Energy Prices, Fuel Poverty and Ofgem

House of Commons

Peter Luff (Mid-Worcestershire) (Con): This is the last occasion on which my Committee, the Business and Enterprise Committee, will initiate a debate on energy policy. We have produced our last report, so this is something of a nostalgic occasion, although it will be much briefer than I had hoped. I would like to associate myself with the remarks of the right hon. Member for Rother Valley (Mr. Barron), the Chairman of the Select Committee on Health. When there are so many Government statements on a day on which there are important matters to debate, injury time should be added to our proceedings, so that all those who want to participate can do so. It is very regrettable that we are down to less than two hours for each of today’s two important debates.

The Government were right to create a new Department of Energy and Climate Change given the importance of the issue of energy, but it is a policy area that members of my Committee and I will miss greatly. It is an endlessly fascinating policy area, with economics, domestic politics, science, geopolitics, social policy and many other considerations forming part of the mix. The policy needs to reconcile three often conflicting aims: security of supply, affordability and sustainability. For example, achieving sustainability often means subsidy and cost, and that is paid for by the consumer, which means higher prices. Security of supply means investment, and that means reasonable profits for the energy companies, which means that prices must move with markets—and with the imperfect wholesale markets, too.

At the start of the year, the six main energy companies announced double-digit price hikes for their retail gas and electricity consumers. Not surprisingly, those steep increases were met with howls of protest from consumers, politicians and the media. The Sunday Times even went as far as to say that the big six were operating a cartel. The firms told us that they were simply responding to rising wholesale prices. Understandably, the Chancellor
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and the Government wanted to appear responsive to consumers’ concerns, so the Chancellor hauled the Office of Gas and Electricity Markets before him and demanded to know what was going on—perhaps surprisingly, as he had had responsibility for Ofgem only six months previously. Ofgem responded:

“Britain’s competitive market in energy is working.”

We did not believe the regulator. We called in the then Minister for Energy, the right hon. Member for Croydon, North (Malcolm Wicks), who is in the Chamber—it is a pleasure to see him here—in order to understand what was happening. His evidence was eloquent and elegant, as always, but I have to say that we were not totally reassured, so we launched our own inquiry. It soon transpired that Ofgem did not believe its analysis of the markets either, as the regulator launched its own probe into the energy supply market little more than two weeks after we had done so. We do not believe that Ofgem would have launched its probe had we not forced its hand. At the very least, our inquiry ensured that the regulator did its job properly. Its initial findings are a very thorough job of work. Our work turned into one of the largest and most complex inquiries that the Committee has ever conducted, and this debate marks its culmination, as we hand over responsibility to the new Committee in the new year.

This debate is primarily about our July report, “Energy prices, fuel poverty and Ofgem” but also tagged is our most recent—and last—report, published last Friday, called “Energy policy: future challenges”. Together, the two reports represent our main views on those complex issues, and I hope that the new Committee will study them carefully. I believe them to be politically and economically well-founded and, for such a complex subject, to be pretty readable, too. I want to thank all the Committee staff who worked so hard to ensure that the documents were published rapidly and efficiently. I am blessed with a great team in my Committee office, and I am proud of them all.

Let me turn to the subject of wholesale oil and gas markets. Any discussion of energy prices must begin with the price of oil. At the start of 2008, the markets heralded a price of $100 per barrel—an amount that would have been unthinkable five years ago. Not content with one high water mark, the markets continued to push prices up for the first half of the year. By the time my Committee published its July report, prices had reached almost $150, and some pundits were predicting that the price would be $200 or even $250 by about now. Such expectations now seem laughable. The energy price bubble has met the same end as most other asset price bubbles; it was pricked by the harsh reality of a sharp economic downturn. That is not to say that the oil price will not reach such heights again—it probably will, but not in the short to medium term.

The important point is that the price of gas and electricity are inextricably linked to that of oil. That is because the UK is no longer self-sufficient in its supply of gas, and must instead depend increasingly on imports, particularly from Europe. On the continent, for largely historical reasons, gas prices are linked to oil prices. There is no economic rationale for that at all, and no one could really explain to us why it persists, other than that it seems rather to suit the interests of the oil and gas companies.

Gas supply from the UK continental shelf is falling rapidly, and almost all the new electricity generating capacity due to come online in the short to medium term will use gas. That means, it seems, that the UK’s dependency on gas imports is set to increase. That poses major challenges for the Government. We have a liberalised gas market in the UK, but it is structurally tied to an unliberalised European market. UK gas prices rarely fall below European levels because our companies simply choose to export surplus production. That is particularly the case in the summer, when gas consumption is lower. In the winter, UK prices have to rise significantly above European levels to attract that gas back. That is part of the reason why we have seen such large spikes in the price of gas during recent winters.

