Energy markets in 2017
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How far have the energy markets
come for consumers in 2017?

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Necessity is the mother of invention.

The energy markets today are more dynamic and innovative than they have ever been – because they have to be.

The good news is that it is an exciting market to be part of, and the environment and consumers are benefitting.

But there are still obstacles to overcome.

How can an energy regulator make sure all consumers are protected in markets that are rapidly transforming in ways that may not be easily accessible to all consumers, and disadvantage some industry competitors? How do we ensure disengaged consumers get as much out of the markets as engaged ones do? How can we keep bills affordable, and supplies secure?

"The energy markets today are more dynamic and innovative than they have ever been – because they have to be.

These competing priorities pull us in many directions, but juggling them is what we as the energy regulator must do.

And if Ofgem can do this while laying the foundations for an even more dynamic and innovative future – one which gives consumers more power and control than ever – then we will have made a difference.

Here we give you a snapshot of what the markets look like at the moment, drawn from Ofgem's comprehensive report on the State of the Energy Market in 2017. It covers the core areas of competition, affordability and vulnerability, decarbonisation, and security of supply in Great Britain.

Joe Perkins
Ofgem Chief Economist

Competition

Is it working?

For some.

If you’re a switched-on consumer, able and willing to seek out good deals, competition will help you reduce the cost of your energy. It’s brought down prices for those on fixed-term tariffs, and made it easier for new suppliers to enter and offer attractive, innovative deals.

But if you’re less active, and maybe on a standard variable tariff (SVT), it’s a different story.

60% of people – around 14 million customers – are on non price-protected variable tariffs, and are typically paying about £300 more for their energy than customers on the cheapest fixed-term tariffs. Suppliers earn more from inactive consumers who stay on SVTs.

It’s that simple.

Suppliers rely on these higher (SVT) prices to cover a greater proportion of their operating costs and profits than from fixed tariffs.

For consumers on SVTs, 26% of the money they paid covered operating costs and profits. For consumers on fixed tariffs, it was only 14%. We estimate that if variable tariffs were reduced to a similar level, then suppliers would have made a loss unless they could cut their costs.

Bills

In 2016, customers of the six big suppliers paid £1,123 on average for gas and electricity, £214 less in real terms than in 2013 when dual fuel bills last peaked – although the six largest suppliers raised their SVT prices in 2017.

Domestic and non-domestic consumers spend around £50bn on gas and electricity each year. This varies by the amount consumed, and the price of energy – but since 2005 consumption has fallen. Prices have increased since then, so bills overall have effectively stayed stable.

Four main things make up energy bills: wholesale costs (the amount suppliers pay for gas and electricity), network costs (the costs of building, maintaining and operating the transmission and distribution networks), environmental and social costs (costs of government policies to meet environmental and social objectives), and other direct costs such as admin.

Why wholesale costs are important

As wholesale costs make up the largest part of a bill, it’s important that wholesale energy markets function well and competitively. Currently, competition is working reasonably well, particularly in the gas market.

The gas and electricity wholesale markets are diverse with a good degree of new entry, firms have little market power (i.e. no single firm has the ability to undermine competition), and vertical integration (the presence of a supplier that also generates the energy they sell to consumers) isn’t a risk to competition. 

The UK’s fuel sources include coal, nuclear, wind, solar, oil, hydro, bioenergy, gas, pumped storage, and imports via interconnectors. A diverse mix is vital for keeping supplies secure.

Profits of the biggest six energy suppliers

Supplier pre-tax profit margins make up 5% of consumer bills.

We can’t say whether profits are excessive, but we can look at profit margins and costs to judge whether competition is working.

In 2016, the biggest six suppliers made £1bn profit before tax. This has fallen from a peak of £1.2bn in 2012 and has been relatively stable since. Profits averaged at £54 per dual fuel customer.

The biggest six suppliers were not equally profitable. British Gas, E.ON, SSE, and ScottishPower made similar and significant profits (7.2%, 7.0%, 6.9% and 5.2% respectively), but EDF and npower made losses (-0.9% and -6.3%).

If competition is working well and without innovation in services, we would expect that over time, profit margins would decline, and costs would be pushed towards their efficient level.

We find that the six largest suppliers (as a combined group) have maintained healthy profit margins since 2012, despite losing customers to competitors. However, the suppliers with high costs have made losses in that period, which suggests some competitive constraint on how much they can charge consumers.

