive Dynamics At a macro level, we believe an unholy cocktail of upstream issues, including concern about wholesale market structures and the complexity of regulatory and market regimes, is acting to inhibit the operation of suppliers and make new entry difficult. We also believe that poor data collection and billing is a common feature of both business gas and electricity markets and that this is restricting customer activity. As a result, we believe competition in the supply of electricity and gas to business customers is being squeezed Wholesale Markets Liquid wholesale markets are important to supply competition as they allow suppliers and, in some cases, customers to source bulk energy. After a 47 We note the Ofgem decision letter on publication of quarterly market share data for the domestic market. Itsits paragraph 7 refers to proposal to issue a decision on the publication of non-domestic market share data before the non-domestic review was to be published in July Cornwall Consulting Report for Energywatch 134

135 surge in the late 1990s, wholesale market activity declined. Key factors behind this have been the exit of American companies, the decline of merchant plant models and vertical integration. Increasingly, a greater proportion of trades are over the counter (bilateral contracts) and vertical integration is also effectively being used as a trading strategy by major market participants. Electricity trading volumes in 2003 were recently estimated at around 2,500 TWh 48 by RWE Trading. It claims to have traded some 20% (501 TWh) of that volume with approximately 40 counterparties, compared with its generation output of 38 TWh. Evidence of how trading strategies can differ by company is provided by E ON which disclosed that its Powergen subsidiary engages in a controlled amount of proprietary trading in gas, power, coal and oil markets in order to take advantage of market opportunities and maintain the highest levels of market understanding required to support optimization and risk management activities. 49 These volumes equated to 40 TWh of electricity and 300 TWh of gas in In evidence to the House of Lords presented earlier this year, a representative of Centrica commented on wholesale gas trading, stating that physical trading is a small, per cent portion of the total physical volume being delivered into the UK at the moment; and then there is paper trading, where the gas is traded many times, and that is perhaps 5-10 times the total physical volume. 50 Figures from National Grid Transco record that in the year from 1 October 2002, 6.9 billion therms of gas traded at the National Balancing Point. In the eleven months from 1 October 2003, some 5.9 billion therms were traded on a similar basis. This figure is nearly 7% lower than the equivalent period of Further evidence for declining liquidity is provided in Figure 8:1 below sourced from a Centrica presentation to investors 51. It plots contracts traded by forward quarter and shows a marked decline in activity in the second to fourth quarters out. Feedback, which is admittedly difficult to assess, from market participants is that this fall in traded market liquidity is making it more difficult for suppliers to source wholesale energy for onward sale to customers. In our research, non production asset (i.e. power station or gas field) owning suppliers in both gas and electricity markets raised this as an issue with us. They claim not only is it more difficult to buy wholesale energy but that the markets have become more unpredictable as the exit of operators with a trading background has seen a decline in the quality and volume of market analysis. This, they argue, makes wholesale markets inherently more volatile. 48 Source: RWE Power/RWE Trading presentation to analyst conference Essen, 1 July, Source: United States Securities and Exchange Commission form 20-F March, This also records that Powergen sold 91 TWh and 170 TWh of electricity to final customers and other market participants in 2003 respectively. 50 evidence to the House of Lords Select Committee on the European Union (sub-committee B) Investigation; European Union Energy Policy Gas Supply and Access - 15 March Source: Centrica presentation to investors - Centrica agrees sale of the AA,1 July 2004, page 15 Cornwall Consulting Report for Energywatch 135

