EON WATCH

EON on Energy Prices, fuel poverty and Ofgem

In EON Parliamentary Statements on January 11, 2009 at 8:38 pm

Who:  Paul Golby, E.ON

About:  Energy Prices, fuel poverty and Ofgem

To Whom:  House of Commons, Business and Enterprise Committee

Date of Oral Evidence:  17th June 2008

Link: PDF 1 PDF 2

Video:  Evidence Session on Video

Detailes after the fold…

The most striking part of the report was on the lack of liquidity for small and medium sized businesses. A whole host of anti-competative prices and practices where found.  The key message from this is that EON and other members of the ‘Big Six’  are using a lot of tricks and pure power to prevent competition from electricity retail specialits who are customer service specialists.

Liquidity

57. The biggest concern raised over vertical integration was about the lack of liquidity in the wholesale electricity market. Ofgem, Energywatch, the European Commission, the independent generators, the large-scale consumers and the small suppliers all highlighted this issue.[110] Because the ‘Big 6’ are able to supply most of their domestic and SME customer base from their own generating capacity, there is much less need for them to trade in the open market. They need only do so to balance or hedge their positions.[111] As a result, the wholesale market has increasingly provided only a balancing function for participants, focused primarily on short-term trading. Total traded electricity is currently equivalent to 2-3 times physical delivery. Ofgem notes that this is low compared to other commodities, for example gas trades at around 11 times physical delivery.[112] It is also in stark contrast to German and Dutch electricity markets, where liquidity in recent years has been increasing.[113] There have been recent signs of greater liquidity, with screen-based traded volumes up 30% in 2007/08 to £41 billion.[114] Nevertheless, Ofgem’s Chief Executive went so far as to say that: “The electricity market remains profoundly illiquid”.[115]

58. The lack of liquidity in the wholesale market has various implications. Small electricity suppliers find it difficult to get forward contracts that provide the volume and shape to meet their customers’ needs.[116] Welsh Power told us: “Quite simply we cannot buy what we need to buy to deliver the power for our customers when we need to”.[117] BizzEnergy told us the ‘Big 6’ firms had proven very reluctant to provide suitable offers for selling their generation, the implicit rationale being: “We do not want to deal with you because all you are going to do is compete against our supply business”.[118] Independent generators are also reluctant to sell their electricity in the smaller amounts required by the smaller suppliers. We heard evidence that the credit worthiness of those smaller suppliers was another obstacle for the generators, but we find this surprising given the very small sums currently involved, with all the independent suppliers put together accounting for only 1% of the market. Suppliers are also less able to hedge out any risks in the wholesale market.[119] Furthermore, for both independent generators and suppliers, the lack of liquidity creates greater volatility in the wholesale price. With limited trading, there is very little price transparency. This further discourages market participants, while those that do trade are less able to determine whether the price they are paying or receiving reflects the true market value. This risks dulling price signals to any potential new entrants both in generation and supply.[120]

59. The ‘Big 6’ companies did not agree that they were responsible for the lack of liquidity in the wholesale market.[121] Rather they pointed to the demise of Enron and TXU, and the restructuring of British Energy several years ago, as key factors in the decline in the number of market participants.[122] There was disagreement over the possible solutions to the issue. Both BizzEnergy and Welsh Power called for Ofgem to require the ‘Big 6’ generators to trade all their generation openly in the forward market.[123] The large industrial energy consumers said they would welcome some fixed proportion of the generators’ output being forced into the open market.[124] However, British Energy noted that any such requirement on the independent generators would increase the collateral they would have to put up to trade in the market, and that this could act as a barrier to new entrants in generation.[125]

60. When we suggested to the ‘Big 6’ the proposal of selling a proportion of their electricity in the open market, they told us they already did this.[126] However, the fact that they trade and hedge an equivalent or greater amount of electricity than they actually produce is different to saying that their generating capacity is available to other parties in the forward market. It is worth noting that EDF Energy subsequently retracted its oral evidence that the company traded all its electricity through the wholesale market, stating instead that it traded “the equivalent of all [the] electricity we generate” for balancing and hedging purposes.[127] We note Centrica argued that the vertically integrated firms would still need to buy back most of their power from the market. The additional transaction costs of this would inevitably be passed back to the consumer.[128]

61. E.ON UK did acknowledge that “the trading market structure can be improved”.[129] To this end, the “Market Design Project” was initiated in 2006 by a number of industry players to help stimulate greater forward market liquidity. However, it has made limited progress to date, and is not expected to make significant advances until at least 2009. Although this project, aimed at “capturing all, or a significant majority of trades” is welcome, Cornwall Energy Associates recently stated that “the bottom line is that an important industry project kicked off three years ago has stalled”.[130]

62. We also discussed the impact that trading rules can have on the market, particularly in relation to the so-called “cash out” arrangements intended to keep the supply and demand of electricity to the market in balance at the time of delivery. We are inclined to agree that these well-intentioned rules could deter entry by smaller generators and suppliers as they currently work. Ofgem is at present examining this issue separately. Given its highly technical nature we make no recommendation on it in this Report, but we look forward to Ofgem’s conclusions on this important issue.

63. The wholesale electricity market suffers from a severe lack of liquidity, which contributes to price volatility and poor price transparency. This, in turn, dulls market signals for potential investors in new capacity, outside of the ‘Big 6’. It also reduces the ability of new energy retailers to compete in the market. As Ofgem has already identified the issue as a serious problem, and in the absence of tangible progress on the Market Design Project, its market probe should propose a solution. As a starting point, and in addition to any increase in transparency that can be achieved as a result of our earlier recommendation, the regulator should conduct a detailed analysis of the risks and benefits of requiring the ‘Big 6’ firms to trade a proportion of their electricity openly in the forward market. We acknowledge that the regulator must take account of the need to balance the effects that greater regulatory risk might have on the investment decisions of incumbent companies. In principle, however, creating a better functioning wholesale market should facilitate new entry both in supply and generation.

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  1. It is interesting that two of the businesses trying to enter the market as retailers with good customer services have now gone bankrupt possibly due to lack of liquidity in poorly functional wholesale markets and cross subsidy of retail by generation.

    On 25 October Electricity4Business, one the few small suppliers to the SME market,went into administration.

    They were followed on 3 November by another significant
    small supplier, BizzEnergy;

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