Jonathan Brearley's speech at the Institute for Government
Press release
Dyddiad cyhoeddi
Sector diwydiant
Supply and Retail Market
Introduction
Thank you, Hannah. I have spent a lot of time here talking about government policy over the years, so it’s great to be back.
Today I’d like to talk about the future of our energy system: where we are, what lessons we have learned from the gas crisis, and what we need to do to shape the energy system of the future that we need to see.
So let me start with where we are today.
First, as always, I think we should acknowledge how difficult it is for many, many households and businesses, to pay for the energy they need.
Our data shows that, from April, households on a median disposable income will spend 10% of that on their energy bills, and those relying on the state pension will spend 29% - that is a truly extraordinary amount of our household budgets.
I speak to customers regularly, and even with the Energy Price Guarantee and Energy Bills Discount Scheme, I know that the scale of the challenge for many people out there remains enormous.
For example, a few months ago I spoke to a lady who has a chronic condition. That condition often leaves her in pain if it is cold, yet she often has to rely on a hot drink or a blanket because she cannot afford to heat even one room.
I have also spoken to people who prefer to be in hospital rather than at home, because it least in hospital they know they have access to the energy and the food that they need.
We also consult regularly with business member groups to hear about the challenges they face.
For example, recently we heard from a group of theatres whose long-stand utility contract ended last October. Their new forecast, before government support, was of a roughly 450% rise in their electricity bill and rise 725% for their gas bill. And when they tried to find alternative quotes, it was difficult to do so for a whole range of issues, including a very different perception of credit risk.
Now sadly, these stories are all too common across Britain today.
So as the energy regulator, alongside government, and the industry, it is our responsibility to doing everything we can to support consumers and businesses through this very difficult period.
Security of supply
At the same time, at the start of Winter, we worked hard with industry, Government and National Grid on risks to security of supply, driven by the gas crisis, and we prepared for a wide range of scenarios.
From where we stand today, some of the strategic risks we saw a few months ago look to have eased.
Mild weather, replenished gas stores across Europe and East Asia, and more benign conditions for energy trading – particularly an improved outlook electricity output from France’s nuclear fleet – have contributed to a challenging, but more robust energy security position through the rest of Winter. However, as today’s events show, and the fact that we are asking for demand response shows that we need to remain vigilant and cautious about what may happen in the future.
We are vigilant, the system is getting more robust, but some risks still remain.
Now these conditions have been matched with successful plans across Europe to reduce demand and, as you would expect, adjustments made by all consumers in response to the extraordinary prices that we see.
Now overall, this situation has been reflected in a fall in gas prices that, over time, which we do expect will feed into customer bills.
However, the situation remains tough, with prices still around 3 times higher than historic averages.
And while we are a long way from some of the more shocking predictions we saw a few months ago, prices are unlikely to go back to the levels we saw pre pandemic.
We cannot predict the future, and we must continue to be vigilant and prepared for a world where prices are high and are volatile.
So Ofgem, National Grid, and stakeholders across government, will continue to work closely together to mitigate risks and prepare for all scenarios.
So in summary, things are better than we feared and are improving, but the challenges and difficulties for customers and for the industry are likely to be around for some time.
Learning from the crisis
Now as you can imagine, I have been reflecting hard on what this gas crisis means for the situation in Britain and how we want to change our energy system. There is a great deal for all of us to learn in the energy sector. The industry, government, charities who support customers, and indeed the regulator.
I would like to focus today on what I see as the two principal lessons, and how we might address them in the years to come.
First and foremost, we should recognise that the thing that affects customers the most, and puts us most at a disadvantage as a country, is reliance on international gas markets that, bluntly, have been manipulated by an aggressive state.
Ultimately, we need to recognise that geopolitics is playing a stronger hand in this country’s energy decisions than we had planned for, or would like it to.
My view is that we should move as rapidly as possible away from a system highly dependent on international gas, but also move away from our current market, which means that gas affects almost all of our energy use.
Simply put, we need to transition towards more homegrown, secure, and renewable sources of energy supply, and design an electricity market that allows us to benefit from that transition.
