Enterprise and Lifelong Learning Committee, 18 Sep 2002

Meeting date: Wednesday, September 18, 2002

Official Report 306KB pdf

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Electricity Trading and Transmission Arrangements

We now move on to item 3. I welcome Callum McCarthy, who is chief executive of the Office of Gas and Electricity Markets and chairman of the Gas and Electricity Markets Authority; Margaret Ford, who is a member of the Gas and Electricity Markets Authority; and David Halldearn, who is Ofgem director for Scotland and Europe. I believe that David is the successor to Charles Coulthard.

I welcome all the witnesses to the committee. I particularly thank Callum McCarthy, because he has taken the initiative and expressed a great deal of enthusiasm over several months for having a session such as this. I am sorry that we have not been able to fit you in before now, but recent events mean that this is probably quite an appropriate time for you to talk to the committee.

Thank you very much for letting us come to the committee. We will not waste your time by making a long introductory statement. I would like to say two things. First, Ofgem's principal objective under the statutes that give us our legitimacy is to protect the interests of consumers present and future, wherever possible, by promoting effective competition. We take that very seriously. Secondly, the reason why we wanted to come to the committee is that Scottish customers are at the top of our agenda. One of the four corporate priorities for Ofgem in the corporate plan that we published for 2002-05 is to bring more competitive prices and greater choice to electricity customers in Scotland. We look on this meeting as an opportunity to explain to the committee why we have made that a priority, how we are tackling it and to answer your questions.

I will kick off with a couple of questions. First, do you have any social justice remit in addition to your competition remit, which I understand is core? I have come across a number of cases of power companies that are competing with one other by visiting elderly people and very often confusing them. Competition has a role, but sometimes the effect of very aggressive marketing—getting older people to change company regularly, sometimes at great cost to themselves—is an issue, particularly in poorer parts of Scotland.

Secondly, given recent events and taking the Scottish economy into consideration, the situation with regard to British Energy is of concern to people in Scotland. From reading very closely about the role of Ofgem in that situation, it seems that it is in effect impossible for your new pricing regime to work and for us to have a viable nuclear energy company such as British Energy. There seems to be a conflict there and it seems to be the case that never the twain shall meet. I would like your comments on that.

I will take the issue of what we are going to do about mis-selling. I will hand over to Callum McCarthy on the second question.

The Utilities Act 2000 gave us specific statutory responsibilities and a new organisation, energywatch, was created at the same time. It took over about 25 per cent of Ofgem's previous duties. It is the consumer body that addresses the individual complaints that people bring to it. There is an energywatch committee in Scotland and a well-resourced office in Glasgow. The Utilities Act 2000 gave Ofgem the powers to act when we see systematic mis-selling and we can assemble a case against companies that are behaving badly in the marketplace.

Only in the past two months has the Government given us the full ability to discharge the powers, which are quite hefty. If we come across a clear case of mis-selling or companies misbehaving in the market, we have the power to fine them up to 10 per cent of their turnover, which is quite a serious penalty in anybody's terms. We mean to take that very seriously. In a recent discussion we concluded that only when the Government took pensions mis-selling seriously did the industry clean up its act. When we come across a clear case of mis-selling we will not hesitate to act, but we have not been able to do so until relatively recently.

How are you able to publicise your role? Most people do not know where to go with a complaint, unless they go to an MSP or MP. We need more publicity to let ordinary people know what the score is.

Absolutely. We had a long meeting with energywatch Scotland to talk about how it can do more. We can work with the Scottish Consumer Council, which is keen to help in this area so that people do not feel bewildered by the doorstep salesman who may or may not be behaving properly.

Before we leave the question of mis-selling and ensuring that competition works, I want to come back to your question about whether we have a social justice agenda as well as a competition agenda. The answer to that is emphatically yes. One of our principal concerns is to ensure that competition works across the whole social structure. We are determined to maintain what is happening at the moment, which is that competition is benefiting the poorest people—single parent families or people with disabilities—as much as or more than the generality. That is terribly important to us.

On British Energy, there is a great deal of misunderstanding about what the new electricity trading arrangements are. Much of the discussion has suggested that Ofgem somehow controls wholesale prices, but it is extraordinarily important to acknowledge that we do not control such prices.

The move that was made in March last year—which I regret to say is confined to England and Wales, although one of our major plans is to develop it for Scotland—was to replace rather artificial arrangements that were made at the time of privatisation in England and Wales. Those arrangements made the wholesale electricity market stylised, easy to manipulate and not competitive and they have been replaced with arrangements that make the market as competitive as possible. Some 95 per cent of electricity is traded either long term over the counter or short-term through power exchanges. Ofgem has no responsibility for that whatever. In so far as it is regulated, it is, like any other market, regulated by the Financial Services Authority.

