Retail Market Review

Distribution Charging Methodologies Forum

Dena Barasi5 April 2012

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Outline

• Reasons for launching the Retail Market Review• Key findings• Proposed remedies

– Tariff simplification– Interaction with distribution charging

• Questions / discussion

The Retail Market Review

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Why we launched the Retail Market Review• Response to earlier remedies appeared patchy

– Minimalist approach to compliance?– Little action on Standards of Conduct?

• Ongoing questions over Big 6 behaviour– Continuing similarity on pricing and hedging behaviour?– Sharp rise in margins – indication of concerns?

Significant concern: is market working for consumers?

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Tariff complexity – the theory• Behavioural economics highlights two relevant consumer

biases:

– Limited capacity: the range of limitations on consumers to assess the goods and services available to them.

– Status quo bias: tendency of consumers not to change from what they are currently doing unless they face strong reasons for doing so.

Loss aversion and time inconsistency may also have an impact

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Tariff complexity – the evidence (1)

Limited capacity

0

50

100

150

200

250

300

350

Jan 07 Jan 08 Jan 09 Jan 10 Jan 11

Online Green Offline GreenOnline Fixed Offline FixedOnline Other Offline OtherOnline Standard Offline Standard

ComplexityComplex domestic pricing more common in energy supply than any other sector

1Office of Fair Trading (2010) “Advertising of Prices Annexe N: Consumer survey data tables”

Num

ber o

f tar

iffs

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Tariff complexity – the evidence (2)

Status quo bias

Switching

Roughly 60% of domestic consumers claim that they have never switched supplier

43% of switches in 2010 were made after talking to a salesperson

Only 16% via price comparisons sites

Evergreen contracts

75% of gas and electricity domestic consumers currently on standard evergreen products

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Our research shows consumers want:

• greater simplicity

• tariffs to be comparable

• for there to still be choice and scope for innovation

Consumer preferences

This implies:

• structural remedies

• clearer information

• balance between simplicity and choice

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Suppliers’ margins and pricing behaviour• Gas margins have increased sharply but from a negative base• Electricity margins positive but declining since 2006• Higher margins on single fuel customers relating to legacy business

• New evidence of asymmetric price response

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Summary of RMR findings

Based on our evidence we still believe there are incidences of persistent consumer harm in the retail market that are being driven by features of the market.

We believe the most important market features are that of sticky customers and the advantages of the vertically integrated incumbents.

Our evidence also tells us that limited or complex information and poor comparability between suppliers lowers engagement and leads to poor switching decisions for some.

RMR: Proposed Remedies

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Core tariffs proposal

For standard tariffs• All suppliers limited to one standard tariff per payment

method for single rate and E7 meters • Compulsory standardised element set annually by

Ofgem and identified separately on consumers’ bills • All other revenue recovered through a single unit

charge, set on a p/kWh format

Save by switchingSupplier A – 13.75p/kWh Supplier B – 14.25p/kWh

For non-standard tariffs• No restriction on number of fixed term products• No auto-rollovers or adverse unilateral contract variation terms • Price information presented in a ‘standard equivalent’ (p/kWh

format)

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Setting the standardised element

• Key component of approach for standard tariffs• National standing charge will cover fixed network costs (i.e. DUoS

fixed charge)• Other categories of cost may be included in standing charge (e.g.

environmental costs, metering…)• Majority of network charges recovered through unit rate, reflecting

charging methodologies• Unit rates differ between regions, reflecting network charging

methodologies

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Standard tariff structure - options

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Standing charge (both options) and regional adjuster (option 1 only)

The regional adjuster will be set annually (1 June) and we propose to change network charges only once each year. However, Ofgem would monitor actual costs incurred by suppliers and may propose a change if we observe significant mid-year changes to network costs.

 

Illustrative annual cost for

average consumer (£)

Recovered through standing charge

Recovered through unit

rate

Gas transmission 6 x üGas distribution 122 x üElectricity transmission 19 x üElectricity distribution 81 ü(£13) ü(£68)Energy Company Obligation*

29 (gas), 29 (elec) ü x

Warm Home Discount* 7 (gas), 7 (elec) ü xMetering*i 23 (gas), 15

(elec) ü xOther supplier fixed costs* 25 (gas), 25

(elec) ü x

* If included in the standing charge.i Metering cost estimates are based on traditional meters, not smart meters.

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Standing charge and regional adjuster• National standing charge in both options

– Fixed networks charges recovered via standing charge– Proposed treatment in licence: Schedule of numbers for early years +

automatic adjuster thereafter

• Regional adjuster in Option 1– Consumption-based network charges recovered via regional adjuster– Historical consumption ≡ current consumption– Proposed treatment in licence: formulae

Electricity DUoS unit rate TNUoS unit rate (peak charge*peak percentage)

Unit rate * consumption

GasDistribution unit rate (tariff/load factor)National Transmission System (NTS) exit capacity unit rate (tariff /load factor)

Unit rate * consumption

Electricity DUoS fixed charge (£/MPAN)

Gas N/A

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Next steps

• Review consultation responses– December consultation on domestic proposals– February consultation on standardised element

• Re-assess proposals in light of responses

• Further research and analysis

• Next publication during summer 2012

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