A further big reason is that the European markets have not liberalised in the same way as we have. There is not much that we can do about that, try as we might. Heaven knows successive Energy Ministers have tried, and I am sure that they will continue to do so.

Mr. Mike Weir (Angus) (SNP): I agree with the hon. Gentleman’s analysis, but does he not agree that the situation is even worse than that? In its evidence to the Committee, the Energy Intensive Users Group said that even when its members were in a position to take gas from continental suppliers, those suppliers would not supply it to them, so they could not take advantage of cheaper supplies on the continent, even where an interconnector existed.

Peter Luff: I am most grateful to the hon. Gentleman—a distinguished member of my Committee—for that remark. As far as I am aware, that issue has not yet satisfactorily been addressed. It seems to be a breach of the simple single market rules of the European Union, and I cannot understand that. It is a matter of great concern to the Committee, and I hope that it will be to our successors, too.

On gas supply, the Government must take some of the blame for the current predicament. If we were able to store gas at times when it is cheaper, the UK would not suffer from the current volatility in prices. Our growing dependency on gas and the need for more storage was a car crash that the Committee, and its predecessor, saw coming years ago, and I am afraid that the Government have been very slow to react to it. We have just 13 days of storage capacity. Germany has 99 and France has 122. Even if all the projects under construction or with the required consents were built, we would add only another five days of storage by 2014. In other words, we need growth of a greater magnitude than that achieved to date if we are to match the Europeans and protect our vital national interests. Planning has been a problem in that regard, as it has been for many aspects of energy infrastructure. We can only hope that the new infrastructure planning commission will help in that regard, although even if it does—there are some doubts about that—it will be some time before it begins to have an impact. The Government must move quickly to put in place a national policy statement on gas storage.

Worryingly, planning is not the only important issue. The industry told us that the economic incentives for the market to build new storage simply did not exist
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until fairly recently. Those incentives have now been virtually wiped out by the collapse in energy prices, and by the reduced availability of financing resulting from the credit crunch. In simple terms, the market will not deliver. If new storage capacity is to be built on time, the Government must think again about the incentives that they can provide.

Lack of gas storage is not the only problem with the wholesale gas markets. Companies have been investing in new infrastructure for liquefied natural gas imports to the UK. One of our main facilities is at the Isle of Grain. Its owners—BP and Sonatrach—have barely used it this year, choosing instead to send LNG to the far east, where economies are willing to pay more. Third parties have the right to use the facility, but none have done so this year. Ofgem has been dismissive of the possibility that the regulatory framework for gaining access might be a factor, despite several witnesses telling us that it is. We believe that Ofgem should look again at the issue. Otherwise, we will have concerns about the outlook for new LNG capacity at Milford Haven.

Liquidity in the gas market is a major concern for the Committee. For those who want to buy gas to use right now, the UK has one of the most liquid gas markets in the world, but that is not the experience for manufacturers who want to hedge prices by buying ahead; they just cannot do that. The financial crisis has served only to reduce liquidity further. Ofgem and the Government—I hope that this will not be true of the new Department—do not seem to believe that that is a problem. The UK’s manufacturing base has told us otherwise. When even an arm of government—the NHS Purchasing and Supply Agency—is concerned that there is

“no effective long term market”

for gas, the Government and the regulator should take notice.

What about wholesale electricity? Failings in the wholesale gas market feed through to the wholesale electricity market, because 40 per cent. of our electricity comes from gas, and it provides the marginal source of generation in the UK—it sets the price. Our Committee found serious failings in that market, too. In 2008, electricity prices have been driven up, not just by higher gas prices, but because of environmental costs. For example, Ofgem reckons that since the start of phase 2 of the European Union emissions trading scheme, £9 per megawatt-hour has been added to the price of electricity, despite the fact that generators receive 93 per cent. of their permits free of charge. The Government estimate that the resulting windfall is about £2 billion a year over the five years of phase 2.

No one knows exactly what the energy companies are doing with their windfall gains, which are distributed very unevenly between energy companies and generators. At first, the energy companies denied that the windfall gains even existed, and to the extent that they did admit to them, companies claimed that the value of the windfall had been passed on through lower prices or greater investment—investment that we need. The Government have rightly taken a different view in clawing back some of that money to tackle fuel poverty—that was one of the recommendations in our July report—but we are disappointed that neither they nor Ofgem have conducted a fuller analysis of what those windfalls were or how they were distributed.