There is a need in any electricity market for a system operator—in England the National Grid Company and in Scotland the two transmission companies—to organise the balancing of electrons moment to moment. That is unavoidable; it happens in every country in the world. Something like 3 per cent of electricity goes through that market and we do not control it. Ofgem's principal responsibility is that when there are rule changes in the market we have a right of veto to prevent the rules from creating a cartel. An artificial and non-competitive market has been replaced with a competitive market. All generators are now competing in that market.

That has been a major contributory factor to the downfall of British Energy.

Since those and other changes were first mooted four years ago, there has been a significant reduction in generating prices. That has caused problems for some generators, but it has also brought great benefit for industrial and commercial purchasers of electricity in particular and it has replaced an uncompetitive market with a competitive market. The uncompetitive market had behaved to the disadvantage of the country.

I am not shy of defending competition, but your principal objectives in law are to protect the interests of consumers, with the qualification "wherever appropriate", by promoting effective competition. How does Ofgem strike a balance between the natural instinct of supporting a competitive market and the possibility of introducing uncertainty or insecurity of supply? The British Energy situation is causing the real concern in Scotland that, if supply is not reinstated or is lost altogether, energy problems will follow. I am not sure where Ofgem sits in trying to balance those two obligations.

Our principal obligation in the Utilities Act 2000 is to protect the interests of consumers. We also have a number of other obligations, which we take very seriously including security of supply, environmental objectives, and ensuring that the companies that we regulate that are not in the competitive sector are properly financed.

It would be completely inappropriate for me to comment on any particular company—we do not do that. However, in general, what is critical for security of supply is whether plant owned by a company will continue to operate irrespective of the financial affairs of that company. That question has been very much in our mind, in relation not only to recent events but to past events.

That reply is very helpful. I must say that I welcome your appearance before this committee this morning—it is a positive innovation. To what extent is Ofgem able to engage with a devolved Administration such as the Scottish Executive?

We happily talk to the Scottish Administration. Indeed, three of us have this morning seen Mr Henry to discuss a number of issues. We have had discussions with past First Ministers. We discuss all matters with the Scottish Executive and the Westminster Government.

I endorse what was said by the convener about difficulties that people encounter; I am sure that all members have had similar experiences in their own constituencies. My experience of energywatch has been very positive. When matters are drawn to its attention, the people there know what is going on. They are also happy to interact with constituency members. I am pleased that energywatch is working. However, many people do not yet know about it.

There is always a balance between effective competition and clutter. As a constituency member, I have come across a number of cases of people finding themselves with a plethora of suppliers and not knowing what is going on. People cannot get a tour guide for the suppliers. In one absurd instance, a chap had to go through a six-week process to get data on which particular form of meter should be installed for new arrangements at his home. His problem was that, although it was all very well having lots of information, no one was showing him the tramlines to allow him to get to it. After getting involved with the industry, I was not confident that there were tramlines within the industry as a guide to what standards of information should be common among installers, suppliers and the like. What is being proposed in that regard?

You are right. There are standards in the industry. Because of the way in which we were set up by the Government, customers' first point of contact is with energywatch. Once energywatch has assessed the case, we provide information and—when necessary, and when such information is provided to us—advice on taking enforcement action. As Margaret Ford said, we have new enforcement powers that we are determined to use, where that is appropriate.

We are trying to improve the joining up of work that is done by us, energywatch and other consumer organisations, so that it will be easier for customers with a problem to know where to go to get a response that addresses their specific need. There is more work for us and the consumer organisations to do towards that, but we are determined to improve the situation as quickly as we can. We have dialogues with the consumer organisations and we are developing better ways of working.

I have two questions. First, you talked about the social justice element of your remit and about ensuring that competition is advantageous to all groups in society. What about the geographic coverage of competition?

Taking as a measure of competition the switching rate—which is not the only measure but a convenient one—there are two things that worry us. First, there are difficulties among the older population, who switch less than other people, perhaps because of natural conservatism. We are working with Age Concern to see whether we can ensure that the competitive offering is appreciated and understood by older people and that they do not feel threatened by, for example, aggressive selling. Secondly, there is a lower switching rate in the countryside, on a GB basis. There are two reasons for that, the first of which concerns the distribution of gas. The customer can make a bigger saving if they receive competitive offerings for both electricity and gas. The offering for electricity alone is less attractive. The second reason is that, up to now, one of the most powerful means of getting the competitive offering in front of people has been doorstep selling, and that is much less economic in the countryside for obvious reasons—the doorsteps are further apart.

I am not aware of any competitive selling in my part of the world.