136 Further evidence for the practical impact of declining wholesale market activity is integration. We believe that integration is one major response that larger suppliers have made to the more difficult wholesale market conditions noted above. Figure 8:1: Gas Contract Trading Activity Source: Centrica We also believe that this response of itself has contributed to difficulties in the wholesale market as independent sources of energy have been absorbed by already integrated operators. The scale of integration currently is shown by Figure 8:2, again sourced from Centrica. It shows estimated demand by major supplier (Scottish Power, Scottish and Southern Energy, Centrica, RWE npower, E ON Powergen, and EdF Energy appear in both charts, with British Energy featuring in the electricity chart) and expected supply sources. We take the implication from these charts that these major companies trade energy to the extent that they equalise their sales and production positions. Declining liquidity and integration are important features of current wholesale energy markets. There is much debate about the exact impact they have had, but, for many customers, the resolution to this discussion is a purely academic one. Much higher energy prices are causing genuine distress to many businesses around the country. Many users cannot relate the prices they are being asked to pay to the arguments they hear that attempt to justify them, especially in comparison to the prices rivals and colleagues in other European nations are facing where the same global energy market conditions apply. Figure 8:3 is intended to illustrate this point. It plots trends in the wholesale gas cost markers most important in driving prices to larger end users in various European countries. Figure 8:3 shows that bulk gas costs in key European countries were lower in the summer of 2004 than they were the previous year, reflecting relatively Cornwall Consulting Report for Energywatch 136

137 weaker oil prices in the winter of In contrast, British gas costs have surged higher, with the consequences that have already been highlighted. Figure 8:2: Indicative Hedging Positions of Major Integrated Electricity and Gas Suppliers Source: Centrica presentation to investors 1 July 2004 Figure 8:3: Key Gas Cost Markers in Price Setting to Major Customers c/kwh Jan-03 May-03 Sep-03 Jan-04 May-04 Sep-04 Germany Spain Netherlands Belgium Great Britain Source: Cornwall Consulting research The following data sources were used in the compilation of Figure 8.3: Great Britain Deloitte Spectron weighted average month ahead index Belgium G price factor used in monthly tariff setting Spain suminstra prima price factor used in monthly tariff setting Netherlands calculation of Gastransportservices neutral price Germany average border cost of gas as calculated by Federal Economics Ministry Conversions to c/kwh have been made as appropriate by Cornwall Consulting. Cornwall Consulting Report for Energywatch 137

138 Table 8:2: Regulatory Investigations, Processes and Reviews Triggered by Concerns over Wholesale Gas Prices Launch Date Sponsor Title Comment September 1998 November 1998 Ofgem St Fergus and Bacton Investigation A number of shippers found to be in breach of their licence obligations during the winter of but no action taken due to change in gas trading regime. Ofgem Investigation into gas balancing prices at the Barrow Terminal during winter October 2000 Ofgem Investigation into shipper conduct in the capacity market in October 2000 January 2001 November 2001 November 2003 European Commission DTI Ofgem Investigation into UK/Belgium gas interconnector Gas: a consultation on concerns about gas prices and possible improvements to market efficiency Investigation in to wholesale gas prices in October and November 2003 (later extended to included gas prices in summer 2004 and for winter ) No evidence of anti-competitive behaviour found. Changes subsequently made to capacity regime through BC 99 process. No evidence of anti-competitive conduct found, but improvements to capacity arrangements identified and addressed through Transco system operator incentives. Requested to investigate by DTI, found certain rigidities in some agreements, but attributed increases in UK spot gas prices to differences in market opening between the British and continental gas markets concerned. No evidence of anti-competitive conduct found - fundamental reason for movements in gas prices was influence of trade with continental Europe through the Interconnector pipeline leading to price convergence. Price increases attributed to links to continental gas markets, declining supply availability, higher storage costs and most, notably, sentiment about supply availability in a severe winter. Questions over a few historic field contracts. Findings forwarded to EU Commission for further action. January 2004 FSA Traded gas prices set on the IPE No evidence of malpractice found. November 2004 TISC Higher gas prices and increases to energy prices to customers. Source: Cornwall Consulting research The House of Commons Trade and Industry Select Committee is to commence hearings in November 2004.

