Energy Prices, Profits and Poverty

Robert Smith Excerpts

Thursday 7th November 2013 Westminster Hall

[Nadine Dorries (in the Chair)]

I inform Members that this debate was listed on the Order Paper earlier in the week as finishing at 3.30 pm, but that was removed from the Order Paper yesterday. The transport debate will start at 3 pm, when this debate finishes.

[Sir Robert Smith (West Aberdeenshire and Kincardine) (LD)]

It is a pleasure to serve under your chairmanship, Ms Dorries. I remind the House of my entries in the Register of Members’ Financial Interests involving the oil and gas industry, particularly a shareholding in Shell. In addition, I have a non-financial interest as the honorary vice-president of Energy Action Scotland—a fuel poverty charity.

The Select Committee on Energy and Climate Change is pleased to have been granted this debate on our report. It is timely, given the issue’s high profile and in the context of the price rises recently announced by most of the six largest energy companies. The subject has come to the fore again just as the winter weather has started to set in and people face the challenge of keeping their houses warm. The Prime Minister has made a number of interventions to try to reduce energy bills, by suggesting that environmental levies will be rolled back and, more recently, that transmission costs can be reduced. However, the Energy and Climate Change Committee considered the subject in detail, including profits and poverty, well before the recent spate of interest. Our inquiry was launched on the Floor of the House in December last year, and we reported at the start of this summer.

Our report’s opening conclusion was that energy bills are rising and are likely to continue to rise. The wholesale price of fuel, driven by rising global gas prices, has been the largest contributory factor. Several other factors also contribute, including the need to invest in and finance the UK’s electricity and gas network and energy and climate change policies. The extent to which energy supply companies are actively working to reduce their operating costs remains unclear. The Committee had hoped to uncover the real story behind energy company profits, but alas, that is significantly more difficult than it should be. At the time of the report, the Committee stated its disappointment that

“energy supply companies have not gone to greater lengths to explain to their customers the reasons behind energy price rises”

and highlighted that poor communication by energy companies

“has resulted in deep mistrust from their customers.”

At a time of rising prices, it is crucial that consumer trust is restored if we are to get the investment that we need. Just last week, the Committee held a session with energy companies to find out what was driving the recent price increases. Following that session, we asked the energy companies to set out information about their profits in a standard format. We published that information on our website today, although it still does not provide a complete picture. Bringing forward the information is an ongoing process, and the Committee will continue to consider how to improve the transparency and comparability of energy company prices and profits.

[Christopher Pincher (Tamworth) (Con)]

Does my hon. Friend agree that one of the difficulties in working out what prices ought to be, based on the wholesale cost, is that whereas Ofgem looks at past prices in projecting what it thinks costs ought to be, energy companies project forward to see what prices might be? That is one reason why there is a mismatch.

[Sir Robert Smith]

That is certainly one factor. Obviously, the energy companies’ hedging ahead could be to consumers’ benefit in smoothing out future peaks and troughs in energy prices, but an additional problem is trying to get transparency on what wholesale prices the companies are facing. To give confidence to the consumer that the margin is right, we need greater improvements in clarity. In particular, the companies’ trading operations need to be examined more specifically, and more analysis is needed on the impact of their trading arms.

The Committee recommended that the Department of Energy and Climate Change should lead a full and frank conversation about the contribution that consumers are being expected to make towards ensuring that we have safe, secure and affordable energy supplies. It is crucial that the public are made aware of the challenge that we face in meeting our energy needs. In its response, DECC said that it had been up front about the fact that energy prices will continue to rise and told the Committee that the combined impact of decarbonisation and energy efficiency policies led it to estimate that household energy bills will be 11% lower on average by 2020 than they would be in the absence of Government policies.

The Prime Minister has said that how the policies will be funded is subject to review. We urgently need to know what that means in practice. Is the review about the outcomes of the funding wished for or the desirability of the measures being funded? Our report highlighted that general taxation may be a fairer funding mechanism than the use of levies, but it also emphasised how crucial it is to tackling fuel poverty that we have an effective insulation programme. Fuel poverty is exacerbated by rising prices and income, but it is crucial to our long-term work on tackling fuel poverty that we improve our housing stock and ensuring effective insulation.

In our report, we highlighted factors contributing to price rises. DECC set them out in its response to us. The percentage breakdown for a typical dual fuel bill is 50% for wholesale energy costs, 20% for transmission and distribution charges, 19% for

“other supplier costs and margins”

and 5% for VAT. The remaining 6% is presumably related to Government policies. DECC itself stated in its reply to the Committee that, in 2013, Government policies to achieve energy savings, provide support to vulnerable consumers through the warm home scheme and incentivise the shift from fossil fuels were estimated to account for 9% of household energy bills. The figures do not quite add up. Perhaps that has to do with where the carbon price is allocated in the breakdown of those percentages; it could have been included in the wholesale cost of energy.

I highlight the Committee’s conclusion:

“The extent to which energy supply companies are actively working to reduce their operating costs remains unclear.”