This will mean:
- A rapid and well-planned transformation of our energy generation, and the pipes and wires that support it, and:
- A redesigned market that enables that those who are able, to be rewarded for moving their energy to times when it will be cheapest – typically late at night or when renewables are producing through the wind and the sun, while also of course protecting our vulnerable customers.
The second lesson is that we need fundamental change in our retail business model and the policy and regulation that sits behind it.
This is because, as I have said, we need to assume that price volatility will continue in the coming years, and as we move through the energy transition we need companies need to be able to create clear offers to customers to encourage us to use our energy differently. This can only be achieved by well capitalised and reasonably profitable companies.
Infrastructure
Let’s start with the build out of the infrastructure that we need.
To move away from our dependence on the international gas market and build the secure, decarbonised energy system that we need as rapidly as possible, and to meet the government’s target to achieve a net zero power system by 2035 and reach net zero by 2050, we will need to build new energy infrastructure at a pace not seen for decades.
When you look at our history, the period immediately after the Second World War most closely resembles the pace and scale at which we will need to build.
From 1950 to 1970, Great Britain’s electricity generation capacity expanded around 4 fold.
Since then, the system has been largely stable in terms of our networks, and regulation has been designed to maintain that system and drive efficiency in its maintenance and in the incremental build that has been needed.
But to meet the scale of future energy demand between now and 2050, we will again need to build out our infrastructure – onshore, offshore, and connections to other countries – at an extraordinary pace, not seen for over half a century.
A huge challenge, but also an economic opportunity – as the recent Skidmore Review rightly emphasised – for business and investment that will cost us more if we delay.
But to do that, we need a different approach.
In particular, we need a holistic assessment of our evolving energy needs, how best to fulfil them, and a holistic plan for the network that will be needed – both nationally and likely regionally.
The creation of the Future System Operator is designed to do just this. Its role should be wide ranging and, within the objectives set by government, it should have the authority to design that strategic plan of the infrastructure needed.
Our role, as Ofgem, should retreat a little, and we should focus on ensuring that infrastructure, once planned, is delivered as efficiently as possible – either through our regulation or through competitive tenders.
At a regional level, it is likely that the system operator will need to do the same and, to start, proactively set the planning parameters for local network companies as they build their own more detailed plans.
With that plan in place, I believe we can vastly increase the pace of investment and the pace of our infrastructure build.
Indeed, we have already shown how this approach will work, and why this approach will work.
In December, Ofgem launched the Accelerated Strategic Transmission Investment. This is around £20 billion of new investment in our transmission network – the major wires that carry our electricity across the country.
This was largely based on the design laid out by the nascent system operator in advance – targeting the connection of the 50GW of offshore wind we expect to be built by 2030.
In short, what in business as usual might have taken Ofgem years to approve, took a matter of months, once we had the confidence that these proposals were laid out in a well-researched, well-evidenced, holistic assessment of Britain’s needs.
Critical to this approach, is anticipating generation, so the grid is ready when the generation is ready to connect as opposed to the prior, much more incremental approach.
Overall, this will reduce time to deliver those large transmission projects by between two and three years.
Of course, that time saved depends on accelerated planning and environmental consents, and we expect network companies to play their part to plan and deliver these projects on time – and they are incentivised to do so.
The next generation of system planning will need to look at net zero targets for 2035 and 2050 more widely, and encompass investment across the electricity and gas grids, including the planning for hydrogen infrastructure.
And ultimately, we will need to plan regionally, heavily involving local leaders, as well as creating a national plan.
So we are reviewing the institutional framework to set a clear vision for local governance arrangements…
… looking at similar model to the Future System Operator at regional and local level to deliver a more joined up approach…
…as well as examining the wider roles of markets and institutions at a local level to achieve net zero at lowest cost.
Reform of the wholesale market
Now, we can change the institutions, but we also need to change the market. So moving on to the reform of the wholesale market.
Alongside this, working with government we are considering reforms to the electricity wholesale market, in particular how to break the link between the price of gas and the price of electricity.
In a large measure, the best way to achieve this is to move as quickly as possible from fossil-fuelled power to renewables and low carbon sources of generation, weakening this link over time.
