SSE Response to Powering Britain: One Nation Labour s plans to reset the energy market, March 2014
About SSE SSE (formerly Scottish and Southern Energy) is a UK-listed and based utility with a core focus on the energy markets in Great Britain, plus Ireland. It is the broadest-based energy company in the UK with interests in the production, transmission, distribution and supply of electricity and gas. SSE welcomes the opportunity to respond to this consultation on measures to improve the GB s energy market for consumers. Executive summary SSE shares the Labour Party s goal to deliver a fairer energy market that works for ordinary people and secures investment for the future. Building on its work in recent years it will work with consumers, political parties, regulatory authorities and any interested stakeholder to achieve this goal so that households and businesses have affordable, secure and lowercarbon energy supplies. This consultation process is welcome and the proposals contained in it would inject further liquidity into the wholesale electricity market and improve transparency in this regard; however the proposals would not significantly reduce energy prices or provide energy investors with the long-term certainty they require to invest in the energy infrastructure consumers depend on. As an active market participant SSE wants to increase further wholesale electricity market liquidity. It has introduced industry-leading reforms to how it buys and sells power which have successfully injected considerable liquidity into the market and improved transparency. Ofgem has built on SSE s reforms with the Secure and Promote licence condition. With time and growing participation from financial institutions, this can provide a reference for longer-term electricity contracts, improving liquidity in these markets as well. Energy companies need to take action and SSE in recent years has demonstrated a willingness to find sustainable solutions for its customers. In March 2014 SSE announced a price freeze until at least 2016, alongside a programme to streamline and simplify its business and a commitment to legally separate its Retail and Wholesale businesses to improve transparency. As a result of these actions the market is better for consumers. SSE continues to have an appetite for reform and will play its part, but it also believes that Governments have a major role to play to take some of the rising costs out of supplying energy and to provide energy investors with the certainty they require to commit to long-term investments in electricity generation, transmission and distribution. Notwithstanding the proposal for a 20-month price freeze, the consultation does not appear to have a clear commitment or a sustainable solution to reduce the costs of electricity and gas. Action must be taken to address the trajectory of energy costs in the coming years and ensure fairness, particularly in how the costs of government energy policies paid for through energy bills are levied from the most vulnerable consumers. SSE is supportive of the principles behind the mandatory social and environmental policies. However, given that energy prices in the UK are at historically high-levels, and these costs equate to around 100, and rising each year, of customers energy bills irrespective of their ability to pay, it is appropriate to consider whether funding such policies through energy bills is fair. - - The UK requires significant energy investment in the coming years to ensure consumers have the secure and lowercarbon energy supplies they depend upon. SSE welcomes the consultation s intention to provide energy investors with clarity and certainty; however given the urgent need for energy investment it needs to go further. There are additional measures which need to be considered before commitments to long-term energy investments can be made. 1
Introduction Rising prices in recent years have led to increased scrutiny of the GB s energy market. Given that energy is an essential part of people s lives this scrutiny is welcomed and is increasingly important if the industry is to assure consumers that the energy market is operating in their interests. SSE shares the Labour Party s goal to deliver a fairer energy market that works for ordinary people and secures investment for the future. It will work with consumers, political parties, regulatory authorities and any interested stakeholder to achieve this so that households and businesses have affordable, secure and lower-carbon energy supplies. In October 2013, Ofgem, the Office of Fair Trading and the Competition and Markets Authority were commissioned to look at competition in the energy market and they are expected to publish the outcome of their review by the end of March 2014. If they conclude that there should be further examination of the energy market, SSE will engage constructively with that process and urges all political parties to respect its independence and ensure that policy development does not pre-empt or prejudice its possible outcomes. The challenges facing the energy industry are not new. SSE publicly acknowledged in 2011 that energy suppliers needed to build the trust of their consumers. In that time it has taken notable actions to make the market simpler, fairer and more transparent. This has included: radically simplifying its tariffs before regulatory requirements ending the out-dated