GB energy industry

An introductory guide to the

2018

ENERGYINNOVATION CENTRE

THE ROLE OF THE SUPPLIER07C

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Contents

60

07 The role of the supplier 61

7.1 The supplier hub principle 61

7.2 Suppliers in the market 61/62/63

7.3 The structure of the markets 64

7.4 Consumer price trends 65

7.4.1 The consumer cost chain 65/66

Disclaimer: While Cornwall Insight considers the information and opinions given in this report and all other documentation are sound, all parties must rely upon their own skill and judgement when making use of it. Cornwall Insight will not assume any liability to anyone for any loss or damage arising out of the provision of this report howsoever caused. The report makes use of information gathered from a variety of sources in the public domain and from confidential research that has not been subject to independent verification. No representation or warranty is given by Cornwall Insight as to the accuracy or completeness of the information contained in this report. Cornwall Insight makes no warranties, whether express, implied, or statutory regarding or relating to the contents of this report and specifically disclaims all implied warranties, including, but not limited to, the implied warranties of merchantable quality and fitness for a particular purpose. Numbers may not add up due to rounding.

ENERGYINNOVATION CENTRE

07The role of the supplier

61

7.1 The supplier hub principleBefore going into the competitive supply markets, it is worth mentioning their broader roll in Great Britain’s (GB) energy sector, and why we have left them until this point of the guide to describe them.Suppliers, especially in electricity, are bound by a regulatory concept known as the “supplier hub principle”. This principle means that by signing a licence, suppliers sign up to all electricity codes and regulations. For gas this is the shipper function. What this means in practice is that suppliers bill for their prime functions, buying electricity and gas and retailing this to customers, as well as network costs and policy obligations. The original aim of this principle was to avoid the confusion of multiple industry bills and taxes for consumers. Suppliers in GB are therefore in a unique position as the sole contact with most consumers. They are also required to pass on network and policy cost rises to customers which they have no control over.

This is explored more in section 8.4 with the consumer cost chain.

7.2 Suppliers in the marketSince the late 1990s all customers have been able to choose their gas and electricity supplier. Opening the energy markets to competition occurred as part of a programme of restructuring and the privatisation of monopoly gas and electricity providers that commenced in the 1980s.

This restructuring culminated in a wave of consolidation of electricity and gas suppliers and power generators into the “Big Six” companies. These are British Gas, EDF Energy, E.ON UK, npower, ScottishPower, and Scottish & Southern Energy. In the domestic sector, if a customer has never switched supplier they will continue to be supplied by their incumbent Big Six supplier – British Gas for gas (nationally) and one of the five electricity incumbents (dependent on region). The consolidation of energy suppliers in GB from 14 regional electricity companies (present at the time of electricity privatisation in 1990) to the Big Six is shown in Figure 14.

62

1990

FIGURE 14: CONSOLIDATION OF REGIONAL ELECTRICITY SUPPLIERS TO

BECOME THE BIG SIX

The energy supply market has been characterised by an influx of new entrant suppliers in recent years, across both domestic and non-domestic supply. Figure 15 sets out new entry in the domestic sector, where there was an initial round of new suppliers in the early 2000s, nine of which exited the market in 2005-06 following a sharp rise in wholesale prices. New entry began again in earnest in 2009-10, with a significant shift in collective market share held by the competitors to the Big Six in winter 2013-14.

The conditions affecting this related to:

— Relatively easier entry to the supply market, through an “Off the Shelf Supplier”, i.e. a pre-registered licence offered by a company that provides a full service of software and support

— A series of price rises levied by the Big Six suppliers on standard variable tariffs

— A political focus on energy prices

Now

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50

40

30

20

10

0

25%

20%

15%

10%

5%

0%

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

LARGESUPPLIERS

SMALL AND MEDIUM SUPPLIERS

SaMS ENERGY SHARE AT 31 OCTOBER*

NUMBER OFSUPPLIERS

SMALL AND MEDIUM SUPPLIER ENERGY SHARE AT 31 OCTOBER11

2 2 5 6 8 9 916

2025

44

60

6 6 6 6 6 6 6 6 6 6 6 6 6

— Falling wholesale prices – new entrants could take advantage of these faster, as many did not have a longer-term hedging strategy in place, and were purchasing energy one to three months out (meaning they weren’t locked into longer term wholesale contracts). These companies were able to pass on the lower price faster in their tariffs, so new entrants were considerably cheaper at a time when many consumers were being driven towards price comparison websites due to the media/ political focus

— The “whole of market requirement” on price comparison websites to display all tariffs available in the market, irrelevant of whether there is commercial arrangement in place to fulfil the contract

