Speakers: Lawrence Slade, CE, Energy UK, and Brian Tilley, E.ON UK
7 November 2017 – meeting notes
All Party Group on the Costs of Energy
Responses to the Helm Review
Chair: Lord Palmer
Lord Palmer opened the meeting by welcoming everyone and introducing the speakers and apologising for the absence of the third speaker, Peter Atherton of Cornwall Insight.
Energy UK welcomes the report and shares Professor Helm’s goal of ensuring that the transition to a low carbon energy system comes at the lowest cost to customers.
There is irony in the fact that a review on the costs of energy comes at a time when we don’t yet have a route to market for onshore wind, which is one of the cheapest technologies. And shouldn’t we also look first at home, meaning that we should look at how much energy we are using. It is true that there are some energy-intensive industries that have probably gone as far as they can in terms of maximising efficiency, but there are other sectors outside of the heavy users where we have barely scratched the surface of looking at efficiencies, and we still haven’t really hit home on the domestic side. So we need to consider missed opportunities as well as the bigger policies.
There’s also the argument that this is more “blue sky” thinking. I would point out that in a report of around 250 pages there are bound to be things you don’t like and things that you do. Given the political climate today and the complexities of the industry, I question whether you could pick up this report and put it into action immediately. I’d suggest you could pick up elements of it though.
Look at the speed of change and look at how quickly this market has developed over the past decade, and then try to forecast how quickly that market might develop over the next decade, and how we might be using electricity in particular, and you’ve got to look at some of Helm’s comments around the current regulatory framework. Is the framework correct? Is the way that we are managing that sector going to keep up with future developments? We’ve got to get that element of flexibility in how we manage the system from a regulatory point of view.
Someone said that a quick precis of the Helm report might be: increase the simplicity of the market; increase the transparency of the market; and then politicians should get out to the way and leave the industry to get on with delivering it. There’s a lot to be said for that: one of the things we’ve been seeking for some time is to give us the framework, agree some kind of long-term strategy for delivery, and industry has a record of getting on and delivering it. It’s got to be good for all players in the market to get a level of transparency.
There are other issues, e.g. economy-wide carbon pricing scheme, you can see the sense of where he’s coming from and what he’s trying to suggest. We’ve certainly seen what carbon pricing can deliver in terms of bringing forward low carbon investment in the UK. It’s done the job, but the scale of complexity trying to introduce that kind of thing, against the background where industry has so many uncertainties around what’s happening now anyway, e.g. membership of EU, membership of ETS, carbon price support and so on – I just don’t think now’s the right time.
So, overall, I think there are some good parts and some bad parts. We need to look at flexibility, we need to look at how we regulate the industry, we need to look at the operating model, we need to look at streamlining: there’s a lot of good stuff here, but I would point more towards the idea of blue sky thinking, and it’s more a case of “Let’s get the discussion going” rather than picking up the whole report and putting it into practice.
Lord Palmer: David (Lewis) mentioned blue sky thinking earlier on.
David Lewis: There are some things, e.g. carbon pricing, that couldn’t happen until after Brexit, so they are things to consider in a few years. In your opinion, which parts of the review do you think could be implemented straight away?
Lawrence Slade: I would lean towards some of the models around regulatory reviews, as how we are currently regulating needs a look: it’s no secret that the regulatory model and the structure of the market we have now are not fit for purpose. I think some of Helm’s suggestions are worth looking at, although none of them would be a straight cut and paste. Also looking at the charging structure would be a good idea, and also the route to market for new generation. I wouldn’t go as far as looking at ripping up the EMR, because I would argue that I think it’s actually working, but that doesn’t mean that we can’t look at how we can improve it. We do need to ensure that we have routes to market for all technologies, and these might not be the same in five or ten years, so what worries me is, is the regulatory framework going to keep up? That’s why I welcome this report, and Laura Sandys’ report, because all are going into the general debate of where we are.