However, the gas price crisis revealed that in the short term, consumers may not be getting the full benefit of the existing renewable and low carbon plant.
One option is to move all renewable plant on to the existing contracts for difference regime, which would stop this happening and give consumers access to lower electricity prices.
Equally, we need a market that that reflects the benefits of using electricity when demand is low and supply is highest, and one that takes into account different locational differences.
This is a complex area. As Hannah mentioned, I led the Electricity Market Reform – and I genuinely know the challenges in changing our energy markets.
I also accept that the design challenges today are even greater than those we faced in 2010 when we launched Electricity Market Reform.
However, this must be done.
If not, at best we will transform to a better energy system, but one that is more expensive than it needs to be, but at worst we will not make the changes needed and face greater cost and security of supply consequences.
Alongside this work, we are looking into ways of tackling grid congestion. This includes considering incremental reforms to the existing mechanism for balancing the demand, to more radical measures that split the wholesale market, so that prices vary across the country depending on the local demand and supply conditions.
Retail market reform
And finally, moving on to retail market reform.
In a world where our energy generation is rapidly decarbonising – with a major acceleration of renewables, nuclear power, and wider local carbon electricity storage solutions, we also need to make new arrangements to fundamentally reshape our retail market – both to manage volatility we see today, but also to manage volatility we might see in the future.
To shape this new market, we know that the regulatory and legislative framework around our retail market, as well as its structure, might need to change.
For me, this principally means three things in the medium term:
First, building a market of financially robust, well capitalised companies, able to invest and partner with those bringing new smarter innovations into the market. And that does mean a market where profit are reasonable.
Second, a retail market that treats its customers fairly and reasonably.
And third, a changed approach to pricing regulation.
In the long term, we will all need to work towards retailers who are sufficiently dynamic and innovative to deliver to customers the opportunity to lower bills by changing the way they use their energy.
Financial regulation
So let me begin with financial regulation, and ensuring companies are financially robust.
The gas crisis exposed several problems with the preceding retail market model – particularly the large number of supplier failures which occurred at the end of 2021 and early 2022.
We carried out a number of actions in response to this – with financial stress tests, strengthening of monitoring and oversight of suppliers, strengthening the market entry process, and extensive use of our compliance and enforcement powers.
And despite the more difficult conditions this winter, the sector is clearly now in a better place than in 2021, with no major failures to date.
We’ve also learnt a number of lessons, highlighted by the Oxera report and recent parliamentary reports.
To ensure the sector is resilient enough to withstand future shocks, we have laid out a series of proposals to strength retail companies’ resilience and put the measures we need to have in place to ensure it happens. And I do need to emphasise that once we have got through this winter, there is more we need to do to recapitalise this sector.
We have set out short term financial controls, such as the ringfencing of Renewable Obligations receipts from 1 April, while also setting a clear trajectory to longer term goals, such as increasing minimum capital buffers for suppliers to reduce the risk of exit, and rolling out a new monitoring framework to ensure suppliers’ liabilities can be met.
This approach is ensuring we can increase resilience while still maintaining a successful, competitive, dynamic and innovative market, producing different kinds of services.
Now, I recognise there is a balance to be struck here.
We do not want to create a cosy market where inefficient incumbents are not challenged, where innovation is stifled – particularly when change is needed in the way retailers work.
But equally, we need to ensure new entrants are properly capitalised, can cope with volatility and the pace of change we need to see, and do not unnecessarily exit the market.
For example, we believe that concerns relating to reliance on customer credit balances can be addressed by strengthening rules around how suppliers can set Direct Debits to prevent those excessive credit balances building up, while preventing unnecessary costs falling back again on customers.
For those suppliers who are using customer money irresponsibly, we will take powers to ringfence those deposits and if necessary prevent further growth or dividends to shareholders for that company.
I recognise these measures are controversial.
A regulator should never try to, and indeed never can please everyone, and this is especially true when suppliers have different very different business models today, where some will benefit from our changes, and some won’t.