139 This has caused a dramatic loss of confidence in wholesale energy markets, which Ofgem s investigation 53 does not appear to have addressed. It is also worth noting, as Table 8:2 shows, that Ofgem s price probe is the sixth such regulatory examination in the last six years, none of which so far has proved conclusive. This loss of confidence is further emphasised by the claims from some manufacturers that they simply cannot afford current rates and will close British-based production. There have been various calls for a competitive investigation into the wholesale gas market, especially the workings of the offshore trading regime. In the course of our research, we have heard them directly from major customers, their representatives, independent suppliers and more than one of the major energy retailers. Energywatch itself has also several times called for an investigation into the wholesale gas market 54. We note a widespread and significant disquiet on the issue, some of which centres on access to information. We also note the response from producers and their representatives on the subject 55. We believe that the history of partial investigations illustrated in Table 8:2 is not proving helpful in the current environment. This is because we perceive that it is being used by those opposing a full examination of the wholesale gas market to bolster their case whilst, at the same time, being used by those seeking such an investigation to imply that there must be something wrong with the current offshore regime. In Section 6.1, the Department of Trade and Industry s Target 4 from its current Public Service Agreement with government was highlighted. It specifically includes an objective to ensure the UK ranks in the top 3 most competitive energy markets in the EU and G7 in each year, whilst on course to maintain 53 On 5 October 2004 Ofgem reported on the findings of its Gas Price Probe. This followed an update in May Ofgem attributed higher gas prices to increased oil prices, declining UK gas availability, higher storage charges and market sentiment about supply adequacy in a severe winter. It highlighted some issues relating to the supply of gas from other European markets and from the North Sea which may have prevented gas flowing. Ofgem has presented the findings of its work to the European Commission for further action. 54 Source: various Energywatch media statements including : Consumer champion calls for action plan to address wholesale gas market (5 October 2004) Energywatch wants explanations for massive price rises (17 September 2004) npower rises fuel calls for investigation (08 September 2004) As consumers are hit with swingeing price rises again, Energywatch chief calls for action now (08 September 2004) Energywatch tells consumers switch away from British Gas (25 August 2004) Also letter from Allan Asher, Energywatch chief executive, to the Financial Times (20 August 2004) 55 For example: UKOOA Statement on Wholesale Gas Prices, UK Offshore Operators Association (7 September 2004) UKOOA Regrets Ofgem's Failure to Conclude Report into Wholesale Gas Prices, UK Offshore Operators Association (5 October 2004)

140 [a series of other energy policy objectives] 56 The last performance assessment was undertaken concerning market conditions in , which are vastly different than today s Market and Regulatory Complexity The complexity and scale of the administrative and regulatory systems used to support supply competition are, in our opinion, in danger of becoming a burden, indeed counterproductive to supply competition. We make this judgement based on the consistency and scale of feedback we received on this issue in our research with customers and, indeed, suppliers. In the course of criticising several specific regulatory initiatives, three general concerns seem to emerge to us: market entry processes are perceived to be over-rigorous, especially for operators which only intend to deal with business customers; governance processes in both gas and electricity markets, especially processes for making changes, are resource intensive and favour larger suppliers; and competition in metering and data services is introducing unnecessary system complexity, and increases the tendency for errors to occur and thus customers to suffer billing difficulties. Whilst all three are important, we believe the latter is the most relevant to Energywatch in its role advocating the customer position. In Section , we noted the comment from a major public sector buyer that it only switched supplier for more than a 5% saving to cover extra administration costs. In 2003, public sector expenditure on electricity equated to 595 million 58. If this buyer s experience is typical of the sector as a whole (and whilst we have no evidence to suggest that it is, we do believe many public sector customers accept higher prices than they would rather because of fear of switching), this suggests that data and administration difficulties are costing the public sector some 30 million every year in un-necessarily high energy prices. We have chosen to highlight the issues of the regulatory burden for new entrants and existing players. We understand they are important issues for suppliers and, because they tell us they are constraining their servicing of the business sector, indirectly for customers. We also believe poor performance of agents in meter reading and data collection functions is causing difficulties to 56 Further information including the full version of Target 4 is included at Section Energy Market Competition in the EU and G7 a report by OXERA for the DTI September source: DTI Digest of United Kingdom Energy Statistics 2003 Cornwall Consulting Report for Energywatch 140

