Energy Prices, Profits and Poverty

Alan Whitehead Excerpts

Thursday 7th November 2013 Westminster Hall

[Dr Alan Whitehead (Southampton, Test) (Lab)]

I begin with an apology to the House: I am on a Bill Committee that, to some extent, requires my presence, so I may not be present for the entire debate, but I was anxious to make a contribution to it. I particularly apologise to the Minister, because I may not be present to hear his response; I had been very much looking forward to hearing it.

As our present Select Committee Chairman, the hon. Member for West Aberdeenshire and Kincardine (Sir Robert Smith), said in his opening remarks, the report represents the best attempt yet at seriously shining a light on one of the central issues in the widening discussion about what is happening with energy bills, what might be done about them and what might be done on levies relating to bills. It attempts, as far as it can, to get to the bottom of what exactly goes on as far as energy companies’ profits are concerned. Clearly, if it is concluded without possible contradiction that energy companies are making what one might term excess profits, the conclusion may be drawn that the bills that stem from those companies’ activities do not bear the appropriate relationship to those companies’ activities, and action may then follow, either through regulation, through the companies themselves, or through further light being shone on the relationship between those two things.

We have seen—most recently in debate in the House yesterday—a considerable difference of opinion about what might best be done about bills, and indeed what might be done on a wider basis, and how the market could be reset if it is considered that the market is dysfunctional, given the way that companies that are vertically integrated—that is certainly the case for the big six—undertake their generation, trading and retail activities.

I imagine that the starting point for a number of those questions is in the table in the report that sets out the aggregate profit margin for the big six companies’ generation and supply. The bald figures are that in 2011, the aggregate margin for profit in generation was 24.4%, and the aggregate margin in supply was 3.1%—a very substantial difference in aggregate profit margin. Bearing in mind that the aggregate profit margin from generation is related to the aggregate profit margin in distribution—one eventually, by one means or another, sells to the other, and there is a retail outcome—we should certainly ask why the two are so different.

Part of what I think the Committee was trying to do in its deliberations and in the report was answer at least some of those questions—questions that I think everyone who took part in the inquiry will agree were extraordinarily difficult, regarding what happens between the generation of electricity and wholesale trading arrangements, and the purchasing of clips to balance supply and demand at a time of gate closure. How that all works along the line is opaque.

The Committee tried to look at how the accounts put forward by companies are presented. The difficulty is that the accounts are presented in different ways and have different internal arrangements. In some instances, they are presented by companies that are not based wholly or partly in the UK and therefore refer, at least in part, to subsidiaries in the UK, which may or may not have a relationship with parent companies outside the UK. It is difficult to say to what extent it is possible to produce the sort of transparency that one might expect and hope for in ensuring genuine accountability with regard to electricity companies.

Ofgem is not the least of those preoccupied with such issues. As the Chair has mentioned, Ofgem had commissioned a consulting company, BDO, to investigate what sort of changes might be made to accounting practices and trading arrangements to ensure greater transparency. As he recorded, the Committee felt disappointed that BDO’s recommendations—to align statements in the same year-end, to require the reporting of trading function results, to produce further work to assess current transfer pricing policy, and so on—were simply not taken up by Ofgem and have not informed Ofgem’s subsequent consultations on wholesale power market liquidity. We feel that it would be a good idea to revisit, even at this stage, what BDO said to Ofgem about those arrangements and to take the recommendations forward more concretely.

I refer to Ofgem’s more recent wholesale power market liquidity document, which came out at about the same time as the Select Committee’s report. That document received considerable mention in yesterday’s debate on energy on the Floor of the House as a document that could substantially deal with the question of transparency in markets and trading.

Trading appears to be one of the most opaque areas that we considered. One of BDO’s recommendations is to require

“the reporting of trading function results, including disclosure of the risk each trading function assumes”.

Ofgem had a go at looking at that, but from what I have observed about the process, it has fallen rather short of producing proposals that can get to grips with the issue of trading, which seems fairly central in trying to find out exactly what is happening. A vertically integrated company will inevitably have a trading arm, which may purchase for its retail operation, and may conduct trade with regard to its wholesale operation. By and large, it will trade on a bilateral basis with itself.