We have had criticism from some suppliers have said we are going too far too quickly, while others complain we are not going far enough. Sometimes those criticisms come at us on the same day. Now there’s an informal intuition in any policy and regulation, that when you’re in that situation, you may well have got things right.
Of course, we now have the hard job of calibrating these regulations. We need to move fast enough to improve the capitalisation of retailers, but with reasonable plans for transition for companies to make the necessary changes.
Ultimately, we have a responsibility to ensure the retail market is as robust as it can be: with both incumbents and new entrants, who are better capitalised and resilient, able to offer a wider range of smart, easy-to-use products and services both for consumers and for businesses.
It is my view, that by moving the retail market to be better capitalised, and by tackling unsustainable business models, we will make the market more attractive for new innovation and investment, not less.
Behavioural regulation
I’d now like to turn to how suppliers treat their customers.
It is vitally important consumer interests are protected and suppliers do not use the gas crisis as excuse for poor behaviours and sharp practices.
We have seen through our consumer research programme that customer satisfaction with their energy supplier has declined over the past few years, from 75% when we started tracking to 66% in Winter 2022.
So throughout these reforms, accepting the challenges the industry has faced, we need to ensure that for all of us, the interest of consumers remains the top priority.
We need to ensure all customers are dealt with fairly and reasonably, and to drive up standards – particularly in a market where the role of people switching between suppliers will not be playing the role perhaps Ofgem once hope it would.
To ensure this happens, we have moved from a largely reactive model of compliance – where we focused primarily on the worse behaviour after it happened, and then enforced…
To a proactive approach, where we assess suppliers on a range of performance measures systematically.
We are doing this through what we are glamorously calling Market Compliance Reviews…
A series of ‘deep dives’ into company behaviour, looking at issues like affordability and customer service; treatment for customers in vulnerable circumstances, and support for those with difficulty paying.
This is about focusing on suppliers’ policies, governance, and processes to ensure they are achieving good consumer outcomes. Where we have seen issues, we have already taken action.
For example, it is very important that consumers can trust that their direct debit is an accurate reflection of their consumption, and are given enough information to understand why they are paying the amount that they are.
So as part of our compliance review into direct debits, we requested all suppliers who increased a direct debit by more than 100% between February and April, look at these again.
This resulted in more than 900,000 customers having their direct debits reviewed, adjustments made for any miscalculations, including potential repayments, and consideration of whether goodwill payments were warranted.
These reviews are relatively new, and we will continue to work with the industry and consumer groups to improve their use. We will continue to repeat some of them to ensure progress continues to be made on issues that matter most to consumers, and adapt them to emerging issues as the need arises.
We have driven a different approach on compliance to support customers through our rules and to drive improvements, but as I will lay out there is far more still to do.
We have clear rules on the way vulnerable customers are treated – wrapped up by the principle that they should be treated fairly, and that those falling behind with payments should be put on affordable repayment plans.
We have strict criteria around mandating customers to move to pre-payment meters as a result of customer debt, making it clear to suppliers that if they do make these installations, they have an obligation to ensure that it is safe, reasonable, and only carried out as a last resort.
In September, we published a Market Compliance Review which assessed the sectors’ approach to customers who are unable to pay their bills.
We examined whether suppliers are proactively identifying customers in payment difficulty, whether repayment rates are being set according to ability to pay, and whether suppliers have appropriate support in place to support customers, such as providing appropriate access to emergency credit, and signposting to third party help.
In almost every case, we identified that suppliers needed improvement, with three companies in particular raising serious concerns.
On the back of this, we enforced against two companies and one paid compensation of £830,000 to customers and Ofgem’s consumer redress fund.
We also wrote to suppliers, clearly setting out their obligations to ensure customers in vulnerable situations are identified, proactively contacted, and provided additional support where appropriate.
We made it clear that suppliers are expected to always consider the ability to pay before escalating the debt recovery process, and that debt recovery actions are fair and proportionate.
However, as is clear from the recent Citizens Advice report and reflecting legitimate concerns raised this weekend by the Secretary of State, we will need to do more, focused on the way in which the suppliers are handling the mandation of pre-payment meters for customers who are unable to pay.