Brian Tilley, E.ON:
We also welcome the review but regret that it focused on electricity. If we are really going to look at this properly and holistically we need to look at the whole cost, covering heat and transport as well, and I do think that this is a missed opportunity. When we think about what’s going on politically at the moment, which is how affordable energy is for domestic and business users, we absolutely believe that there is so much more we can do in the efficiency space. From a domestic customer perspective, it would be save £100s on household bills if we can improve the fabric of the home. This would have a much bigger impact that some of the discussions that are going on in this circle at the moment, so we think that energy efficiency needs to be in the national infrastructure as a priority, creating jobs, helping businesses grow, and helping to decarbonise at low cost.
Turning to the report itself, I’ll go through the various sections, starting with Wholesale Markets. I read with interest his thoughts, but I’m yet to be convinced that there’s anything fundamentally wrong with the framework. If you think about EMR, it’s only a few years since we went through that process, and the CFD framework on the whole is working – we moved earlier than originally intended in terms of competitive auctions. Some of the early enabling contracts look pretty costly for our customers and, arguably, we should never have gone down that path. However, we are where we are, and the recent CFD allocation round was a real success for customers and for decarbonising the economy.
So my response to Dieter is that I don’t think there is an argument for ripping up that framework: we should build on it. In particular, we should move as quickly as possible to single technology-neutral CFD auctions, so that any technology can access that. I am absolutely convinced that doing so would deliver the lowest possible cost for customers.
Intellectually, I agree with Dieter about the role of carbon pricing as the best way to provide the signal to investors, but in the real world it is very hard to believe how anyone could have invested on the back of the carbon price floor. Look at the numerous interventions that have already taken place since it came into existence, and I think the same can be said for any other form of carbon taxation. And so, how to make those long-lived assets in renewables or nuclear or whatever, purely relying on the wholesale market and carbon pricing – well, I just don’t think that works. Yes, he’s right theoretically, but in practice it’s not something that will work for the vast majority of investors.
I would say that the Government has broadly got it right with competitive auctions teasing out the most cost-effective solutions, and that means we are moving closer and closer to the end goal, which is a subsidy-free regime.
That takes me to his next point, which is around the possibility of CFDs and the capacity market almost merging into one. It’s not clear how that would work in practice but it’s an idea worth exploring.
In E.ON’s view there is an element of missing money here because we haven’t really developed well-designed markets to support the needs of the system going forward. The markets were designed for an old world, and I would congratulate the campaigns that have started to drive through the reform agenda. Let’s build on that and create new markets which will create new revenue streams for a more decentralised energy system that certainly we want to see take off in a major way.
And that leads into my thoughts on the CM, which I would say on the whole is not broken. It has delivered new and different solutions from what the Government expected, but that is a good thing, and that competition will help build security of supply at lowest cost. My one concern is with the possibility of BEIS officials and senior ministers looking to drive out particular solutions, such as CCGTs, and keeping on changing the rules, at the risk of other promising technologies, the latest of which is about batteries where they are looking to change the CM rules to distort the market. Frankly, this is not fair and we should be sticking to a level playing field.
Turning to networks, this is where I have the most sympathy with the review. 26% of the cost of a bill is due to networks, which suppliers simply pass on, and I think we should be looking for ways to bring more competition into that market and see how we can successfully fund new investment in new ways. It also goes into the role that demand-side can play, with alternatives to investing in copper and wires in the ground and overhead lines to deliver the same solutions, and so that creation of the market at both the transmission system operator level and also local distribution level, has significant opportunities to deliver savings to customers. We need to embrace that more. Consideration should certainly be given to the idea of national and regional system operators to see how that could work, avoiding actions with unintended consequences where actions at a local level could actually increase the cost, and vice versa.
On policy cost and taxes, my thought is that today on the bill around £200 is made up of social and environmental obligations and these should be funded through general taxation, which would be fairer and more progressive. Dieter’s idea of a legacy pot, especially if it was hived off and taken care of by the Government, is a good one and the idea of a legacy pot could be something worth exploring, although I’m not sure what else a legacy pot really achieves in practice.
Retail: from E.ON’s point of view we’ve just had an independent CMA investigation. We didn’t agree with everything and in particular we strongly refute the so-called £1.4 billion detriment, which in our view is fundamentally flawed, and as Professor Littlechild said, “If we are really to believe the number the whole industry would be making a loss”, and that is just not sustainable. In that world I really can’t see how anyone would invest in essential energy infrastructure in the smart world that we want to embrace. I really do question that as the basis for a lot of the intervention talk that is going on at the moment. Our view is that we should give the CMA remedies a fair chance of working.