One of the practices we heard about, which appears to be wholly without transparency, is netting off. A number of activities, particularly those further down the curve—further out than what might look like trading —do not appear as trading at all and are netted off in the company’s accounts. We heard recently that varying percentages of the big six energy companies’ activities appear to be based on netting off. That appears to be outside the purview of what Ofgem had to say about wholesale power market liquidity.

There are other arrangements that struck me that remain outside the mechanisms that may enhance transparency in trading. There is the practice whereby one side of an organisation realises, near to gate closure, that it is unbalanced in terms of its previous purchases. It will effectively phone itself up to balance itself on the other side by creating trade—that is, creating generation that would not otherwise have taken place. That may appear as a trade, but it is not; it is a pre-order to prevent the company from going out of balance and incurring costs that it might not like to at the point of gate closure.

There are also mid-stream trading arrangements, which a number of the big six operate; they bring under their wing small independents, which act as if they were trading on behalf of the larger company. The trades made by the larger company are offered to the smaller, independent company. It is a little like some south American countries using the dollar as their currency while technically being independent. That may bring considerable benefits to those smaller companies, but it means that a number of the trades that take place do not look quite what they are.

We seem to need to go a lot further to establish how the various flows within vertically integrated companies take place, and how the outcomes of those flows either benefit or disbenefit customers. Certainly, there is the argument that some of the issues, such as netting off and gate closure balancing policies, may benefit customers, inasmuch as they save money, even though they appear to be anti-competitive in terms of the way in which trades are arranged. Getting full disclosure right may have the consequence that some costs go up rather than down. Indeed, one needs to be clear and careful about what those effects look like, and how they pan out, in terms of the relationships between companies.

I endorse the report’s recommendations on the necessary clarification of trading and company reporting arrangements. I would go a little further: I believe that the Committee has the appetite to continue investigating how to overthrow the trading arrangements that appear to take place within those vertically integrated companies, albeit in the context of ensuring that above-the-table arrangements are increasingly transparent.

The Committee also considered the relationship between prices and poverty. Interestingly, the Committee considered the role that levies might play; that was rather prescient, in the context of the levy review that has been announced. I am now clear on what is and is not in that levy review. What are essentially regarded as green levies are not in the green levy review, and what are essentially not regarded as green levies are in the green levy review. The levies that one can determine to be true green levies on bills, such as the renewables obligation, feed-in tariffs and the upcoming contract for difference, are not going to be reviewed. Levies such as the warm home discount, the energy companies obligation and the earlier levy on smart meters, however, remain to be reviewed. They are not green levies, and neither is the carbon floor price, which looks like a green levy but does not actually save any carbon and goes entirely to the Treasury. When those levies are reviewed, exactly what will the review consist of, and what will be its objectives? If the review simply asks to what extent we can remove those levies, a number of the issues raised by the Committee—how the levies continue to be important in combating fuel poverty, undertaking energy efficiency and insulating homes of the fuel-poor—will be overthrown.

The Committee concluded, somewhat presciently in light of the recent debate, that

“the increasing use of levies on bills to fund energy and climate change policies is problematic since it is likely to hit hardest those least able to pay. We note that public funding is less regressive than levies in this respect.”

Would a review of those particular levies—we concentrated, among other things, on the energy companies obligation—consider moving some of the obligations into general taxation? Or is the purpose to reduce the overall impact of the energy companies obligation on bills? I understand that, in recent days, No. 10 has issued a target to the Department of Energy and Climate Change on the expected outcome of the energy levy review. I am interested to hear whether that target exists, what it looks like and in what form it will be met.

The Committee also concluded that as it stands, the ECO is not sufficient to fulfil the targets of energy efficiency, demand reduction and combating poverty that the various programmes within it were set up to do. Indeed, the Committee concluded that the ECO falls far short of that ambition. Removing a substantial part of the ECO because of a levy review when it is already established that the obligation falls far short of its ambitions would be a retrograde step. I am anxious to hear more about the relationship between those levies and fuel poverty. Are the Committee’s points on fuel poverty and the levies well made? How will the Government address that in the context of the levy review?

I conclude by commending the report, as far as it goes, which was produced under difficult circumstances. I freely accept, as I am sure everyone does, that it is extremely difficult to shine a light on the subject accurately and unwaveringly without all sorts of considerations being raised that may or may not be germane to the direction of that light. If we can shed better light on all the arrangements, our debates will proceed much more objectively. If the Select Committee continues its work, I hope we will do a service to the debate.