Issues which May Inhibit Competitive Dynamics

On the following pages we summarise the views put to us on factors in the market which may serve to limit the workings of competition, together with opinions on how some may be addressed. As in Section 7.2.1, they are presented according to source.

Reflecting the position on the level of competition, unsurprisingly smaller customers and their representative groups tended to focus on matters that would directly improve their participation in the market. Larger customers and suppliers tended to raise more issues relating to regulatory policy and market structure.

7.2.2.1. Smaller Customers

Smaller customers and their representatives are keen to ensure that the market works better from a practical perspective. Amongst the suggestions they raised are:

• information on choice and education about it should be made easier to find;

• suppliers should be encouraged to improve their registration and billing operations, with information on individual performance readily accessible;

• mis-selling is an issue and can be reduced as the conduct of sales agents should be improved through a code of practice, as has been the case in the domestic sector;

• efforts should be made to ensure competing tariffs are comparable;

• consumer protection measures should be improved at the point of sale – contract terms should be clear and fair and made apparent by sales representatives at the point of sale. Cooling off periods may be worth introducing; and

• bills should be made clearer. In particular, they should show all elements – the climate change levy should appear on all bills as a separate line item.

7.2.2.2. Larger Customers

Whilst larger customers are keen to improve the working of the market from a practical point of view, they are just as much, if not more concerned, by structural and policy issues, especially those connected with wholesale energy markets. In this area, there is sometimes a correlation of views between larger customers and their suppliers, especially concerning issues around regulation and market structure. Arguably, the two most significant areas of concern to larger customers at present are wholesale prices, especially gas, and the transfer process. Concerning the latter, one public sector user group told us that “this is clearly a barrier to competition, with many consumers avoiding the tendering process in order to stay with the

incumbent supplier and even if they do tender, they still look for reasons to stay with the incumbent.” Some customers told us that difficulties in the transfer process often heralded the start of major problems with billing. One user group told us that, in its opinion, inaccurate billing often stems from bad estimates and that some customers will not change suppliers until they have recovered monies owing to them, a process it argues can “take an inordinate amount of time.” Frequent industry rule and cost changes were also cited by users as a major factor behind the billing problems they experienced, but

perhaps the most important single factor raised by customers was supplier systems integration.

Suppliers have acted to integrate and combine billing systems on completing the acquisition of their rivals. This process appears in several cases to have been problematic and more time consuming than expected. For their customers this situation has often led to practical difficulties in

managing their accounts as bills are either not submitted at all or submitted inaccurately. These difficulties appear to have been concentrated on the major integrated suppliers: all bar Scottish Power have acquired rival suppliers serving the industrial and commercial sector since 2000. For example, one major retailer told us that, since its supplier was formally absorbed by an acquiring company in October 2003, it had not received an accurate bill. It states that “this is due apparently to a lack of training and a lack of communication between” the staff of the two suppliers. We asked the suppliers for their perspective on this issue and their responses are

summarised in the following Sections.

On the subject of wholesale prices, one manufacturer told us; “not enough UK gas, or storage, or true competition. Therefore, [there has been a] price increase of 40% [which is] totally unacceptable to industry.” Others made the point very forcefully that any continuation of delivered energy prices at 2004 levels for a sustained period of time would lead to capacity cutbacks.

Furthermore, they made it clear that they did not trust any market that they perceived to be so opaque. There is a widespread perception amongst larger customers that offshore gas field maintenance is somehow planned to

manipulate the market. Their concerns are clearly also familiar to their

suppliers and are encapsulated in the following description from one of these companies as “the phrase that the ‘market is where it is because it wants to be’ cannot reflect a truly competitive market and the linkage between oil and gas; and [in turn] gas and electricity is often cited as the reason for price

movements, particularly upward movements. Whilst this is true, the linkages are often broken and no reflection can be made. This linkage can be difficult to comprehend in some cases, as UK gas deals are not linked to oil deals, as is the case in mainland Europe.” Another supplier told us that customer

scepticism about the wholesale gas market hinders supply competition because “one effect is that, if customers don’t believe the prices, they delay signing contracts or take short term deals, meaning that a bad situation could be much worse if we have a difficult winter. This is happening now.”

Large customers and their representatives have lobbied for a wide-ranging regulatory investigation into offshore gas markets. We asked some of these organisations for their reasons for taking this stance. They told us that such an investigation was now necessary because:

• British electricity and gas prices have moved significantly above those of key peer nations, giving industry a cost disadvantage against its rivals;

• there is an absence of local drivers that might cause price increases in excess of general price drivers elsewhere; and

• they are unable to rationalise, even remotely, reasons that might justify the magnitude of the price increases they are facing because the

offshore market is very opaque.