The Government’s answer to the Committee on that point was:

“Competition between energy suppliers will put downward pressure on their costs and Government and Ofgem are taking steps to increase competition in the market.”

The crucial simplification of tariffs to improve competition and people’s ability to switch is certainly a helpful step in putting pressure on companies to compete effectively to reduce their margins and operating costs, but it seems that the Prime Minister is not completely confident that the steps to increase competition are working, or working quickly enough. Otherwise, he would not have announced a review of the competitiveness of the market.

It is a pity that Ofgem rejected our recommendation that it publish targets for improvements in the market as a result of its retail market review measures, which were designed to reform the market to deliver greater competition. It would have been good if Ofgem had set out criteria for judging the effectiveness of its measures, but Ofgem does not think it appropriate to set specific quantitative targets for success. The Prime Minister’s new competition review appears to be in addition to the new state of the market reports that Ofgem has agreed to produce in direct response to the Committee’s recommendations. We expect Ofgem to publish the first of the reports in spring next year.

Ofgem said in its response to the Committee that it doubted whether using metrics such as “profit margin” and “rate of return on capital” would help it to determine whether the market is competitive. However, measuring profits and the rate of return on capital, and their movement, would show whether the market was bearing down on costs or allowing them to rise. I repeat the Committee’s assertion that excessive profit margins are a symptom of poorly functioning markets, which underlines the need for complete transparency in what the profit margins are.

That brings us to the fact that we need greater transparency regarding energy companies’ finances. The Committee discovered that, although segmental statements had gone some way to improving the transparency of profit making in the big six’s retail and generation businesses, there was still a lot of information missing. That was acknowledged by the accounting firm BDO, which led a review of the statements commissioned by Ofgem. BDO made a number of suggestions for improvements. Surprisingly, Ofgem took none of them forward in their original form, arguing that their costs outweighed their benefits.

We made a number of specific recommendations about how energy companies could improve the way that they report their profits, based on BDO’s recommendations, including reporting trading activities, which, as I mentioned earlier, is a crucial part of trying to establish the boundaries between wholesale and retail and whether the consumer is getting a fair deal; having consolidated segmental statements independently audited, to provide confidence that they are a true and fair reflection of the allocation of costs; and requiring companies to align their financial reporting periods.

The Committee was not convinced by Ofgem’s assertion that the implementation of those recommendations and others that were suggested by BDO would place an unnecessary burden on the energy companies. The Committee requested that the cost-benefit analysis underpinning that assertion be published, but we still have not seen it. Ofgem needs to recognise that, given the breakdown of confidence, the benefit of restoring confidence and providing clarity makes the costs a worthwhile incentive to produce a better understanding of the companies’ profits. However, Ofgem remains unpersuaded that there is a case for full implementation of BDO’s recommendations.

Ofgem has launched a new consultation on transparency, but is it really necessary to have another consultation to find out whether a full independent audit of energy companies’ statements would help to provide reassurance that those statements are robust? I think that the evidence to the Committee spoke for itself.

Regarding the transparency of bills, it is disappointing that the Government and Ofgem have not taken up the Committee’s recommendation that energy companies should be compelled to identify the various components that make up their energy bills, including profits, on the bills themselves. The Government and Ofgem have rejected this proposal for fear of confusing customers, and because the information is available elsewhere. It is a shame that the Government and the regulator do not credit the British public with the ability to digest this information if it is clearly set out on bills, and to say that it is available elsewhere suggests that they have some confidence that the public can understand it. It would seem to make sense that in one item of correspondence—when the bill comes through—people receive the breakdown of how that bill was established.

Do the Government not recognise that consumers can understand complex information if it is presented effectively? Is there not something to be gained through the discipline of making energy companies state the breakdown of bills, including profits, on the bills themselves? That would certainly contribute to the honest conversation about energy prices that the Committee has been calling for, not only in this report but in our previous report, “Consumer Engagement with Energy Markets”.

When the Minister responds to the debate, it would be helpful if he said what the Government are doing to promote this necessary conversation with the public about rising energy prices and the need for investment. Why will the Government not support the full implementation of BDO’s recommendations on consolidated segmental statements to help to deliver the transparency that is so badly needed? Also, it would be extremely helpful if the Minister said what form the Prime Minister’s competition review will take and what the consequences will be if it discovers that competition in the energy industry is not effective? Finally, can he outline the time scale and process for conducting the levy review and say whether it is on the outcomes or on the funding mechanism? When can we expect to see that review, and how can people make an input into it?

Our energy supply needs investment that is paid for by profits—that is an inevitable reality of life—but effective competition and transparency are crucial if consumers are to have confidence that they are paying a fair price for that vital investment.

I commend the Committee’s report to the House.

--- Later in debate ---

[Sir Robert Smith]

Perhaps the Minister could write to us with more detailed answers to substantive questions. I would like to echo the thanks to the staff of the Committee for the excellent support they have given us in producing this report. It is a matter that we will have to keep at, in order to get transparency and effective scrutiny to ensure that people do not pay more than they have to for their bills at such a difficult time.