141 suppliers administering their customer accounts and that claims from some independent suppliers that they suffer disproportionately from this are worth further investigation Recommendations Given the views outlined above, it is recommended that Energywatch consider the following measures. Again they are intended to improve the competitive position of business energy either directly or indirectly through encouraging supplier participation: 6) Energywatch should press the Department of Trade and Industry to provide an up to date assessment of its performance against Target 4 of its Public Service Agreement as a matter of the utmost urgency. If this assessment finds that the UK no longer ranks in the Top 3 of the most competitive energy markets in the EU and G7, Energywatch should seek immediate actions from DTI to remedy this situation; 7) Energywatch should build on its proposed gas Network Code modification (seeking the publication of near real-time data at UK subterminals, and thus improved customer access to price influencing information) by seeking appropriate changes to rules which will improve customer confidence in wholesale energy markets. Energywatch should also be mindful of its supercomplaint powers (see Section 6.7) to secure regulatory investigations under the Enterprise Act 2000, and consider whether these may prove useful in improving both domestic and business customer confidence in the wholesale gas market; 8) Energywatch should consider sponsoring the establishment of robust means for business customers to compare the service provided by suppliers of electricity and gas. Such a means should allow regular, timely information for customers to assess non-price factors including quality of individual supplier billing and transfer processes; 9) Energywatch should investigate further, and confirm the issues experienced by multi-site customers that are restricting their access to the competitive market; 10) One of the original benefits of NETA was that there would be more demandside participation but this has failed to materialise and business customers are largely uninformed of its potential benefits. Energywatch should work to encourage demand-side participation through the active promotion and development of current initiatives; Cornwall Consulting Report for Energywatch 141

142 11) Energywatch should ensure that its customer advice service recognises the business market as distinct from the household sector, and is able to provide timely, accurate advice to small business users in particular; 12) Energywatch should continue to monitor industry codes and agreements on behalf of all customers and table improvements it believes will improve their operation. However, it should weigh carefully its support for any regulatory measures or changes which may increase the cost burden faced by suppliers in administering the market. In such and other cases where the benefits to customers do not appear clear, Energywatch should engage with users and/or their representatives to determine their views and respond accordingly; and 13) Energywatch should encourage wherever possible the simplification of market entry standards and procedures for new suppliers, with particular reference to their appropriateness for participants intending to service business rather than household customers Prospects for Competition Our research leads us to the view that supply competition works best for larger customers with most supplier interest in this sector. Competition for smaller sites (including large groups of small sites) seems constrained by data problems and information, causing some of the customer attitude noted above. There is also no doubt that Britain s competitive energy markets face some significant challenges. Climate change and secure supplies are rightly on policymakers agendas, and there is a widespread expectation that the objectives they set can only be afforded from increased energy prices. In this context, we believe that Energywatch can fulfil two important roles on behalf of business energy customers. Firstly, it can act to inform and educate users of the opportunities open to them (both in terms of their purchase and for onward assistance in improved energy management). Secondly, it can play a sectoral good role communicating policy changes to customers and relaying their views to policy makers. We believe the latter role is particularly important as we perceive that the energy policy agenda is being far more influenced by major suppliers than customers. We suspect there is a tendency for some policy makers not to question the reasons behind current high energy prices too closely in the expectation that they will, in some way, ensure that energy supplies in the medium and longer term will be more secure. This may well be a very brave bargain to make. We also believe there is a tendency for the current deteriorating competitive market to be justified in comparison with perceptions of competition in other European markets. It is also arguable that there is a tendency to look outside the Cornwall Consulting Report for Energywatch 142