Market shares and new entrants

The landscape of the retail market has changed dramatically in a very short space of time.

There are 60 suppliers in the market today. The six largest suppliers who have traditionally dominated it have seen their market shares shrink.

They still make up just over 80% of the domestic retail market, but have lost over 4% market share in the past year. Since June 2012, the biggest suppliers have lost 2.1 million and 4.3 million meter points in gas and electricity respectively, reducing their market share by around 17% for both fuels.

“The six largest suppliers who have traditionally dominated the market have seen their market shares shrink dramatically in a short space of time.

Switching

Switching rates also give us a good idea of whether the market is working well enough to facilitate competition.

If switching is easy and quick, it will make competition more vigorous. In 2016, 16% of domestic gas and electricity customer accounts changed supplier – the highest switching rate since 2011.

But the current switching systems were developed in the late 1990s. They’re complex for suppliers and can lead to delays, errors and costs, which are often borne by consumers.

Switching isn’t the only way consumers are engaging more with their supplier. Many say they feel more confident in making complaints, understanding their bill, comparing tariffs, and deciding who to switch to.

These are important indications that consumers are feeling bolder in dealing with their energy and getting a good deal.

But there is still a big proportion of domestic consumers who remain inactive. Some have never switched, or have only done it once. These consumers often say they are satisfied with their supplier, or think switching will be a hassle, and one that they won’t benefit from. Many consumers are worried that they won’t save as much money from switching as they’d been led to believe, and saving money is usually the main motivation.

Switching is a major focus for Ofgem. The ability of customers to ‘vote with their feet’ helps individuals to get a better deal and drives up standards across industry.

We’re trialling radical new measures to encourage more people to shop around. Behind the scenes, we’re overhauling the system to make switching quicker and easier, working with industry to put a central registration system in place and setting targets for faster switching by 2020.

Switching for small business consumers

The non-domestic market paints a different picture. Half of small businesses that had not switched said that they couldn’t because they were tied to their current contract, or that they would be charged a fee for leaving.

To help make competition work for non-domestic consumers, the CMA ordered suppliers to stop locking firms into automatic rollover contracts from June 2017. This means that suppliers are no longer able to charge exit fees or to include no-exit clauses in automatic rollovers. Customers can now give termination notice at any time.

In 2016, more than a quarter of businesses believed that it was too complex or time-consuming to find a new tariff or supplier, and ultimately not worth their while.

Trust in energy

Domestic and non-domestic consumers still don’t trust the energy industry. Compared to other sectors, the major energy firms are rated towards the bottom of Which?’s annual satisfaction survey. But the survey shows that trust has increased slightly since 2014, which is a sign of improved competition.

Affordability
and vulnerability

Protecting vulnerable consumers is a major priority for Ofgem.

It’s a paradox that those who can afford their bills are more likely to get good deals anyway.

It’s the people who can’t easily shop around, and who don’t get offered attractive deals who end up worse off.

In the past, elderly consumers were more likely to be fuel poor than the average consumer. But, in England, the demographics of fuel poverty are changing. Fuel poverty is increasingly affecting children and young people, while older consumers are now the least likely to be fuel poor.

The rates of fuel poverty in the UK nations are calculated differently, so cannot be compared with one another. Here's what the latest available data from each shows:

Fuel poverty in England

In England, a household is fuel poor if it has above-average energy needs, and if it were to spend the amount needed to fully meet these needs, it would be left with income below the official poverty line.

In 2015 – the latest year with available data – 2.5 million households in England were living in fuel poverty. This is 11% of consumers. Although the fuel poverty rate has remained roughly stable since 2003, people in fuel poverty are in much greater need than 10 years ago, because their bills are higher.

In 2015, the average fuel poverty gap – the amount by which a consumer’s energy needs would need to be reduced in order for them not to be fuel poor – was £353, which is 39% higher than in 2005, in real terms. Over the same period, the average energy bill increased by 27%.

Households with children under 16 have had consistently high rates of fuel poverty and the proportion has risen.

Over a quarter of young people that live independently are in fuel poverty. These differences may be related to lower incomes and the higher rate of private rental among these households, which is associated with substantially higher fuel poverty.