Other issues inhibiting competition from the larger user’s perspective include market complexity. One user group believes this increases suppliers’ operating costs reducing their “ability to make a fair profit”. Examples of such market complexity quoted by it and other larger users include the introduction of competitive gas metering, the fragmentation of the price control on Transco’s gas network charges, and the possible sale of some regional gas distribution networks by NGT.

Other issues to emerge consistently from our research include customer perceptions that:

• the high cost of entry to the market and of compliance for suppliers may explain subsequent exits and consolidation;

• a lack of resources on the supply side to quote, administer and bill contracts is hindering competition;

• diminishing agent competition and reducing performance are resulting in heavily restricted choice in meter reading, data aggregation and collection;

• the declining number of suppliers available is also lowering service standards as customers have less discretion in who they choose to deal with; and

• the lack of meter readings for small sites is making competition more expensive. This situation is argued as being worse in gas and has meant that many customers use their own meter read data in their tenders. However, this is resource intensive.

Many large users are very frustrated at what they perceive to be a muddling of regulatory priorities. One major user group told us that

“generally this is regarded as not always being in the consumer's interest, but rather a theoretical economic plan which is not always pragmatic and adds to the complexity of the systems.” Others observed that there seems to be a political tension in regulation between Ofgem and the DTI which is hindering the investigation they would like to see in to the offshore gas market.

7.2.2.3. Smaller and Independent Suppliers

Smaller and independent suppliers typically expressed concerns about the workings of the supply markets and argued that a number were directly

inhibiting their ability to compete. Many of these concerns can be traced back to wholesale market structures and current dynamics in that sector.

The typical, but by no means exclusive, view smaller suppliers wished to relay to us is that, due to consolidation in the wholesale sector, either by integration or contract, freely traded power available to small suppliers is becoming more difficult to source. They attribute vertical re-integration as the main driver behind falling wholesale market liquidity. One small supplier told us that it had six counterparties with which it could normally expect to trade electricity. Another told us that it had three. Furthermore, they argue that the traded market is becoming more granular, with trading moving towards power station lots and not smaller tranches more suited to independent suppliers. In the half hourly market, we were told, there is very little trading as the larger players seek to retain necessary flexibility to meet demand fluctuations in their own generating portfolios. One told us that it feared that very soon all marginal plant will be in the hands of vertically integrated companies so that small players would not be able to buy shaped products on the wholesale market.

One independent supplier with recent experience of both gas and power markets told us that, in its opinion, the situation is worse in the gas market. Liquidity is such that small players cannot cover expected times of high, volatile prices as there is no diversity of players willing to provide it. It alleges that gas is being held back from trading to be released back to spot at times when there are electricity peaks. One smaller supplier informed us that it believes the major integrated players are very reluctant to offer wholesale product to suppliers. It claims that a number have told it the reason for this is that the small supplier competes with the retail business of the integrated operator, but this has never been put in writing. The failure of independent generators and their acquisition by existing scale players also means there is much less free capacity to buy from.

Even where smaller suppliers can negotiate a wholesale arrangement, they note what they perceive to be a general tightening of credit terms, which, they argue, acts to squeeze them unfairly from the market. We asked for further detail on this claim and were given the following response by one supplier. It told us that in the early summer of 2004, it had received an offer to provide week-ahead purchases of half hourly load shape to a typical value of £20,000 to £60,000 from the trading arm of a major integrated supplier. This offer incorporated the following terms:

• an £8,000 per month facilitation fee payable for maintaining the

relationship (i.e. whether or not any business is transacted between the two parties);

• a cash deposit, depending on mark to market values, initially proposed at £300,000; and

The supplier told us that, in order to transact in the business electricity market, it believed an operator needed to have a working capital facility (covering industry credit, agent commissions and short-term wholesale trading) of at least two and a half times the monthly turnover of that account, assuming no serious issues with the customer. In its opinion, the typical half hourly customer will not break even in cash terms for at least 18 months, whilst in the non half hourly sector, it might expect to break even in cash terms in just under a year. Moreover, this situation leads it to the conclusion that, whichever sector a stand alone power supplier operates in, in order to grow it needs more and more working capital because the business at any one time will not be cash generative. This creates, in turn, an incentive to chase the large market where profits are slimmest, but turnover is greatest, to secure cash. Therefore, in its opinion, the key determinant of the competitive

electricity market is the financial strength of the main players rather than innovation and service.