143 British market for issues which may be impacting trading conditions in what is still a relatively isolated system. Against this background, we believe there will be no shortage of issues which will impact customers including: vertical reintegration of the supply industry; continuing disquiet about wholesale energy markets; and the growing costs of environmental obligations both directly and indirectly in reforms to grid access charging (current proposals for rebalancing transmission charges from 1 April 2005 represent a good example of this) Recommendations Therefore, we conclude that Energywatch should consider the following action: 14) We believe that major customers are struggling to have their concerns on the wholesale gas market and other issues taken seriously by policy makers; therefore Energywatch should actively engage with business customers (of all types) on such issues, and advocate their views to key bodies including the Department of Trade and Industry and Ofgem; a) we believe that in order to fulfil this role Energywatch needs to establish formal channels of communication with major customers. This would require a mechanism to ensure proper engagement with customers, for example, through the establishment of a business user panel and regular stakeholder briefings Role of Intermediaries Our research has yielded significant concerns from some customers, their representative groups and suppliers about the conduct of some brokers. These concerns are to the effect that some brokers are pursuing their own agenda at the expense of unwary customers, placing contracts with suppliers for the best commission term rather than the best deal for their clients. Some argue that such behaviour is only possible because the broker sector is unregulated. We believe that there is a diverse range of intermediaries providing competitive services of considerable value to business energy customers. These services enable customers to access competitive terms more quickly and conveniently than by their own efforts and, in many cases, probably secure better terms than the typical, non-specialist energy buyer would be able to achieve in its Cornwall Consulting Report for Energywatch 143

144 own right. However, we believe it is worth assessing whether the market might be improved for customers if an accreditation scheme of some sort were established for intermediaries. Given the competitive nature of the sector and opacity of some broker offerings, including the alleged non-disclosure of fee earnings from purportedly free services, the most benefit may be obtained for the least cost from establishing a voluntary code of practice. Markets are fast evolving and larger customers are adopting more complex purchase structures, some of which can provide for their separating financial management from physical supply contracts. Some are seeking to establish separate risk management arrangements with financial institutions rather than energy suppliers, for example, sometimes assisted by advisors. We expect this to be an increasing trend. We are concerned at the lack of clarity amongst market participants about the necessity for such advisors to be subject to financial services regulation. We believe this lack of clarity may be encouraging some advisors to offer services for which they may not be qualified Recommendations Therefore, we conclude that Energywatch should consider the following actions: 15) Energywatch should investigate whether it should sponsor a voluntary code of practice for energy brokers. Such a code of practice should balance simplicity of purpose and ease of administration. It might address the following: a) charging principles - for example, whether the consultant earns income from direct charges to the customer and/or commissions received from suppliers; b) breadth of market coverage (number of suppliers approached and reasoning for non-approaches); and c) transparency of all evaluation calculations to customers with appropriate explanation of final choice. 16) Energywatch should seek legal advice on the financial services implications of independent brokers advising end users to commit to financial products as a part of their energy procurement. Energywatch should publicise the conclusions of this advice to market participants. Cornwall Consulting Report for Energywatch 144

145 Appendix A: Energywatch Complaint Codes by Category Energywatch advisors categorise complaints received from customers in order to aid analysis of market conditions. There are four general complaint categories concerning complaints about: the sales process (reference code MA in the list below); metering (reference code ME), contract disputes (reference code SU) and the switching process (reference code TR). Energywatch Complaint Codes by Category Category Category MA.1 - Suspected forged signature SU.1 - Clarity of bill MA.2 - Staff Behaviour SU.2 - Frequency/Infrequency of bills MA.3 - Sales Misinformation SU.3 - Disputed account MA.4 - Consumer agreed only to receive information SU.4 - Consumer not responsible for bill MA.5 - Signatory not responsible for account SU.5 - Estimated bills/consumption MA.6 - Misleading Media Advertising SU.6 - Refunds ME.1 - Meter accuracy SU.7 - Range of payment methods offered ME.2 - Meter provision or exchange SU.8 - Misdirected payments ME.3 - Meter positioning SU.9 - Security Deposits ME.4 - Meter reading/data collection SU.10 - Debt recovery practices ME.5 - MPAN/MPR number dispute SU.11 - Unsuitable Payment scheme to cov TR.1 Transfer in error due to incorrect SU.12 - Disconnection/forced PPM without TR.2 - Cancelled contract not actioned SU.13 - Disconnection/forced PPM in Erro TR.3 - Breach of Erroneous Transfer Charter SU.14 - Disputed Rights of Entry TR.4 - Problems arising from Contracts SU.16 - Prepayment meters (PPM) settings TR.5 - Supplier unable to supply SU.17 - Delay in issuing PPM card TR.6 - Inaccurate Meter Reading on Trans SU.18 - Consumer is having difficulty in TR.7 - Billing problems with Old Supplier SU.19 - Suspected meter tampering/theft TR.8 - Billing problems with New Supplier SU.20 - Unfair contract terms/notificati TR.9 - Supplier objection to transfer SU.21 - Disputed Domestic/I & C Premises TR.10 - Supplier objection to transfer Cornwall Consulting Report for Energywatch 145