practice of cold calling customers securing Living Wage accreditation, making SSE one of the largest accredited Living Wage employers in the UK leading the industry with major reforms to make energy trading more transparent These actions demonstrate that SSE acknowledges its role in finding sustainable solutions for consumers. It has continually shown an appetite for reform and alongside this response to Powering Britain SSE has announced a proposal to freeze energy prices for all customers until at least January 2016. In order to achieve this SSE is taking costs out of its business, accepting that at a time of higher prices it needs to address customers concerns as effectively as possible. Nevertheless, there are considerable costs levied through, supplying energy that are reflected in consumers energy bills. These costs are largely as a result of policies introduced by governments featuring all three of the UK s largest political parties - intended to ensure that the UK has secure, affordable and lower carbon energy supplies. SSE will work with all political parties to find enduring ways to reduce the costs of supplying energy and ensure that the costs of government energy policies are levied equitably to protect vulnerable customers. In all of this, SSE hopes that consumers will not see SSE as part of the problem, but as part of the solution. 2
Leading the industry towards more transparent and competitive wholesale markets At a time of rising energy prices consumers expect greater transparency in how energy costs are determined. Greater transparency is supported by SSE as it is the most effective way to build consumers trust that the energy market is operating in their interests. The GB s energy markets are designed to maintain a downward pressure on the cost of electricity and gas, for the benefit of consumers, and encourage diversity in the supply of fuels in order to ensure there are secure energy supplies. The liberalised market structure that was introduced with NETA/BETTA led many market participants, large and small, to become vertically integrated (meaning that they have interests in energy production and energy supply). This structure has allowed companies to better manage the market risks and has had further significant benefits for consumers. For example: it provides the balance sheet necessary to finance long-term energy trades to secure energy supplies of electricity and gas for consumers. Without a strong balance sheet, financial credit requirements can escalate. it ensures that companies can remain stable over the long-term despite times of negative or falling profitability in either part of the business (the early years of this century showed the extent of the difficulties than can be experienced by production-only or supply-only businesses). Current market structures provide security to withstand huge increases in wholesale prices which have resulted in several smaller supply companies being dissolved in the past: a number of non-integrated suppliers and generators did not manage these risks and went out of business which is ultimately to the detriment of consumers and to competition. Business separation SSE continues to believe that the integrated management of Retail and Wholesale businesses brings significant benefits for consumers, but has also acknowledged that more needs to be done to make the energy market easier to understand. SSE has already confirmed in conversations with the Labour Party and others that it has no objections in principle to greater separation of its Retail and Wholesale businesses. Subject to securing the necessary third party consents, SSE will reorganise its companies so that there are separate legal entities for its energy supply (Retail) and electricity generation and energy portfolio management (Wholesale) activities. This change, which is scheduled to be completed by 31 March 2015, will enhance the transparency of the basis of reporting and measurement of the performance of these businesses and be consistent with the expected evolution of Ofgem s Consolidated Segmental Statements. Longer term, SSE remains open-minded about further reforms that are in the clear interests of consumers, including further steps to improve the transparency of financial reporting and operations. However, SSE also understands that to ensure that there is improved transparency and reform should be done in a standard way across the industry. 3
Transparency in the wholesale electricity markets The consultation document is correct to note that wholesale energy costs are the largest component of energy bills, making up around half of the average customer s bill. Suppliers purchase energy for their consumers in a number of different ways with objectives to ensure that consumers pay a fair price for their energy and are protected as far as possible from the volatility in the wholesale market. Whilst trading arrangements have worked in consumers interests and shielded bill-payers from market volatility, SSE accepts that more can be done to continue the process of making trading in the wholesale electricity market more transparent, although it is important to recognise that markets of this kind are inherently complex. Therefore, SSE supports the direction of the proposals in the consultation to: require companies to buy and sell 100% of their power via open exchanges require participants in un-cleared