That is why E.ON changed business model in September to embrace smart metering and the regulatory changes that Ofgem are making to look at how we can better engage our customers and move them onto better deals.
Last week’s Ofgem’s “State of the Energy Market” report was interesting. One aspect discussed the question of what the features are of a well-functioning market. In many areas, the market is in pretty good shape actually, with 60+ suppliers, record levels of switching, new tariffs, e.g. clean energy tariffs – and plans to do much more. It’s through those innovations that we will help our customers take more of an interest in what we can do to help them and to improve their lives. We want to empower customers to take more of a stake in the market. We’re on the cusp of radical change and intervention could actually really undermine and destroy that opportunity. I really hope we can take a step back and consider what is the right thing to do.
So overall, it’s a mixed picture I think, with some things we like and others we don’t.
Comments and Questions
Lord Whitty: Active customer engagement in markets has been pretty limited and tends to be sequential, with the same customers engaging repeatedly. The market is now changing sufficiently for there to be very substantial choice, but I don’t think the customer attitude has changed, or the attitude of the major suppliers and the people who actually bill the customers (not necessarily the same thing) is not changing. My other point is that, because of the carbon targets etc., the sector is facing dramatic change in the form of the electrification of heat and transport. Both of these will change the nature of customer engagement, particularly transport. If we’re all driving electric semi-autonomous vehicles by 2030 or 35, that’s going to be a major part of the market, and that changes almost everything. That’s a comment rather than a question.
Brian Tilley: Over the last three quarters we have managed to get 10% of customers off SVTs onto other tariffs, but we do absolutely see the rollout of smart meters as a game changer, as do the CMA. This is why we have focussed so much on smart meters as we see that as the key to customer engagement, starting with automatic movement from SVTs onto other tariffs. But that’s just the start of the solution and it will lead to wanting to sell a broader package which will best fit the personal needs of the customer. We see a journey towards a more personalised energy situation.
As we move to a digital world from an analogue one, we are fully behind the Government in supporting the growth of electric vehicles which will play a key role in decarbonising the energy space. We have a role ourselves as a key enabler to making that work, and in the process that will also help engagement.
The transition to a smarter world will create many opportunities
Lawrence Slade: There are some myths that need to be busted around some of this.
The latest switching figures show that 55,000 people changed their current account in September. But in October, 600,000 changed their energy supplier. In this year so far the number is 4.6 million people. We are already ahead of last year’s figures and we should surpass 5 million households by the end of the year. Mathematically, these can’t just be the same people – engagement is going up. Look at the numbers leaving the major energy suppliers and joining the smaller mid-tier suppliers, look at the growth of their customer base and the shrinking market share of the Big 6 which is down to 80% and maybe even the high 70s. So I think it’s about time that we change the narrative about engagement. What’s important is how we look at how people use their energy in the future. Not everyone will want to actively engage – some customers will want things to be looked after for them. As Laura Sandys said in her report, Amazon have something like 200,000 different customer segmentations but we’ve never had that in energy. As we move into the new world, digitalising an analogue market, the stream of data will result in a stream of products specifically tailored to different customer types, both domestic and business. We have to make sure that the industry has the freedom to deliver all this, albeit with protection in place for how people want to interact with the market and how we look after vulnerable customers, etc.
Brian Tilley: We can definitely see how it’s going to change fundamentally and the future looks fantastic. My worry is, in this current political climate, how to make a credible case for UK investment.
Some Government intervention can be quite unhelpful. A more rational debate on where we are now and where we want to get to can’t come quickly enough.
Andrew Mayer, BASF: It’s an interesting situation. On the one hand the energy industry is saying that there aren’t enough incentives to invest and on the other hand we’ve just had a big report released saying we’re one of the most expensive places in the world to decarbonise. Both can’t be true simultaneously. The Helm report is a devastating report, and essentially identifies previous energy policy as a ragbag of errors and mistakes and wrong tracks that should be quarantined into a legacy cost area and stuck on people’s bills so that they can see just how bad it was.