For these reasons, this particular operator expects minimal new entry and the exit of most remaining independent electricity and gas suppliers. It concludes with the opinion that the integrated suppliers are using their terms of trade (including rules on the credit status of those with whom they will trade) as a key tool in maintaining their positions, whilst talking up the need to protect themselves from the possible failure of other larger suppliers. The failure of a small supplier would probably have minimal impact on them, yet these operators must post cash security while their integrated rivals can use posted letters of credit, backed by credit ratings drawn from strong positions in capital intensive activities like generation and distribution.

Smaller and independent suppliers also expressed concerns about the increasing stickiness of the customer transfer process. Following a change in the electricity Master Registration Agreement, suppliers can now object to a customer leaving if it has an outstanding debt of more than 28 days. One operator told us that this change had seen the rate of objections to transfer increase from around one in ten to three in ten, and that it had employed a new team to help resolve these issues. It contended that it believed certain suppliers were routinely objecting to all transfers regardless of whether a legitimate reason to object was put forward. Subsequent contact with other suppliers from both this and other backgrounds yielded some common names of operators alleged to be acting like this.

Smaller suppliers also complained about the service they obtained from agents in the ‘supplier hub’ process, particularly meter readers serving the non-half hourly (NHH) sector. They claim poor performance directly inhibits their ability to bill and serve their customers properly. One supplier, which targets the non half hourly market, informed us that it had data issues for 25% of new customers and 10% of its existing portfolio of customers. Another told us that it was able to bill around 88% of its NHH accounts on actual annual read data against a meter reading performance threshold of 97%. It claimed that only one meter reading agent was achieving this level at the present time.

In some regions, it claims performance is worsening. It told us that it typically uses the successor business to the local electricity supply company’s metering business for NHH meter reading services. Small suppliers claim they suffer from worse performance than their larger rivals. A key member of a relevant industry work group acknowledged this as “the biggest open secret in the industry” and pointed out that the major suppliers would be the largest customers of the agents and, therefore, it might not be surprising that they concentrate on them as opposed to smaller suppliers. In one instance, the successor business has indicated the intention of withdrawing access to the services of its metering provider to other suppliers.

The issue of regulatory change is also one that was raised by operators from this background. A consistent claim of a lack of resource to keep up with industry changes was the main argument made, with the inference being that there are too many, and some are of questionable benefit. One supplier told us that it would have objected to some BSC modifications had it been aware of their full implications. It also claimed that the practice of

rebalancing transmission charges (both the PLUGS change of April 2004 and the expected BETTA change of April 2005) puts unmanageable price risks into the market. It stated that the introduction of the PLUGS methodology to transmission use of system charges from 1 April 2004 had cost it the equivalent of one percent of its gross margin. If it is assumed that the

operating margin is typically five percent, this change alone would equate to one fifth of its gross profit. Another supplier told us that it believes there is a lack of understanding by the regulator on commercial issues. An example of this is the commercial impact of changes to the MRA which do not always seem to have been thought through. The right to object change noted above puts the onus on the new supplier to prove the intent to switch and,

effectively, acts as a deterrent to switching, in its opinion. 7.2.2.4. Larger and Integrated Suppliers

Reflecting their general view that overall the competitive market is working to the benefit of customers, the concerns expressed by larger

suppliers tended to reflect specific rather than general issues. We quote in full the response from one major integrated supplier.

“The gas and electricity markets are still strongly influenced by the thresholds and consumption levels used to introduce competition. These influence systems and processes, and act as pricing delineators for the natural monopoly providers. Against this scenario, it is unlikely that new suppliers entering the market would be able to constrain incumbent suppliers’ prices. System requirements necessary to participate in the energy supply markets, especially those required for electricity, are highly technical and complex. Its is, therefore, unlikely that a new entrant would be able to sustain unusually low prices long enough both to cover its start-up costs and be profitable.

The difference in market conditions between England and Wales, and Scotland also inhibits competitive dynamics, more particularly in the

electricity market. Key issues continue to include the extensive use of radio- tele-switched meters, the wide dispersal of customers and the purchase of power direct from competitors. The prevalence of dynamically radio-tele- switched meters, which are remotely switched by the distributor, reduces our ability to forecast usage for such sites and so lowers our ability to cost and price these sites. There are also some issues around having to buy power from our direct competitors at an administered cost. We have seen very aggressive win back pricing in-area from both the major Scottish competitors to an extent not seen in the domestic market. We look to these anomalies being addressed by BETTA with when it is introduced.”

We did receive a counterview on the nature of competition in Scotland from another major supplier. It told us that, in its opinion, balancing arrangements were more lenient in Scotland and trading systems were less complex, making it easier for rivals to compete than south of the border.

One supplier particularly made a point of bringing default tariffs to our attention. These are the arrangements which apply in the event that a