When the Committee published its report, the big six controlled 55 per cent. of electricity output, with the rest shared among the independent generators. In recent months, further consolidation has been promised, with the purchase of British Energy by the French company, EDF, which will own nearly a quarter of the UK’s electricity output, with the big six controlling nearly three quarters of that output. Our report pushed the regulatory bodies to ensure that that consolidation did not affect the competitiveness of the market adversely, and I hope that the European Commission will have something to say about that when it reports on the acquisition of British Energy.

Consolidation, however, was not our only concern. Many witnesses hid the fact that their companies owned both wholesale and retail arms—there was no transparency on where their profits were made. If other firms—potential new entrants—cannot see where profit-making opportunities lie in the value chain, it is easy to see why they are reluctant to enter the market to compete with the existing players, which is why we welcome Ofgem’s decision, following the Government’s prompting in response to one of our recommendations, to require the vertically integrated companies fully to disaggregate their accounts. That is an important, and big, step forward.

Mr. Weir: Again, I agree with the hon. Gentleman, but does he not accept that there is a problem, as many of our energy companies are owned by multinationals, and it is even more difficult to find which part of their profits comes from the UK?

Peter Luff: The hon. Gentleman makes an important point with which I agree. It is something about which British Gas is particularly aggrieved, because it sometimes gets more of the blame than other companies because its profits are more visible than those of its competitors.

Sadly, that is not the only issue facing new entrants. We found that the electricity market suffers from a profound lack of liquidity—a problem exacerbated by the financial crisis—which contributes to price volatility and poor price transparency. It contributed, too, to the exit of two of the largest independent electricity suppliers outside the big six in recent months. We welcome Ofgem’s tough line on this issue, announced in its probe findings, and we hope that our successor Committee will look at the issue in detail. As it stands, the market discourages new investment in generation by new entrants, which leaves us heavily dependent on the big six to deliver the conventional capacity that the UK needs to replace the nuclear and coal-fired power stations that are set to close in the coming years. We are fearful that the economic and financial crisis will lead to delays in that much-needed investment.

That creates a serious risk, highlighted in our most recent report, that the UK could face an “energy crunch” in the coming years. As with gas storage, it is clear that the market could fail to make the necessary investments on time without intervention from the Government. Every month that we lose increases the risk of the lights going out, or of increased dependency on gas generation, or both. The Government have already said in their White Paper last year that security of supply is their top priority alongside reducing carbon emissions. They will now have to work very hard to ensure that those two objectives do not become mutually exclusive. For example, new coal-fired generation will be possible only if there is
significant progress on carbon capture and storage, which requires a much greater level of investment from the Government. They must quickly make the relevant national policy statement on nuclear power, and learn from the recent Finnish experience of cost overruns and delays, if new nuclear is to play the role that they want in the future energy mix, and which I believe it is right to want.

The retail markets receive most attention, and we uncovered many problems in the service provided to households and small businesses. I want to make it clear that neither we nor Ofgem found any evidence of the energy companies acting as a cartel, but they do not need to do so. Given that the market is dominated by just six players, it is easy for them to make informed judgements about one another’s actions and position in the market. They do not need to collude because the market is broken. Ofgem has, rightly, always advocated the benefits of consumers switching to realise the benefits of the liberalised markets. About half of households have changed either their electricity or gas supplier since liberalisation. Most of them have done so to benefit from a dual fuel tariff or some other offer. However, 20 per cent. of households have never switched, and they are predominantly pensioners, people in social group E and those in rented accommodation—in other words, some of the most vulnerable people.

Our inquiry and Ofgem’s probe found that those consumers least likely or able to switch were most likely to be the victims of price-discriminatory practices by the energy companies. For example, suppliers charge their legacy customers—the ones who stay with them and do not switch—an average of 6 per cent. more for electricity than “out of area” customers. Suppliers earn much higher margins on electricity than on gas, thus disadvantaging 4.3 million households that are not on the gas main. Both standard credit and prepayment meter users are disproportionately overcharged compared with direct debit customers. I therefore welcome what Ofgem said today, but I want to highlight the issue and ram the point home: it is not just about prepayment meters—where standard credit terms operate, that is where the bulk of fuel poverty exists.

John Battle (Leeds, West) (Lab) rose—

Mr. Russell Brown (Dumfries and Galloway) (Lab) rose—

Alan Simpson (Nottingham, South) (Lab) rose—

Peter Luff: I shall give way, first, to the right hon. Member for Leeds, West (John Battle), secondly to the hon. Member for Dumfries and Galloway (Mr. Brown), and thirdly to the hon. Member for Nottingham, South (Alan Simpson).