Lawrence Slade: Yes, it’s interesting looking through the report and some of the analysis, especially around pricing, and the gas price in particular that was assumed by DECC and latterly BEIS. My comment is that we have in the electricity sector achieved a tremendous amount, and we’ve achieved that by Government policy. You can argue about the prices that were originally struck and the deals that were done, but inarguably a high volume of low carbon generation is now on the network, and look at what we’ve achieved . . . for example the latest round of offshore wind settlements, where by having a long-term vision, and incentivising the industry by showing that support is there, you can show costs are falling and you get the deal that comes down to £57.50. So undoubtedly it has been an imperfect process and undoubtedly there has been a lot of opaqueness around the makeup of the bill and where those costs sit. We’ve been arguing for quite a long time for a good honest debate around the makeup of the bill.
The other point that I would like to make is that the emphasis has been continually on electricity generation. Look at what we’ve achieved, with coal-free days, and 45-50% of electricity over the summer coming from renewable sources. But this is just one part of the economy. We haven’t really touched transport or agriculture and, as Helm says, there are other parts of the economy where there can be quick wins. Looking at all these things together I think we can achieve a lot more in the coming years. So, we are where we are, yes, we’ve got that investment and it’s been painful at times and could have been done better, but moving forwards, let’s make sure we have a route to market for the cheapest versions of renewables.
Andrew Mayer BASF: So is that yes or no to the question of whether these costs should go on bills as legacy costs?
Brian Tilley: I’m not sure what it really achieves, because most of us seek to explain the makeup of the bill anyway: what’s government programme costs, what’s network costs, etc. broadly happens anyway. So what does Helm’s view do that changes that? Unless it’s that the rest of the customer base funds investment costs that are industrial costs being saved by not having to pay them? If that’s the case then we do need to have a debate because that would lead to higher bills and in this political climate I would have thought that was not acceptable. I’m not sure people have fully thought through the consequences.
Hence why, our clear preference is that these are government programmes and they should be funded out of general taxation.
Lawrence Slade: It’s an important point. Understanding the makeup of the bill and how that hits different families and businesses is very important. We need to have a conversation about where this will be paid for if it’s removed from bills.
Ofgem are having a conversation at the moment around network costs and how they are balanced and settled, if you have a company moving off grid or reducing consumption, that’s fine and good – but we still have to pay for the grid, so how is that going to be managed in the future? Conversations need to happen now because it takes so long to implement change.
Ashutosh Shastri, EnerStrat Consulting: I accept that the rest of the economy has to start moving on the decarbonisation process, but I’m a little confused that decarbonisation of heat and transport is a priority, because they use completely different technologies.
Lawrence Slade: There’s a tendency to say ‘electrification of heat’ when we are talking about decarbonisation of heat, and that is too quick an answer. There are a tremendous amount of households and businesses who rely on gas central heating and to contemplate converting all that to electricity would just be wrong. It hides looking at how we can use gas more efficiently, how we can look at green gas, hydrogen, methanation of gasses – all significant options being investigated across the world, and we need to make sure that as we look at how to lower the carbon output of heating, that we look at the least-cost methodology. We also have to bear in mind that there are lots of people who are off the gas grid and we need cost-effective solutions for them too. I’m with Brian when he talks about more efficiency, and to quote the old adage, “The cheapest gas and electricity is the gas and electricity you don’t use”.
Brian Tilley: On heat, I don’t think it’s as simple as electrification. This is where the idea of decentralisation comes into its own because different areas suit different solutions, whether they be electrification, district heat, existing gas networks, green gas or whatever. The honest answer is that these solutions are not necessarily cheap, and I agree with Dieter that research and innovation is needed to find the right pathway. There won’t be a single “right” solution and we need to look at how to drive down until we get to a price that is acceptable politically and we can continue the journey of decarbonisation.
On transport power, E.ON’s position is fairly clear – the future is electric. We think that this can be done in a way that doesn’t involve huge amounts of generation or significant investment in the network. The move to smarter and flexible energy system is at the heart of it because you can actually transition to that point by optimising current network infrastructure and making sure that we harness the fact that, for example, people won’t need their car batteries charged instantly. Through smart charging infrastructure and innovative tariffs we can avoid issues and ensure that all the customer needs to know is that when he wants to go from A to B, he can.