OTC (over-the-counter) trades to allow brokerages or platforms to publish anonymised transaction details As an active market participant SSE wants to operate in markets where there is sufficient liquidity. It is for this reason that SSE introduced an industry-leading reform to how it buys and sells power. This move was intended to make the process more transparent and set a robust benchmark price which helps the Day Ahead market as well as forward trading (anything up to 3 years in advance of delivery). As a result of SSE s move considerable liquidity has been injected into the wholesale electricity market (see overleaf). SSE has led the way in terms of injecting liquidity into the wholesale electricity market: the proposal to mandate that all market participants buy and sell all of their power via open exchanges is supported. It would further boost liquidity, help competition and increase transparency, whilst not representing a burdensome cost to the bill payer or the taxpayer. As an active market participant SSE wants to operate in markets where there is sufficient liquidity. It is for this reason that SSE introduced an industry-leading reform to how it buys and sells power. 4
SSE s measures to inject liquidity into wholesale electricity markets In response to customers wishes for greater transparency about how energy is bought and sold, SSE introduced a new approach to trading in October 2011. It began to phase in the auction of all of its electricity supply and purchase all of its electricity demand in the Day Ahead market through the existing trading platform N2EX (which suppliers pay to trade-on). SSE now regularly commits 100% of its demand and generation into that market. This move, also used in the Nord Pool and Baltic markets, marked a major change to how power is bought and sold and has been welcomed by new market entrants. By April 2012, largely due to SSE, the daily volume of power traded in the N2EX day-ahead market was up 300% (see overleaf). Ofgem said the reforms: create greater liquidity and more efficient price discovery on the Day Ahead market. Auctioning in this way, known as Gross Bidding, provides a transparent price which all suppliers can trade against with clarity about who is trading at what volumes and that the price is fair and determined by the market. A robust Day Ahead price also provides a benchmark for long-term trades. This trading arrangement is, in effect, a market based pool. The principal difference from the previous Pool is that the auction allows for a competitive market based on self dispatch rather than by central dispatch. Following Ofgem s Secure and Promote licence condition other market participants have followed SSE s lead and now trade in this way which has boosted liquidity with volumes traded on the Day Ahead market around 50% of total GB consumption. The N2EX exchange reached record levels in 2013 and on Tuesday 3 December the N2EX market set an all-time volume record, with over 500 GWh traded in a single day. With all of SSE s generation and demand going through this market and fully accounted for in financial reporting, there is, quite rightly, nowhere to hide. Smaller independent suppliers also now know they can access the electricity they need to supply their customers. Only SSE regularly commits 100% of its supply and demand in this way. The proposal in the consultation document will attract all market participants to a market in which they can be assured of liquidity thereby helping competition, market transparency and setting clear benchmark prices. Using an existing exchange, such as N2EX, is strongly supported as it has the benefits that it: requires no costs from the bill payer or Exchequer to establish (unlike returning to a Pool ) can be introduced quickly and amended should additional measures be required does not require fundamental changes to the existing market structures does not represent a considerable cost to companies to participate (to mitigate this being a barrier it can be determined proportionate to the size of the company) Alongside this, SSE also helped new market entrants get access to their power they need by introducing the industry s first bespoke trading commitment for any new market entrant with fewer than 250,000 customers. This arrangement is in place with three new market entrants and SSE underwrites credit to overcome one of the principal barriers to entry in the energy market. Ofgem has subsequently built on SSE s reforms with the Licence Condition ( Secure and Promote ) to improve accessibility and liquidity in the UK power market, and this is supported. 5
GWh traded in the Day Ahead market since SSE began trading all its electricity supply and purchasing all of its electricity demand through the existing trading platform N2EX 6