Older consumers are now the least likely group of consumers to suffer fuel poverty (7.1% in 2015, having reduced significantly from 12.7% in 2003, when they were one of the groups most likely to be fuel poor). This reduction reflects increases in financial support given to pensioners, in particular the Warm Home Discount and Winter Fuel Payments.

Fuel poverty in Scotland and Wales

Although their methodology is different, in Scotland and Wales households are said to be in fuel poverty if they spend more than 10% of their income to be comfortably warm.

In Scotland in 2015, 30.7% of households were in fuel poverty (a reduction of four percentage points since 2014), and 8.3% in extreme fuel poverty (a reduction of one percentage point). Older households are the most likely to be fuel poor.

Forty-five percent of older households are in fuel poverty, compared to 16% of families and 29% of other households. This is because on average they tend to have lower incomes, larger houses, and often need more heating.

In Wales, 23% of households are in fuel poverty in 2016, a reduction of six percentage points since 2012. Severe fuel poverty fell from 5% to 3% over the same period. Fuel poverty in households considered vulnerable is slightly higher, at 24%. For customers in social housing, the rate of fuel poverty is even higher again, estimated at 27% in 2016, having reduced from 33% in 2012.

Fuel poverty is changing dramatically – in 2017 children and young people are increasingly affected.

Photograph of a young male and female sitting on a sofa looking concerned at a letter Photograph of a young male and female sitting on a sofa looking concerned at a letter

Vulnerable people

There are many reasons people become vulnerable. Some of those are long-lasting, such as being poor, being mentally or physically ill, or disabled. But others are temporary, such as becoming unemployed, or being bereaved.

People can be vulnerable in multiple ways, and these can worsen their situation.

For example, if someone already has mental health problems, not being able to heat their home – or being worried about paying their bills – will cause their mental health problem to worsen.

Vulnerable consumers are less likely to engage in the energy market

Nearly half of consumers from lower social grades (D or E) and 39% of consumers earning less than £16,000 have never switched, compared to under one-third of other customers.

These groups are also more likely to never use the internet or to use it less frequently, so it’s harder for them to shop around. Internet access is key to comparing tariffs and accessing lower prices: 55% of customers who switched supplier found deals through a price comparison website. In addition, the cheapest direct debit tariff available if the account is managed completely online is around £100 cheaper than if the customer receives paper statements. 

Prices and vulnerability

Changes in energy prices affect consumers on low incomes most. In 2015, the 10% of households with the lowest disposable incomes spent 10% of their household expenditure on energy, but households with the highest incomes only spent 3%. 

Here are the types of consumers who are mainly affected, because for one reason or another they can’t access the cheapest deals in the market:

Support for vulnerable consumers

There is help available to vulnerable consumers, but it only reaches a small proportion of those who need it.

For instance, between 2011 and 2017 Citizens Advice helped 60,000 customers in or at risk of fuel poverty on engaging with the energy market, and trained frontline workers and volunteers who support an additional half a million customers.

Government directs most vulnerability support to pensioners. In winter 2016-17, Winter Fuel Payments paid £2bn to 12 million individual pensioners. In winter 2015-16 (based on the latest available data), the Warm Home Discount redistributed £325 million from billpayers to 2.2 million vulnerable consumers, many of whom were low-income pensioners.

The financial impact of this support is considerable. A low-income pensioner on Pension Credit could receive £340 or £440. For those in the lowest income decile, £340 reduces their bills from 10.8% of their expenditure to 7.5%. A low-income pensioner that receives financial support and switches their tariff would reduce their bill further.

The Fuel Poor Network Extension Scheme supports fuel poor households by helping towards the costs of connection to the gas network. At March 2017, this had connected 96,000 eligible households since April 2007.

Using less energy: 'efficiency' vs 'rationing'

Consumers are using less energy.

In 2016, electricity consumption for the average household was 3.9 MWh, 21% less than in 2006. For gas, the average household consumed 13.8 MWh, 20% less than in 2006.

We estimate that for an individual still consuming energy at 2006 levels, their bill in 2016 would have been £284 higher than the average bill in 2016 (i.e. if their consumption remained at the average 2006 level, their electricity and gas bills would be £145 and £139 higher respectively).

Low-income households in particular have reduced their consumption more than households with higher incomes. Households earning below £30,000 reduced their gas consumption by 35% between 2005 and 2015. Households earning over £50,000 reduced their gas consumption by 30% or less.