Lord Whitty: Regarding the perennial comment that all these programmes should be funded out of general taxation: it’s totally understandable, and possibly even logical, but it’s not going to happen. Either programmes will stop or will carry on being funded through bills. Some of the environmental programming could perhaps be reflected through the overall CFD pricing mechanism or something like that, but that complicates that end of things. So I think you have to accept if these programmes continue in the next 5-10 years they will be paid for via bills.
Brian Tilley: I agree. Moving the costs to general taxation is what we would ideally like, but being pragmatic about it, what I would say about legacy costs is if we could draw a line on the past and have a debate about whether certain customers avoid paying certain costs and others don’t. Putting that to one side, it’s really important that it’s more forward-looking and that we design policies that will give the most efficient outcomes. The past is the past: we can design for the future and that’s where the focus needs to be.
We acknowledge that the cost of decarbonisation is coming down: competitive auctions are beginning to deliver value, and as we continue the journey of decarbonisation we just need to make sure that we do so at the lowest possible cost. Let’s learn the lessons of the past to help with policy-making in the future.
David Lewis: On that last point, costs have come down in the auctions but one point in the review says that what we need to do is bring the whole market together so that people are picking up their own costs, such as balancing, deep reinforcement and so on. What impact do you think it would have on prices we are seeing coming through in those auctions if renewables have to pick up those things?
Brian Tilley: In our view, we already have markets in place that actually provide strong incentives on intermittent generation to balance, and if you look at what those balancing costs might do over time, they tend to go up, so the clear incentive is to ask, “What can I do to avoid those costs in the first place?”
The second thing is, I think it’s worth thinking again about network charging and whether those signals are the most efficient from a location perspective, because it doesn’t matter whether it’s wind, coal or whatever – if it’s in the wrong location, that has a system implication. I do get the impression that intermittent generation is seen very negatively when in fact it’s a much more complex issue.
Thirdly, around the role of flexibility, creation of new markets will help to optimise the system and keep those costs as low as possible. I think there’s quite a bit of scaremongering going on about the impact that wind and solar might have on the system and we mustn’t forget that coal, gas, nuclear, etc. can all be out of action when the system needs them, and no one thinks of that.
William Webster – Oil & Gas UK: My point is around the interactions between wholesale and retail markets because I think that the interactions came out of the CMA investigation as one of the strengths of the UK market. The gas market is a real strength to the UK as it is the most liquid gas market in the world and contributes to security of supply because anyone in the world with spare gas can sell it at the national balancing point. Likewise the electricity market, which balances on a half-hourly basis, gives the right signals for people to come on and off the system as required. My question is around the interaction between the wholesale and retail side. One of the concerns I have around various ideas of capping markets is that you will affect people’s behaviour on the downstream side and lead to people second guessing what the regulator is going to say about recommended purchases on the wholesale market, which would unravel the liquidity a bit . . . so do you share any of these concerns and do you see a way out of it, to deliver the political imperative of looking at how SVTs are working, without damaging the wholesale market?
Brian Tilley: It’s a good question and you will have heard from our CEO that E.ON is really not supportive of the draft bill, unsurprisingly. But, putting aside all of that, if a cap is going to come in it must be designed in a way that doesn’t lead to suppliers leaving the market, because that could have huge implications. I think it’s far from clear that the existing Ofgem arrangements to deal with a major supplier going bust have really been tested. I say that because hedging strategies play a key role in this. There are huge amounts of money at risk and as we’ve seen in the past, if you get that hedging strategy wrong it can really hurt a business. So in that world, having clarity is really important.
My bigger concern though is that if we go down the intervention route, what will the tests be for Ofgem to prove that the market is working compared with where it is today. I don’t think they will ever be able to prove it. In today’s world where we have 60+ suppliers in the market and increasing switching, and a recent attitude survey telling us that, actually, prices are not a big issue for customers . . . on the whole I think that the market is working and I can only see those metrics going in the wrong direction. How is Ofgem ever going to prove that the intervention has solved the perceived problem, whatever it is? If we’re not careful, it could easily become permanent, which would be a disaster. So I’m not quite answering your question but I am very concerned about this.