My second question relates to renewable sources of energy. Both Scottish and Southern Energy and Scottish Power are running renewables projects. I am interested specifically in the transmission lines. If the role of renewables is to grow in the provision of energy in the UK as a whole, power will have to be exported from Dounreay all the way to the south coast. That will incur a considerable infrastructure cost. Does your remit cope with that need for investment? Government policy is clearly to drive towards a 40 per cent provision of power from renewables over a period. That investment is needed; how it will be made is a good question. However, if your remit is to drive down cost on the basis of competition, how does that square with Government objectives on renewables and the nation's desire to see more clean energy produced?

We are engaged in work on BETTA—the British energy trading and transmission arrangements—and have asked the Government for legislation early in the next session. We understand that we will be given an opportunity to start that process in the autumn. The transmission side of that is just as important as the trading side. We are trying to do two things. We are trying to bring a more competitive offering to Scotland because we know that pre-privatisation electricity prices in Scotland were 5 per cent less than those in England and Wales, whereas the prices are now 9 per cent more. We want to do something about that. Secondly, we are addressing the issue of transmission, which you have raised.

If a renewables industry is to be developed, we need a route to market for the energy produced, and the current arrangements, including the financial and physical structure of the market, do not facilitate that. We want to ensure that we have a genuine UK market, where the companies that are generating renewable energy in Scotland have a route to market and where Scottish or other companies have the right investment incentives to invest in renewable energy. What we are working on now requires primary legislation because we do not currently have the powers to achieve it. That would address both the trading side and the transmission side.

So you do not envisage circumstances in which it would be uneconomic to develop renewables. The conventional thinking is that they will be at the margin. You do not see your competitive requirements getting in the way of the development of renewables on the west coast of Scotland, for example, where investment in transmission lines will be significant.

Last Tuesday we held a big conference on almost exactly that issue. I do not think that most people in the country generally recognise the scale of the change involved. If the Government's present targets are to be met—and I think that the targets for Great Britain are more likely to be increased than decreased—that will involve a huge change in the structure of generation and the distribution of energy within Britain, and therefore in the infrastructure of the wires that would be needed to serve that.

To give a specific example, any distribution network operator, such as Scottish Hydro-Electric or Northern Energy in England, probably has about 300 distributed generators in the whole of its network. If we achieve the targets set for 2010, every single substation is likely to have 300 distributed generators attached to it. That involves a huge change in thinking. The reason why we held a conference last week was to get the companies to start thinking about that seriously and to expose to them the range of ideas that we are prepared to develop with them in order to deal with exactly the sort of problem that the committee has identified.

It is important that we do not simply wire up the country from north to south and from east to west without having some proper demand lying behind that. We are looking for a proper means of carrying out the task so that we can respond effectively and quickly to real demand, but not on the basis of sloganism. That would be environmentally disastrous and would be very bad for customers, because very substantial sums would be involved.

I have some specific questions on the third paragraph of Ofgem's written submission, on the lack of competition in the wholesale market, specifically on the cost implications of that. Do you have a money figure for the 9 per cent extra that Scottish customers have to pay on average compared to the average figure for England and Wales? What does that difference mean in terms of the total market price? In other words, what is the value of the Scottish market?

Do you mean the difference on an average bill?

That and the overall size of the Scottish market. Those are figures that I do not have at my fingertips.

The overall size of the electricity market in GB, at the retail level, is about £10 billion. The Scottish part is about 10 per cent of that, so it is about £1 billion.

That is slightly above Scotland's percentage of the population—that is the point that you are making. A premium is being paid in Scotland largely because of the lack of competition in the wholesale market, to which you allude in your submission. Is that lack of competition feeding through because of inefficiency or because of excess profit taking?

That is a difficult question. In a competitive market, one would expect competition to drive companies to be more efficient. Competition in fact provides quite a big incentive for companies to improve efficiency. The Scottish companies are also active in the England and Wales market, which is very competitive. Inevitably, the extent to which companies are not being efficient means that resource is wasted; the extent to which they are efficient will feed through to companies' profit lines. I am afraid that I could only give that general answer to what was a hard question, but it is the best that I can do.

We do not attribute the whole difference to the lack of a competitive market. Some genuine costs are involved on the part of the Scottish companies; so is the way in which the industry was structured at the time of privatisation. We are not saying that the whole gap is down to the companies' behaviour; some things to do with the way in which the system is structured in Scotland are outwith the companies' control.

What are the proportions involved?

It is difficult to get the specifics, as the information is quite difficult to disentangle. We could do some more work on the question and give you some more information, but it is difficult to be precise.

You say specifically that a lack of competition is the main reason for the higher price of energy in Scotland, so it must amount to more than 50 per cent of the difference.

The justified extra costs that Scottish companies face do not account for the whole difference. Those costs relate specifically to the operation of wires. Because of Scotland's geography, some wires are very long and serve areas that are not highly populated with customers. That has cost implications.