"Lower consumption can reflect better energy efficiency, but for vulnerable consumers it can be a concerning sign of energy rationing.

But for vulnerable consumers in particular, it can be a sign of energy rationing, which is a concern.

Living in a cold home is likely to create health problems, particularly for young children, older people, and those with existing health conditions. The NHS spends substantial amounts treating preventable cold-related illness.

Better energy efficiency

The typical home has become more energy efficient over the past decade, and is using less energy. Between 2005 and 2015, the energy and environmental performance of UK households has improved considerably. This is mainly being driven by better insulation, more efficient boilers and electrical products.

Government helps some households invest in energy efficiency improvements. In particular, some of its support programmes target low-income households, who cannot do this with their own money.

What Ofgem is doing to address vulnerability

We’re committed to creating a fairer, more competitive market for vulnerable consumers. This includes:

    Decarbonisation

    Are we making good progress?

    In the short term, yes.

    In 2016, the UK emitted 467 megatonnes of greenhouse gases, a 42% reduction since 1990.

    The government tracks its progress on reducing emissions against carbon budgets. and is on course to meet the first three of these (2008-2022).

    But the Committee on Climate Change says that we will fail to meet budgets beyond 2022 without:

    • an additional 100 TWh of low-carbon power stations
    • carbon capture and storage
    • high take-up of electric and low emission vehicles
    • increased energy efficiency and low-carbon heating.

    Emissions come from across all sectors of the economy. In 2016, the largest four sectors for emissions were:

    • transport (26%)
    • industry (22%)
    • heating for buildings (19%)
    • electricity generation (17%).

    Since the Climate Change Act 2008, over half of the reduction in overall emissions comes from generating cleaner electricity. Subsidies combined with reductions in development costs have grown renewables to 25% of electricity generation. However, progress in reducing emissions from heat and transport has been slower.

    Carbon intensity has fallen steeply since 2012. This is because carbon prices now make coal unprofitable. Last year, UK power stations were charged £22 per tonne of carbon dioxide they emitted and the contribution of coal-fuelled power stations was 9% of our electricity generation in 2016. In 2012, coal supplied 40%.

    Low-carbon sources of electricity generation now contribute 45% of supply (before imports). Nuclear power provides 20% of our electricity needs. In 2016, renewables provided another 25%. The UK aims for renewable sources to meet 30% of its electricity demand by 2020.

    The cost of decarbonisation

    The government has committed to removing coal from the UK’s energy mix by 2025.

    So far, renewable sources of electricity have needed financial support on top of the money they receive on the wholesale market (including carbon prices). In 2016, consumers spent £7.4 billion subsidising renewable generators.

    Low carbon generation in the UK has not been provided at the lowest-possible cost to consumers. Reasons for this includes the government prioritising less-established technologies and issuing Contracts for Difference – a scheme incentivising low-carbon generation by providing certainty of revenues for investors – without competition.

    Heating

    Heating from renewables

    The government aimed for 12% of heating to be supplied from renewable sources by 2020. In 2016, only 4% of heating came from low-carbon sources.

    The Renewable Heat Incentive has helped over 55 thousand domestic consumers and non-domestic consumers install 4.3 GW of renewable heating sources since 2011.

    Heating buildings

    So far, reducing emissions from buildings has relied on energy efficiency improvements. In 2016, heating buildings emitted 89 megatonnes of greenhouse gas, 15% less than in 1990, despite the UK population growing by 8.4 million over the same period.

    But improving efficiency has made slow progress, and heating buildings released 9% more emissions in 2016 than in 2014. Fewer homes are having insulation installed.

    Transport

    As the carbon intensity of electricity falls, it offers a way to reduce emissions from the most polluting sector in 2016. In 2016, the transport sector emitted 121 megatonnes of greenhouse gas, similar to 1990 levels, but 3% more than in 2013.

    At the moment, not many people have electric vehicles. But this will change. In 2017, 106,000 electric vehicles are on the road, nearly triple the number registered in 2005. The current impact on overall demand for electricity and emissions is negligible. It is highly uncertain what impact electric vehicles will have on overall and peak demand in the future, dependent on factors such as policy choices, technological development, and the success of smart charging arrangements.