John Battle: Most of us welcome the Committee’s work and the timely reports that it has produced. Does the hon. Gentleman agree that many of the 6 million people on prepayment meters in particular do not have bank accounts and cannot switch, so it is not an option for them? They pay £100 a year more than standard payers, and they pay £500 a year more than people on direct debit. Even under Ofgem’s proposals, they will pay £51 a year more. Is it not time to end the iniquity of the poorest subsidising the rest of us, and to ensure that people on prepayment meters do not pay a penny more?

Peter Luff: The Committee’s view on that point was very simple. There are additional costs involved in running prepayment meters, and it is essential that there is no excessive recovery of price beyond that actual economic cost. If the Government want to say that those people should pay the same price for electricity as people on other terms, some kind of subsidy is required—either a cross-subsidy from other consumers or a subsidy from the taxpayer. That is a perfectly legitimate thing to want to do, but I point out that a cross-subsidy from standard credit customers to prepayment customers would work against the interests of tackling fuel poverty. However, I accept the point that the right hon. Gentleman makes.

Mr. Russell Brown: May I, too, congratulate the hon. Gentleman and his Committee on their work? In recent weeks something has come to the fore that I discussed with interested groups in the summer recess, and it concerns people who pay by direct debit who have received demands from their supplier to increase their monthly payment. On a personal basis—and I let my good lady wife deal with this—I received a demand in recent weeks for an increase of 57 per cent. on what we previously paid. When my wife challenged that—that is the point: I have encouraged people to challenge those demands—the energy company reduced it to 17 per cent. The companies are taking people’s money, putting it into their bank accounts, and they may well be dragging people needlessly into fuel poverty.

Peter Luff: I am grateful to the hon. Gentleman for making that important point, which I was going to mention later.

I said some things about that to the BBC two or three weeks ago, and all hell broke loose. My e-mail inbox and my postbag have swollen to huge proportions, because there are many experiences like that. The essential weakness of the energy companies’ position is that nine times out of 10, they reduce the price. When the Minister appeared before the Committee, he admitted that he had a similar experience with his direct debit. I have had a similar experience with mine. I know police officers, journalists and colleagues in the House who have all had the same experience. The problem is too widespread to be ignored. I gave a file of evidence to Ofgem, which is looking at what it can do to investigate the problem. It says that it lacks quantitative evidence but, my God, it has a lot of qualitative evidence. It needs to get on with it and look at this, because it is an important issue. If we want to move people on to direct debit terms to get the benefit of better prices, we must tackle other aspects of the deal that hurt those people, as could well be the case at present.

Alan Simpson: I, too, am grateful for the work of the hon. Gentleman and his Committee. Were they able to look rigorously at the weakness of Ofgem’s claims about switching and the fuel-poor? The reality is that 1,000 households a week have been forced, as a result of fuel debt, to come off standard tariffs and on to prepayment meters, which is the only choice that they are offered. Even the argument that someone who has not been forced on to a prepayment meter could choose to switch to another tariff is not valid, because they do not have access. Conditions applied by energy companies say that to gain access to the best tariff people must have been a customer for at least a year before they can have such an entitlement. Those measures progressively exclude the fuel-poor, rather than include them.

Peter Luff: That is a powerful point. I strongly suspect that my hon. Friend the Member for Wealden (Charles Hendry) will make some observations about the Post Office card account when he speaks on behalf of the Opposition, and offer some proposals to deal with that issue. The hon. Member for Nottingham, South is absolutely right, but that is not the only concern, because we are concerned, too, about the number of people who switch on to higher tariffs. The evidence is that 20 to 32 per cent. of households move on to a higher tariff after switching, so it is a mess.

On the specific issue of the fuel-poor and direct selling, recent evidence from Ofgem showed that 48 per cent. of gas customers and 42 per cent. of electricity customers who switched as a result of a direct sales approach—doorstep selling—failed to achieve a price reduction. Ofgem has proposed action, but we think that although direct selling plays a role in helping people switch, if it helps people switch wrongly, it is doing more harm than good and needs to be banned. We will look at that carefully.

Incidentally, it is not just private individuals who are affected, but small and medium-sized enterprises. We heard compelling evidence of predatory pricing, delaying tactics to win back customers, and confusing contract cancellation requirements. We are glad that Ofgem is looking at the SME market as well, but it is sad that that has come too late for my constituency company, BizzEnergy, which has gone into receivership, and for Electricity4Business, which has been driven out of the market. The market is thus becoming less, not more, competitive.