A fairer approach to energy prices Whilst wholesale costs represent the largest single component of energy bills, and can be made more transparent as the consultation suggests, rising costs in recent years have principally come from non-energy costs. These costs include the costs of using the energy networks, the smart-meter rollout, for which there are EU mandated requirements, and the costs of the social and environmental schemes introduced by the current and previous governments, which suppliers currently have to collect from consumers through energy bills. These costs are forecast to increase further. SSE supports the intention set out in the consultation to: ensure that every scheme and intervention that is funded by either the consumer or the taxpayer is as cost effective as possible. It believes that such a forensic approach to costs must be taken with specific regards to: the 11bn roll-out of smart meters to all UK households by 2020. SSE is currently undertaking a detailed assessment of the programme and where costs can be reduced without harming the programme s objectives. In particular, it believes that cost-saving opportunities could arise from seeking to comply with EU legal requirements, rather than exceed them. the deal which the UK government has reached with EdF over the construction of two reactors at Hinkley Point, which will add considerable costs to consumer energy bills for 35 years. One leading analyst, Peter Atherton, described it as the most expensive conventional power station in the world and a clear case of socialising risk and privatising profits. However, notwithstanding the proposal for a 20-month price freeze, the consultation does not appear to include a clear commitment or a long-term solution to reduce the costs of supplying electricity and gas. In order to address the trajectory of energy prices in the coming years there needs to be greater fairness, particularly in how the costs of energy policies are levied across the most vulnerable consumers. The consultation does not appear to include a clear commitment or a long-term solution to reduce the costs of electricity and gas SSE s price freeze protects customers, but the costs of supplying energy need to be reduced SSE has said that, following its reduction in prices in March 2014 that it will now freeze prices at these levels until at least 2016. SSE announced this price freeze alongside a programme to streamline and simplify its business. It means that in the coming years SSE will be below its profit target of 5% across its Energy Supply activities. This target has not been met in recent years Price rises in recent years have been due to a combination of rising wholesale costs, rising network costs and rising government scheme costs. These costs are forecast to increase up to 2020 and if the objective of any market reform is to reduce energy prices then attention needs to turn to reducing the costs associated with supplying energy. An externally-imposed 20-month price freeze would not reduce the costs of supplying energy. The costs of mandated social and environmental policies funded by energy bill-payers SSE remains extremely supportive of the principles behind the mandatory social and environmental schemes that are paid for through energy bills, namely improving household energy efficiency and supporting renewable energy. These policies help to make the us of energy more efficient and make energy supplies less carbon intensive. However, whilst there is an absolutely clear benefit to these schemes there should be no illusions regarding the iniquitous distribution of the costs and benefits. 7
SSE s own analysis suggests that environmental and social policies will comprise around 200 of a typical bill towards the end of this decade compared to around 100 today. These increases in policy costs would add another 9% onto today s tariff. The merits and associated benefits of these polices are not in question. What is in question is whether they are being levied in the fairest way possible. Clearly some of these costs should continue to be paid through energy bills (i.e. the costs of using the maintaining the energy networks, the capacity mechanism and carbon pricing). However, the policies intended to improve household energy efficiency and provide financial support for vulnerable customers can be better delivered and target if funded in a fairer way. (see overleaf) The costs of the mandated social and environmental policies funded through energy bills 2014/15 and 2019/20 Points to note when considering the figures below: the costs shown reflect a typical SSE dual fuel customer assuming consumption levels remain constant in 2019/20 nominal prices are what customers will see in their bills DECC s own analysis, published in March 2013, outlined policy cost in 2020 of almost 300 for a typical customer. SSE s forecast is lower as it reflects policy changes that have been announced since DECC undertook its analysis the below gives no view on wholesale energy costs or the costs of using the energy networks, which are both forecast to increase the below is specifically concerning the price of the policies: it gives no reflection of the associated benefits in terms of reduced usage the combined cost of RO, CfD, FiT is assumed to be at the cap laid out by DECC within the Levy Control Framework the smart meter costs are based on DECC s estimates. The smart metering programme is an uncertain cost item and as has been seen by international experiences could entail a higher net cost to suppliers the EU ETS costs are based on current estimates the costs of the capacity mechanism are forecast by DECC at 25/KW in 2019/20 the Warm Home Discount costs are not increases in real terms the table below does not include VAT levied at 5% of the bill. Price Impact of Policies on a Dual Fuel Customer Nominal Prices Real (14/15) Prices** Today In 5 Years Time Today In 5 Years Time 2014/15 2019/20 Vs Today 2014/15 2019/20 Vs Today Policy Energy Company Obligation 34 37 +3 34 31-3 Costs Warm Home Discount 13 16 +2 13 13-0 Feed in Tariffs 10 17 +7 10 15 +4 Renewables Obligation 39 51 +12 39 43 +4 Contracts for Difference - 37 +37-31 +31 Capacity Mechanism - 24 +24-20 +20 EU ETS 6 17 +12 6 15 +9 Carbon Floor Price 15 26 +11 15 22 +7 Smart 5 10 +5 5 8 +4 Sub Total 122 236 +114 122 199 +77 % on bill 10% 14% +9% 10% 14% +6% ** RPI at 3.5% per anum 8