146 Appendix B: Text of Letter Seeking Stakeholder Views Energywatch approached around 150 market participants, including customers, their representative groups and suppliers, seeking views on the nature of competition in business electricity and gas supply. Below is reproduced the core of a letter sent to customers. Similar letters were sent to representative groups and suppliers. 11 th May 2004 Dear Stakeholder, Energywatch review of business electricity and gas supply competition I am writing to inform you that Energywatch is undertaking a review of levels of competition in supply to industrial and commercial end users. Its purpose is to secure a basic understanding of current supply competition dynamics and, where necessary and appropriate, highlight areas for reform and improvement. Energywatch is very keen to ensure that the review incorporates the views of market participants and to this end would be pleased to receive comment on: 1. Your perception of the level of competition in supplying electricity and gas to your requirements, both as a whole and also whether there are particular requirements you have where you find competition more problematic 2. Your assessment of the prices and service levels currently and how they have developed since 2001; 3. Any views you may have on issues in the market that may act to inhibit competitive dynamics along with suggestions for how improvements may be made; and 4. Your views on how competition in supply is likely to develop over the next two years given the continuation of the current environment. We have prepared short questionnaire designed to address responses to these issues in summary form, which we would be very grateful for you completing (it follows the letter in this file). Additionally should you wish to make a fuller response we would be very pleased to hear from you. Whilst we are striving to undertake as full and comprehensive analysis as possible, we are well aware of the commercial sensitivities in this area. To this end, whilst we would prefer as open a process as possible, we understand that there may be information you may wish to provide us confidentially. We and our advisors will of course respect any information provided to us in this way. Cornwall Consulting Report for Energywatch 146

147 Appendix C: Respondents to this Review Business Energy Markets 2004 Energywatch and Cornwall Consulting would like to express their gratitude to all those who participated in this analysis. They include the respondents listed below and a small number of other organisations and individuals who asked that their identities be kept confidential. Air Products BAA plc Bhs Ltd. Bizzenergy Ltd. Boots plc. BP Gas and Power British Energy plc British Library Centrica plc Chartered Institute of Purchasing and Supply Chris Lewis Ltd. Churchfield Joinery CIES Ltd. Cogonis Performance Chemicals Compugraphics International Ltd. Continental Conveyor Limited E Save Ltd. Eastern Shires Purchasing Organisation ecotricity Ltd. EdF Energy Energy Information Centre Energy Intensive Users Group Energy Retail Association EnergyQuote Energytrak Ltd. Federation of Small Businesses Fisco Tools Ltd. Gaz de France ESS Ltd. Glebe Mines Ltd. Highland Council John Hall Associates Ltd. K-TECH Ltd. LAGUR London Borough of Camden London Borough of Islington Medics Group Ltd. NHS Supplies Npower Office of Gas and Electricity Markets Opus Energy Powergen PSR Energy Brokers Ltd. Rockwood Electronic Materials Ltd SB Whittles & Son Ltd. Scottish and Southern Energy plc Shell Gas Direct Statoil The Power Switch (.com) Total Gas and Power Cornwall Consulting Report for Energywatch 147