I would say a great deal more about fuel poverty, but time is against me and a number of colleagues wish to speak. Briefly, we believe that fuel poverty levels will reach 5.5 million. That figure is quite widely accepted. The Government will therefore fail to meet their target to eradicate fuel poverty for vulnerable households by 2010, unless there are sharp reductions in price in the future. In our reports, we asked for the Government to go back to the drawing board in their approach to fuel poverty.

We asked for a mandatory definition of what constitutes a social tariff and who qualifies for it. We said that income-raising measures should be targeted more accurately at the fuel-poor, not only pensioners. Pensioners are not the only group in fuel poverty, just as prepayment meter customers are not. Disabled people and many other vulnerable groups are also in fuel poverty, and we need to take action to help those groups as well, particularly through levels of investment in the energy efficiency of our housing stock.

We were very pleased to see the Government’s £1 billion fuel poverty package, which we thought struck the right note. That will prove the most effective way of addressing fuel poverty in the long run. However, I repeat that we are very sorry that so little has been done to address of the needs of the fuel-poor other than pensioners.

Finally, our work over the past year has shone light on many problems in the UK’s energy markets—energy markets of which we all thought we could be rather
proud. That light caught the market’s regulator, Ofgem, unawares. We feel as a Committee that we have set the agenda for Ofgem on too many occasions—for example, the direct debit issue was not being considered, but as a result of our Committee’s activities, it is being looked at now.

Although we welcomed the regulator’s recent probe of the energy supply market, and many of its proposals, we hope Ofgem will make a new year’s resolution for 2009 and take time to reflect on how it fell so far behind the curve in 2008. Part of the solution may lie in its powers. We hope the Government will look to ensure that the regulator has all the tools it needs to police the sector effectively. There is an important recommendation in our most recent report in relation to market abuse powers, which we are sympathetic to Ofgem’s claim to gain for itself.

Mr. Elliot Morley (Scunthorpe) (Lab) rose—

Peter Luff: I give way with pleasure to the right hon. Gentleman.

Mr. Morley: I am grateful and add my support for the report. It is a very good job and extremely readable. I was interested in what the hon. Gentleman said about whether Ofgem’s powers had kept up with the changes in the energy market. Interestingly, the report mentions that where Ofgem had tried to intervene, the Competition Commission had blocked it. Does he think it is just an issue of Ofgem’s powers, or is there a bigger structural problem?

Peter Luff: What the chief executive said to us is that

“‘the Enterprise Act or the Competition Act is quite often a very clumsy tool—using a sledgehammer to crack what may be a big or a small nut’”.

If we could give Ofgem more carefully defined and targeted market abuse powers, it could crack those small nuts, which are the often the problems that cause most grievance to our constituents, and understandably so.

Such considerations as we have been debating need also to be placed within a wider debate on the effectiveness of the overall regulatory regime for energy. A plethora of bodies now exists. They include Consumer Direct, Consumer Focus, the energy ombudsman, the energy companies and Ofgem itself. I find such a framework confusing and I am trying to work my way through it. Members of the Committee find it confusing, and the witnesses who came before us said that they thought it probably would be confusing.

I know that there have been changes recently that will take time to settle down, but one wonders how our average constituent is supposed to understand the system. After saying that I was referring the direct debit issue to Ofgem, I have been getting quite a lot of letters saying, “But Ofgem has been abolished.” No, it is Energywatch that has been abolished. These constant changes are unhelpful, and the structure runs the risk of not properly informing the regulator about issues and problems in the market.

The events of 2008 within the energy sector and the wider economic context have profound implications for the UK’s future energy policy. Ofgem and the Government must now rethink whether the assumptions that they have made are the right ones. Is the market working as effectively as both claim? I do not think it is. Will that market deliver security of supply? It is far from certain that it will. Can that be achieved without sacrificing our carbon reduction ambitions? It must be, and I hope it will be.

Are the renewable energy targets really achievable? I have yet to hear anyone who thinks they genuinely are achievable. They are good targets to work towards, but can we achieve them? I doubt it very much. A question that worries me a great deal is whether it is right to devolve important social policy questions about poverty to Ofgem and the energy companies. Are those not matters for Government to decide?

On a specific point, I think smart meters are an important part of the answer to the direct debit question, to carbon dioxide reductions, and to informing consumers about what they are consuming. I note that the Government are in a two-year consultation period for a 10-year roll-out programme for smart meters. Italy did smart meters in three years, so I hope we can move a little more quickly on that subject. We could find mechanisms to enable us to do that. There might be some extra cost, but the benefits would be huge.

These are many of the questions—not all of them—that the regulator, the Government and the new Energy and Climate Change Committee face, among others, in the coming years. I am sorry to kiss goodbye to these issues. They are vital ones, and the Committee and the Government have some very important questions to face.

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