Fairer payment of policy costs Energy bills have reduced in recent months following the UK government s decision to reduce the delivery costs of the Energy Company Obligation. The decision to freeze the Carbon Floor Price, taken at Budget 2014, will also reduce the costs of for households and businesses towards the end of this decade. However, given that energy prices in the UK are at historically high-levels, and these policy costs equate to more than 100 (and rising) of every customer s energy bill, irrespective of their ability to pay, it is appropriate to consider whether funding such policies through energy bills is fair on bill payers, particularly the most vulnerable customers. Building on the announcement of changes to the ECO and the Carbon Floor Price, a solution to reduce energy prices still further and ensure government policies are funded in the fairest possible way is to take more of these policy costs off energy bill payers and fund them in a progressive way, such as taxation. This is particularly the case for policies intended to improve household energy efficiency. Whilst energy suppliers have demonstrated their ability to improve household energy efficiency through several government mandated programmes, the scale of the energy efficiency challenge in the UK means government must consider alternatives for delivery as well as funding. Policies to date have principally focused on measures related to electricity and the simple-to-install measures. Greater integration of funding and delivery of energy efficiency policies is now required. Although suppliers may have a continuing role, local authorities have a much greater awareness of which properties in their locality are owner occupied, private rented, or social housing and could therefore target energy efficiency measures accordingly. A street-by-street approach to energy efficiency could be hugely beneficial and SSE believes that local authorities are well placed to work with other key stakeholders to drive the necessary property investments. Taking some of these policy costs off energy bill payers will: reduce customer s energy bills by around 100 protect the most vulnerable energy consumers by ensuring they do not pay the same amount to fund these policies as others who can afford to pay more Consumers views on funding social and environmental levies* Approximately 100 of an average annual energy bill contributes towards funding clean technologies (e.g. renewable energy) and government energy efficiency schemes. Some believe this money should be paid through taxation so the amount customers pay is in proportion to their earnings, while others think it should continue to be paid through customer energy bills. Which of these comes closest to your view? Funded through taxation to be proportionate to earnings - 62% Funded through energy bills - 17% Don t know - 21% To conclude, there is no silver bullet to reduce energy prices. However, consideration must be given to some of the social and environmental mandated costs passed to consumers through their energy bills and whether it is fair to collect these costs through energy bills, particularly given the impacts of the regressive way in which these costs are passed onto consumers irrespective of ability to pay. *Source: Populus interviewed a random sample of 2055 GB adults aged 18+ from its online panel between 14th - 16th March 2014. Surveys were conducted across the country and the results have been weighted to the profile of all adults. Populus is a founder member of the British Polling Council and abides by its rules. Further information at www.populus.co.uk. 9
Ensuring clarity and certainty for energy investments The consultation is correct to note that the UK urgently requires investment in its energy infrastructure to ensure consumers have secure and lower carbon supplies of energy. In recent years SSE has invested around 1.5bn annually into the UK s energy infrastructure, particularly renewable sources of energy and the energy networks on which people depend. This investment has provided employment (both direct and in the supply chain) and growth in areas predominantly outside of the South East of England. Investments in energy are made over the long-term; as such they require policy stability and clarity. At present there is considerable investor uncertainty about the direction of the UK s energy markets and the frameworks which investments are made within. This lack of clarity has been caused by a number of factors, principally uncertainties about the details of key parts of the Electricity Market Reforms, as noted in the consultation and the prospects for further legislative or regulatory changes in the years ahead. As a result, much-needed investments in new capacity to generate electricity are not forthcoming. This has exacerbated concerns about the security of energy supplies in the UK in this decade: Ofgem s Electricity Capacity Assessment Report 2013 forecast that the electricity capacity margin in the UK could fall from 