Ofgem has already heard directly of instances of customers being switched over to these meters without knowing this is being done, leading to households being cut off and left with no heating.
For example, during our review of how suppliers treat vulnerable customers, we heard directly from an elderly gentleman who thought he had had a power cut because he had not been told he had been switched over to a prepayment meter. This meant he spent days without light or heat, not knowing what was happening.
At any time, but particularly in this cold weather, this is obviously unacceptable.
That is why we have written to suppliers again today to remind them of their obligations and inform them that we are launching a rigorous market compliance review into self-disconnections, remote switching, and forced installations of prepayment meters.
This will assess how suppliers are complying with existing regulations and expose any unacceptable practice.
We welcome the industry’s positive engagement on this, and encourage suppliers to respond to the Secretary of State’s call for transparency on this issue.
Alongside this, we will shortly be commencing work looking at whether change is needed in the rules we set, or the guidance that accompanies it, particularly if we find a wide range in the way the current rules are being interpreted.
I do need to emphasise that poor supplier behaviour is far from universal. Many suppliers – including several represented here today – have been very active in improving their response and improving their processes.
I have sat with customer service agents myself while they deal what is, ultimately, a very difficult and complex situation.
For example, we welcome those suppliers who have put in place a voluntary pause on debt collection.
Now when customer service agents do talk to customers in distress, it is clearly a tough job for them. It is clearly a hard balance between protecting customers running up high debts, making sure they can recover the money for the energy needed, and dealing with what is usually a difficult set of circumstances for their customers.
But right now, ultimately it is incumbent on all of us as an industry to identify those customers, and do everything we can to support them.
Ofgem’s message to suppliers is crystal clear: now is the time to increase your efforts and do all that we can to look after vulnerable customers.
The rules are clear, but they are just a minimum standard – and we welcome you going further, voluntarily, as the Secretary of State has suggested.
Equally, we recognise that, despite the positive effects of the Energy Bills Discount Scheme, this is still an extremely difficult time for businesses.
To be clear, Ofgem’s remit is to protect the interests of all consumers – including businesses that rely on our industry.
We are aware of problems for some businesses getting fixed rate energy deals due to high prices, or requests for large deposits from their suppliers.
So we are working hard to increase our monitoring across the non-domestic market, carrying out a compliance review to investigate high prices for non-domestic customers, and a review of the obligations of suppliers in this area.
In the longer term, we are working with the Department for Business, Energy and Industrial Strategy on its broader retail market reforms, wholesale market review, and looking at regulatory options for third parties and brokers.
Pricing regulation and the price cap
I would like finally to turn to the way in which we regulate prices in energy.
The price cap was designed with good intentions.
It was targeted at the legitimate concerns that the industry had been, in effect, overcharging those of us who did not shop around and, equally, prevented a drive for greater efficiency amongst suppliers.
In a stable market, the price cap worked well.
However, the market today is far from stable, with forward prices for gas and power fluctuating by around 45-60% in the final quarter of last year alone.
As I said at the start, we do not know the future, but need a system that is robust in a wide range of scenarios.
The problem we face is this: an inflexible price cap, combined with a volatile market for buying energy, increases the financial risks that suppliers face.
This was most evident, when, with the price cap only changing every six months, the cost in the formula versus the market price at that time, were very different.
In October 2021 to March 2022, the assumed price for gas in the cap was the equivalent of 63p per therm, but the market price to buy gas was between around £1 and £5 per therm.
Now of course companies can hedge against the price cap expectations, and there is a methodology that is well known to do so. However, there will always be residual risk, which in a stable market is small, but in a volatile market can be much higher.
For example, supply that is unused in warm weather, and extra demand in cold weather, both present risks for suppliers even when they are well hedged.
Now with this system, this may mean, over time, that companies will need to hold more capital to manage these risks; ultimately that means increased costs, and increased costs for customers.
Now we have already changed the price cap, so that adapts more quickly, changing every three months.
On our current projections, although gas prices remain volatile, the price cap level may fall below the Energy Price Guarantee level in July, and possibly do so as early as April. This will save billions of pounds in the expected public spending on that measure.