    The electricity system needs to adapt

    Decarbonisation is changing how we generate power in three important respects:

    • Increasing the proportion of power generated by ‘intermittent’ sources: generators that do not control when they produce electricity. In 2016, wind and solar produced 15% of our power.
    • Reducing the contribution of some forms of ‘flexible’ capacity: for instance a fall in the contribution of coal-fuelled power stations from 40% of supply in 2012, to 9% in 2016.
    • Increasing the amount of embedded generation: power sources that do not provide electricity to the transmission network. In 2016, embedded wind and solar generators supplied 19 TWh of electricity (6% of the UK’s power demand). But across the year their contribution varied.

    Adapting to these changes affordably needs the energy system to be more flexible.

    • Flexible generation: Flexible generators can provide abundant power quickly when intermittent power in unavailable, and switch off easily and affordably when it is not required.
    • Flexible demand: instead of shifting supply to match demand, consumers could shift their demand in response to rises and falls in supply. ‘Time of use’ tariffs would charge consumers more in peak periods, and less in periods of low demand to prevent strain on the system.
    • Storage and interconnectors: Storage allows electricity to be moved to periods in time with scarcer supplies. Interconnectors allow us to move electricity to a location with scarcer supplies. Both reduce the need for supply and demand to match in specific periods and locations.

    What Ofgem is doing to help decarbonise energy supplies

    We’re working with the Department for Business, Energy & Industrial Strategy (BEIS) to encourage flexibility, helping to integrate low-carbon generation at the least cost.

    Our work includes:

    • creating new roles for industry parties by: 
      - supporting more large industrial and commercial customers to participate in providing flexibility.
      - encouraging distribution network operators to make more efficient use of new technologies and providers, and work together to deliver the best outcome for the whole system.
    • working to remove barriers for new business models by clarifying:
      - the role of aggregators in markets.
      - the legal and commercial status of storage.

    Security
    of supply

    Will the lights stay on?

    Great Britain has kept energy supplies secure without substantial intervention to balance supply and demand.

    Keeping the lights on requires the energy system to be working well, reliably, and to be resilient to demand and supply shocks.

    Our gas supplies are diverse. In 2016 our gas infrastructure was able to deliver 600m cubic metres per day, compared with actual peak demand of 372m cubic metres per day. If this isn’t enough for whatever reason, National Grid can take emergency measures to maintain demand and supply.

    National Grid is confident there is enough supply capacity to meet peak demand, even if there is a major infrastructure outage or interruptions to supply from a major source. It expects gas demand to fall in the long term, driven by reductions in use of gas to generate electricity and heat homes, as alternatives become cheaper, and more reliable.

    The margin between peak electricity demand and available supply has generally been falling since 2010. Great Britain had over 100 GW of installed capacity in 2016-17, compared to an estimated peak winter demand of about 60 GW. But not all of that capacity is available at any given moment. About 30 GW comes from solar and wind, which are intermittent – providing power only when the wind blows or sun shines. Government has introduced the Capacity Market from this winter in order to try to ensure that generation capacity remains adequate.

    Ensuring value for money for consumers

    In 2013, government set a standard of reliability which balances the value of security to consumers with its cost. Over a number of years, the standard requires that on average the number of hours of intervention – when National Grid employs additional activities to balance supply and demand beyond those provided by the normal operation of the market – is around three. From 2005 to today, we’ve seen an average of one hour of such intervention per year.

    The costs of balancing the system have increased, and in 2016-17 were at their highest level since at least 2011-12. National Grid is taking several actions, encouraged by Ofgem, to ensure consumers get value for money from investments in secure supply, including:

    • Improving demand forecasts: National Grid’s demand forecasts underpin the assessment of how much the Capacity Market should procure. Its one-year ahead forecasts of peak demand on the transmission system have been on average about 1.5 GW above out-turns since 2010/11. We have placed incentives and obligations on National Grid to improve its forecasts, and have introduced an obligation requiring National Grid to explain what it is doing to improve its demand forecasting. This should help to place downward pressure on cost.
    • Increasing competition: National Grid is rationalising the products it uses to balance the system to try to ensure they best serve consumer interests – and to allow more effective competition among different technologies and approaches.

    The complete Ofgem report – The State of the Energy Market 2017 – is available to download from the Ofgem website.

    For more energy insights and data visit the Ofgem Data Portal and the Ofgem blog, or please subscribe for updates.

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