14% in 2012/13 to 4% in 2015/16. This situation has been created by a number of factors leading to plant closures and an insufficient rate of new build. With this in mind it is critical that energy investors are given the clarity they require to commit to the long-term investments that need to be made to meet the needs of consumers and the country as a whole. The consultation s proposals to provide investors with clarity by seeking to maintain the arrangements in the EMR and try to introduce long-term clarity through the creation of nongovernmental advisory boards are a step in the right direction. However, clarity is needed about the details of how these arrangements would operate. SSE fully understands the importance of having a strategic focus on ensuring that the UK has secure electricity and gas supplies. It believes there is merit in a restatement of responsibility for security of energy supply and in the establishment of an independent and authoritative Energy Security Board to ensure agreed standards of energy supply security are identified, monitored and are being secured. Further measures to restore investor certainty include: 1. Assurance that a Labour Government would continue with the arrangements in the Electricity Market Reform (EMR) for a capacity mechanism The Capacity Mechanism is critical to maintain security of energy supplies. With thermal plant running more and more as back-up for low carbon energy, the price signals from selling their energy are inadequate to finance the building of new plant or keep existing plant open. The Government has realised this and has rightly legislated to introduce a Capacity Mechanism to remunerate power plant for being available to run. However, uncertainties about its introduction and design will lead to investments being delayed and lead to existing plant being mothballed, meaning they will be temporarily taken out of the energy system and require time and costs before they can generate power, or be forced to close. 2. Preserving an independent energy regulator, with a clear role This independence is not only a legal requirement but also important to give investors clarity about the licensing framework they will operate within and ensure that long-term investment programmes, such as Price Controls for energy networks, are not subject to political uncertainty. 1 For background see Royal Academy of Engineering Report GB electricity capacity margin, October 2013 10
3. The sustainability of the Carbon Price Floor This policy was intended to bolster the carbon price set by the EU ETS. A European mechanism remains the most effective way to determine a robust carbon price and stimulate low-carbon investment. In the absence of a robust EU-wide carbon price the disparity of carbon pricing between the UK and the rest of Europe created by the Carbon Floor Price leads to a number of consequences for investors and consumers: - it is an additional cost to the wholesale price of electricity paid for by households and businesses - the absence of clarity about the price is a cliff-edge to investments - it damages liquidity in the power markets as it is a tax that cannot be hedged against. SSE believes that the Carbon Floor Price can be a mechanism to support low-carbon investment if long term clarity is provided and the perceived risk of political interference is reduced. A solution is to set the UK s carbon prices in primary legislation to provide long-term certainty. 4. Preserving the principle of grandfathering existing assets It is critical that policy makers protect the legitimate expectation that long-term assets will not see their existing arrangements unpicked by a future government. If grandfathering is not respected it creates considerable investor uncertainty and the appetite for investors is significantly reduced. To summarise, SSE welcomes the fact that the consultation explicitly supports measures to give energy investors the clarity they require to commit to long-term investments. There is no single policy lever which can attract energy investment into the UK. However, these four policies will go some of the way to improving the outlook for investments which ultimately benefit electricy and gas consumers. 11
Summary SSE shares the Labour Party s goal to deliver a fairer energy market that works for ordinary people and secures investment for the future. This document demonstrates that it has shown willingness in the past to find sustainable solutions that work in the interests of consumers. It has repeatedly taken action, most recently announcing a price freeze until 2016, alongside a programme to streamline and simplify its business. Government also has a major role to play. Whilst the proposals outlined in Powering Britain are a start and will have some benefits for wholesale market liquidity and transparency, what is also required are policies which make energy affordable, particularly for the most vulnerable customers, and policies to attract long-term energy investment into the UK to provide jobs, growth and ensure that the UK s consumers and businesses have secure and low-carbon energy supplies. SSE recognises the challenges facing the UK s energy markets and will continue to work with consumers, political parties, regulatory authorities and any interested stakeholder to ensure that households and businesses have affordable, secure and lower-carbon energy supplies. 12