— Targeting of niche market segments, such as the prepayment market (in particular offering a smart service), the rental sector, green tariffs, bundled services with broadband or smart thermostats

There have also been several new entrants in the non-domestic sector, particularly those targeting smaller businesses. New entry here has tended to come from one of three backgrounds:

— An existing domestic energy supplier

— Companies with interests in energy production or trading

— Companies with a background in business energy services or TPI-related activity

FIGURE 15: NUMBER OF DOMESTIC SUPPLIERS AT 31 OCTOBER EACH YEAR

IN THE GB DOMESTIC MARKET, AND TOTAL SHARE HELD BY SMALL AND

MEDIUM SUPPLIERS

64

4Ofgem, April 2017

7.3 The structure of the marketsThe domestic and non-domestic supply sectors hold some key structural differences, set out in table three. While consumers in the domestic market typically purchase their electricity and gas on a combined contract with one supplier (dual fuel), the non-domestic market has remained fairly segmented, with specialist suppliers for each fuel. There are around 27 million consumers in the domestic electricity sector, and around 85% also have a gas contract. The non-domestic sector records significantly fewer customers by number, but sees a similar level of consumption, with much wider ranging contracts by volume supplied.

Looking at contracts, the domestic sector has roughly 64% of consumers on standard variable contracts4 (where the prices can change with 30 days’ notice), rather than on a fixed contract. Fixed contracts in the domestic sector typically run for one year, and are fixed by length of tariff, and have a fixed unit rate (the amount you are charged based on your consumption) and standing charge (a daily charge irrelevant of usage). By comparison, the non-domestic sector has a wider range of contracts:

— Out of contract

— Deemed

— Fixed

— Flexible

— Pass-through

TABLE 3: KEY DIFFERENCES IN THE DOMESTIC AND NON-DOMESTIC SUPPLY

SECTORS - DATA AT 2017

NON-DOMESTICDOMESTIC

ELECTRICITY GAS ELECTRICITY GAS

Accounts / Meters 27.57 22.85mn 2.6mn 0.87mn

Annual supplied volume (TWh) 104 298 188 238

Dual fuel 84.8% N/A

Contracts Fixed variable tariffs Wide ranging

Cost £700-£1,200 £000s to £mn

VAT 5% 20%

65

7.4 Consumer price trendsThe supplier forms the main point of contact with the customer – known as the supplier hub principle – and is therefore responsible for passing on a number of industry costs to the customer. The supplier is also responsible for billing customers and passing costs back through the value chain to relevant parties. Figure 16 outlines a set of overarching categories that result in a single bill for a consumer.

Tariffs in the market typically increase/ decrease following changes in the price of wholesale energy, or other network or policy cost elements, but can also reflect any added value services, operational efficiencies, or pricing strategy.

Price trends in the non-domestic market are less transparent, as many contracts are bespoke for medium to high users. Access to customers often goes through Third Party Intermediaries (TPIs – or brokers), with 27% of the SME market and 67% of the I&C market brokered at October 2017.

7.4.1 The consumer cost chainAll of the pricing elements above feed into the consumer cost chain. Figure 16 overleaf details the respective cost elements for typical electricity and gas bills with the indicative ranges representing the differences in domestic and business bills and the volatility of some elements of pricing.

Three key things to note from these cost chains are:

— The electricity bill is more weighted towards network and policy costs than the gas bill. This is due to the previously mentioned weighting of policy obligations on the electricity bill and the rapid rises in renewables deployment and their network integration

— While gas bills have been relatively stable, the electricity bill has increased markedly due to increasing policy obligations

— Overall, whilst the supplier has some control over wholesale buying/ hedging and retailing/ sales/ margin, around half of the electricity bill and 40% of the gas bill is “take or pay” and largely uncontrollable for suppliers

The rapid rise in end user bills has seen an increased focus from government and the media on affordability and supplier margins in recent years. This culminated in a proposal in late 2017 for a price cap on domestic customers taking Standard Variable Tariffs (SVTs). This proposal is currently passing through Parliament and is expected in late 2018.

FIGURE 16: THE CONSUMER COST CHAIN (INDICATIVE)

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50% - 60%extraction,

refining, trading

35% - 45%fuel,

operation,maintenance

5% - 10%providing

assets, system

balancing

15% - 20%providing

assets

15% - 25%ECO, RO,

FiTs

5% - 25%VAT, CCL

1% - 10%billing,

metering, margin

1% - 3%providing

assets, system

balancing

15% - 20%providing

assets

0% - 5%ECO

5% - 25%VAT, CCL

1% - 10%billing,

metering, margin

Wholesale Transmission Distribution Governmentschemes

Tax Operating

Gas

Electricity

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