And although highly uncertain, it is also possible that prices may well fall below this through the summer– which would be welcome news for all customers, both household and business.
But even with the reforms we have in place, there is a risk and therefore ultimately a cost that needs to be borne by customers.
In addition, to maintain stability in the market as a whole, we also need to maintain stability in a market which is volatile. Therefore we have had to introduce temporary measures, like the market stabilisation charge.
Frankly, this is something none of us would like to see in the market, but with the volatility we have witnessed, alongside a blunt price cap, it is needed to maintain market stability and protect customers from the unnecessary cost of unnecessary failures in the market.
As structured in legislation, the price cap therefore has costs as well as benefits for customers.
The government has already stated that it is reviewing the retail price regulation framework, and we welcome that.
It is my view that we should be exploring more flexible ways of achieving the aims of the price cap, and comparing the costs and benefits of these with the legislative framework we have today.
Accepting that the market has changed, there may well be a better, more flexible way to protect customers’ interests, and if it turns out that the benefits are higher than the costs, then we should actively pursue those options.
But we also need to think about affordability and vulnerable customers.
So returning to the situation of vulnerable customers, even with the welcome Energy Price Guarantee implemented by government and Ofgem, and the wider support in place for families, there are many households that cannot afford to pay their energy bills.
In simple terms, when their budget is assessed against their income, there is no room, necessarily, to pay current bills.
Now as described, we will be highly active, with companies, on how they treat customers who fall into arrears.
However, the root cause for some customers, despite the enormous, widespread support by government, is their inability to pay for their basic energy needs.
Therefore, we think that there is a case for examining, with urgency, a social tariff that limits the impact of extremely high prices and reduces volatility for a defined set of vulnerable groups.
To be clear, this tariff would need to be subsidised when prices are high and preferably paid for through funds raised in a progressive way.
There are a wide range of regulatory and policy options that could deliver this, and I recognise that there are trade-offs involved that are beyond a regulator’s power or vires to assess.
For example, defining the group who have access to a social tariff is hard, with inevitable cliff edges between different groups of people and any subsidy may well involve public spending, which is not a matter for the regulator.
This is why, ultimately, as with the strategy to tackle the wider affordability of energy, this is a matter for government, and we are working closely with them to explore the full range of options.
The Energy Price Guarantee has worked well in protecting all customers and, indeed limiting the impact of energy on inflation. But if prices do ease, there may well be a case for focussing any subsequent intervention on those who are most vulnerable.
Future retail models
The structure I have just outlined is what is needed in the medium term.
But, in the longer term, retailers will need to play a more fundamental role in decarbonisation and in the energy transition.
They will be on the front line of persuading customers to install the equipment needed to vary our energy use, where possible to match with times when demand is low and/ or supply is high.
This will mean providing access to new technology, products and services that allow consumers to offer flexibility, and to be rewarded for doing so.
And the pricing, behavioural, and financial regulation I have outlined will need to adapt over time to make sure the retail market is able to do this.
Not all of this is decided yet, and we will continue to consult with the government, industry, consumer groups and charities as we shape this approach.
And I should just advertise that we are currently consulting on our Future Work Programme for the coming year, which intends to do just that.
Conclusion
In conclusion, the gas crisis has strengthened the need for pace in changing our energy system to meet customer needs and to meet our low carbon goals.
Equally, to respond to the short term market conditions and more fundamental long term change, a dramatically different approach may be needed in our retail sector.
A short to do list can be summarised as follows:
Set up the Future System Operator for success by giving it the power to lead the industry and design an energy system that meets our national, regional, and local needs.
Reform the electricity wholesale market to break the link between the price of gas and electricity and ensure customers benefit.
Reform the retail market to make it more financially resilient, improve company behaviour, and drive up standards.
Reexamine our approach to price protection, perhaps through alternatives to the price cap, and move to a model when customers are rewarded for moving the time they use their energy. And finally:
Consider stronger price protection that limits the impact of extremely high prices for a defined set of vulnerable groups, such as through a social tariff.
I believe that if we follow these actions, we will have a robust path to a better, more secure and low carbon energy system that meets this country’s needs. Thank you.