Some of the costs that companies face relate to the restructuring contracts that were put in place at the time of privatisation. Some of those contracts, which are complex documents, still exist but are due to end quite soon.

The figures that the companies have provided suggest that the extra costs resulting from restructuring contracts and the cost of wires are about equivalent. However, there are other factors. In Scotland there is a huge surplus of generating capacity, which is much greater than the surplus in England and Wales. In those circumstances, one would expect wholesale prices to be pretty competitive. In fact, because we regulate wholesale prices, they are pegged at more or less the same level as in England and Wales. In a properly competitive environment, one would expect wholesale prices to be focused much more sharply, which would benefit customers.

Some of the restructuring contracts will also come to an end. In a competitive market, one would expect the benefits of that process to flow through to the customers and to have a serious impact on the price difference.

I am still confused about the root of all the problems. It would be useful if you could provide the committee with some figures.

We can do that.

What role do you play when new generators come on board? Is your role simply to regulate what is produced? Do you have no part to play in determining how much is produced?

The Government has powers to license new generation as it comes on stream. It used those powers when there was a moratorium on new gas-generated energy plant. We have limited licensing powers, which we use to ensure that we get information from generators. We play no part in deciding whether there should be an increase in generation.

So you play no part in determining the relative cost of energy.

No. The determining factor in generating prices is now a competitive market.

Let us take the specific example of further nuclear development in Scotland, which I support. Many statements are made about the relative costs of nuclear and renewable energy. Does Ofgem or another body determine whether those statements have a factual basis and evaluate them in terms of competition?

We do not. It is Government policy to have a renewables obligation. The Government has set the value of that obligation. Ofgem administers the renewables obligation certificate system, both in England and Wales and, separately, in Scotland. We work with the Government in an executive capacity. However, quite properly the size of the renewables sector, the nuclear sector and sectors based on other forms of generation is an issue for elected members of Parliaments rather than for Ofgem. It would be inappropriate for 11 appointed members of an authority to make decisions of that magnitude.

I would like to ask about the requirement for companies such as Scottish Power and Scottish and Southern Energy to buy in a proportion of their production from nuclear generators. What impact does that have on competition?

When the industry was privatised, a contract called the nuclear energy agreement was put in place. The output of the two Scottish nuclear plants is sold to Scottish Power and to Scottish and Southern Energy, which are obliged to buy that output. Those companies account for about half of Scottish consumption, so that agreement has a major impact on the potential for competition in Scotland. The contract was due to end in 2005 and the companies have been in active negotiation about it—indeed, they have been to court about it. It clearly has a major impact, but it is due to end quite soon.

One of the reasons why we were keen to get the new trading arrangements for Scotland in place by 2004 is that we saw the end of that agreement coming and it was extremely important that British Energy had a market for that energy. That was another part of our thinking about changing the Scottish trading arrangements.

I was glad to read your comments about signing up to the social action plan for low-income and vulnerable families, but I would like to get a rough idea of how your system works. Do you monitor the service provided to low-income and vulnerable families and do you have targets for the wholesalers? Are there set targets for the number of more expensive pre-payment systems or the number of disconnections? Do you monitor those figures, impose targets and put pressure on the companies to improve their record?

We carefully monitor those and a number of other parameters. We do not have a mechanism for imposing targets, but we have a degree of moral suasion that we use as powerfully as we can. Ever since Ofgem was set up, one of our great concerns has been to deal with the terrible scourge of fuel poverty that exists throughout Great Britain and particularly in Scotland.

It is important to recognise that there are three causes of fuel poverty. One is that people are poor, another is that they are in lousy housing and the third is energy prices. Of those three, we can make the biggest impact on the third. We hope that the Government will do something on energy efficiency measures to improve the housing stock. Through lower energy prices, we can also improve incomes generally, by making the country more competitive. However, the main thing we can do is on energy prices; the reduction in energy prices over the past five years has been the biggest single cause of bringing people out of fuel poverty.

So you are effectively encouraging greater corporate and social responsibility among the companies.

We are also trying to establish best practice in particular companies and to ensure that it is applied in other companies. Some of the Scottish companies have been very good at developing ideas and we want to encourage others to imitate that.

I thank Callum McCarthy and his team for their extremely helpful evidence. We very much appreciate your coming.

Before I conclude the meeting, I should point out that this is the last meeting that Ellen-Raissa Jackson of the official report will be attending. Members may not all know her by name, but she has been here since the Enterprise and Lifelong Learning Committee began. The bad news is that we are going to lose her, but the good news is that she is going to the BBC—I hope that she will give us very fair coverage once she is there. We wish you all the best, Ellen. Thank you very much indeed.

Meeting closed at 12:59.