William Webster: A market needs an upstream and a downstream to work efficiently.
Brian Tilley: It’s also third party costs, because we have to forecast transmission costs, distribution costs, and if the regulator is going to make assumptions about these, and if they’re wrong, they could really hurt the balance sheets of suppliers of all sizes.
Lawrence Slade: I agree. No one can answer my question which is “what does ‘good’ look like?” I have asked but no one can tell me. We are facing intervention in the market when some parts of the market are actually working well. The facts are there in front of you. It’s true that we need to do more to help the vulnerable, and let’s see what we can do to improve support for competitiveness of British industry, but I’m really worried around this question of what is the problem that is trying to be solved? Especially when it is already being solved. And, secondly, what does ‘good’ look like when these interventions are lifted. How can we be looking at bringing in legislation when there’s a perceived problem but we’re not sure what the solution looks like?
Brian Tilley: If you believe the CMA, and we do, the route to a smart world is going to be a game-changer. The minority report of Martin Kay was only talking of a temporary cap of a couple of years. So given the trouble that Ofgem will have trying to demonstrate that the market is now working, maybe it would be better to tie in the successful rollout of smart meters with the removal of the cap, rather than giving Ofgem the almost impossible task of deciding when to recommend its end. But it is now for politicians to consider these things and to look at the draft bill and see what could be done to address that issue.
Andrew Bainbridge – Major Energy Users Council: I think our business customers (who consume 25% of energy in this country) have had a rotten deal from politicians. I put this to Lord Deben recently and he responded, absolutely not, because energy is a tiny percentage of business costs and business make far too much fuss about it. I couldn’t resist sending him a note to say, “Well, I hope you have read the Helm review, where Dieter is not quite in agreement with you”. We’ve had constant changes of secretaries of state, energy ministers, civil servants – none of whom seem to learn much from each other. Do you believe we’ve had a rotten deal and is it always going to be like this?
Lawrence Slade: I agree that the constant swapping and changing hasn’t helped, but that’s unavoidable and, in fact, it shouldn’t be a party political issue. There was cross-party consensus on the Climate Change Act. If there is chop and change, then the cost of capital goes up because the certainty of investing in the UK, and the certainty of the return, goes down. You can look in the public domain at the cost of capital compared to other markets and sectors. I do agree that changes don’t help. If there is long-term clarity – and we accept there will be always be an element of business risk, that’s life – you will see costs come down because it is easier to get commitment to invest.
I was pleased to see in the clean growth strategy, the commitment on energy efficiency, albeit domestic, out to 2028. For the first time, I’ve got a 10 year horizon. Now if I’m in that market I can go to the board and ask for investment. Governments may come in and change that but even though we’ve been doing energy efficiency since the 1990s, we’ve never had this kind of horizon.
If I add on to that the aspiration of having energy efficiency level C in domestic houses by 2035, I’ve finally got something to get my teeth into. Yes, there’s an argument for saying you’ve had a raw deal but let’s learn from that, pick up some of the points in the Helm report, and get some long-term clarity going forward.
Brian Tilley: We’re fully aware of the issues around carbon leakage and carbon prices across Europe. UK competitiveness is really important, and even if the Government doesn’t accept the point of funding all government costs through general taxation, if we’re really concerned about the risk of factories going offshore to other countries because of a more favourable regime, then there is an argument for the Government to think about how it can step in and alleviate some of those costs. However, I’m concerned that a little old lady in a village might be helping to fund keeping a factory open by paying a proportion of those costs. Is that the right approach? I also think that the Government needs to step up, and to be fair it has started to speak the right kind of language in industrial strategy and to help businesses make improvements in the efficiency of their regimes. For energy-intensive industries clearly energy is a key cost and they should on the whole be doing that already, but in other businesses it can be hard to get it higher up a board’s priorities, but that’s the way to improve productivity and cut energy costs. Where they do look it at there are usually no regrets but it can be hard because there are so many other things that demand attention, so energy efficiency doesn’t get looked at.
The meeting closed at 1830.