State of the energy market 2017 REPORT State of the energy market report Foreword The energy sector is changing rapidly, with significant • Third, the dramatic progress to ensure potential benefits for consumers. clean and secure electricity supplies has sometimes come at a higher cost to • In generation, new technologies, encouraged consumers than necessary. On average, by regulation and financial support, mean that consumers currently pay about £90 each year pollution is falling rapidly. Renewable power towards environmental policies. This will rise as sources now provide around a quarter of total low-carbon generation increases. Rapid falls electricity generation, compared to 5% in 2006. in the costs of wind and solar generation show • In retail markets, the number of accounts, not the scope for competition and innovation to limit including prepayment, on poor-value standard future cost increases. But consumers will lose variable tariffs has fallen from 15 million in April out if there isn’t effective competition for low- 2016 to 14 million only 12 months later (which we carbon support schemes and for measures to estimate to be around 12 million households). This help the energy system to work effectively. is because of near-record switching rates in 2017 so far. There are two major challenges to ensure that a transformed energy market works for all consumers. These changes are exciting, but looking at the state • Vulnerable consumers must be protected, of energy markets, we have three concerns about and able to engage in the market more how they currently work for consumers: effectively. We are consulting on extending our • First, the market works well for those who safeguard tariff to a further 1 million vulnerable engage. But some are being left behind. The consumers this winter. We are also working to retail energy market features two distinct tiers. make the switching process quicker and easier, so Consumers that actively look for cheap prices that retail markets work better for everyone. We have made large savings. But more than half of are assessing the case for more use of collective consumers are still on default tariffs, paying higher switching, which could enable less engaged prices. For the typical household, a standard consumers to reap the benefits of competition. variable tariff costs about £300 more each year • Innovation must be harnessed in ways than the cheapest tariff available. that bring benefits to all consumers. Many • Second, consumers paying the highest consumers already generate their own electricity, prices are often those least able to afford and can monitor and control their consumption them. Many markets charge different prices to using smart meters. In future, the traditional different consumers. But in the energy market, ‘supplier hub’ model, whereby suppliers manage consumers with low incomes are much less likely most interactions with consumers and the wider to switch to the cheapest prices. Support schemes market, may break down. Peer-to-peer energy such as the Warm Home Discount help some trading and greater customer ownership of their vulnerable consumers, particularly pensioners. But data should allow different ways of engaging with identification of and support for other vulnerable the energy system. groups are not yet good enough. 3 State of the energy market report Meeting these challenges will be tough. But our ambition is clear – collectively, we need to build a transformed energy sector that provides secure and clean energy to consumers – at a cost that consumers recognise as fair. Ofgem will continue to monitor energy markets to ensure that we act quickly to address problems. Where the market is not working well, we are taking action to protect consumers, both by reducing the harm that results, and by tackling the root causes. But this report makes clear that solving these issues needs continued action on our part, and on the part of companies and government. We would like to thank all of those organisations and individuals who helped us to produce this report, including the Department for Business, Energy and Industrial Strategy, the Committee on Climate Change, Which? and Citizens Advice. The report draws on the work of many people across Ofgem. Following the Competition and Markets Authority’s recommendations, it was led by Ofgem’s Office of the Chief Economist, separately from Ofgem policy teams. We are happy to hear from you. If you have any questions or comments about this report, please contact [email protected]. 4 Contents Foreword 3 Executive summary 6 Key Findings 9 Chapter 1: About the energy system and Ofgem 11 Chapter 2: Competition in energy markets 18 Retail energy markets 20 Wholesale energy markets 41 Chapter 3: Affordability and vulnerability in the domestic sector 56 Energy bills 58 Managing energy prices to reduce bills 63 Consuming less to reduce bills 69 Chapter 4: Decarbonisation of energy 77 Progress reducing emissions 79 Financial support for low-carbon electricity 84 Adapting to new sources of power 90 Chapter 5: Security of Great Britain’s energy supply 93 Security of Great Britain’s gas supply 94 Security of Great Britain’s electricity supply 97 State of the energy market report Executive Summary Energy is an essential service, key to every aspect of Retail markets – where homes and modern life. We use gas and electricity to heat our businesses buy energy homes and workplaces, power the phones we hold in our hands, the appliances we cannot live or work without Competition continues to benefit consumers and, increasingly, our cars. British households spend who are able and willing to shop around, around £30 billion on gas and electricity each year, an meaning they can usually get a good deal. As of average of around £1,123. Businesses, charities and June 2017, there were 60 suppliers offering electricity public bodies spend an extra £20 billion each year. and or gas, 16 more than a year earlier. Since 2012, new suppliers have intensified competition, shrinking Energy markets are rapidly transforming to meet our the six largest energy suppliers’ share of the market need for clean, secure and affordable energy and to from nearly all consumers to just over 80% of them. accommodate changes in the way we consume energy. Switching and engagement are increasing. Annual The pace and scale of changes to generation, networks, household switching rates reached almost 17% in retail supply and consumption are unlike anything we’ve June 2017, the highest since August 2011. ever seen in the sector. The transformation is being helped by major investment in generation, networks and But competition isn’t working well for consumers energy efficiency. But the benefits of these investments who are less active. More than half of consumers will only flow to consumers if energy markets work well. (58%) have never switched supplier or have switched only once. 60% of consumers are on a default variable tariff, which can be around £300 more Ofgem regulates Great Britain’s gas and expensive each year than the cheapest fixed-term electricity markets, to protect the interests deals. Despite losing consumers to competitors since of current and future consumers. Through 2012, the six largest suppliers have maintained a our regulation, we aim to deliver five healthy combined profit margin of between 3.9% and outcomes for consumers: 4.5%. Price differences between variable tariffs and fixed tariffs have widened over this period, suggesting Lower bills than would otherwise suppliers can offer low-price fixed tariffs to attract have been the case active consumers and cover direct costs, but rely on Reduced environmental damage the higher prices charged to less active consumers to both now and in the future cover operating costs and maintain profits. Improved reliability and safety Retail markets typically work well for larger Better quality of service, appropriate businesses, but small and microbusinesses for an essential service pay much more on average. Larger business consumers can often negotiate good deals with Benefits for society as a whole, suppliers, but smaller ones tend to pay more for their including support for those struggling energy, and switch infrequently. Average business to pay their bills electricity prices are around 50% higher for very small firms than for large or very large consumers, while non-domestic gas prices can be twice as high (some In this report, we assess how well energy markets of this is driven by cost differences). More than a are working based on these consumer outcomes. quarter of businesses (27%) believe it is too complex The report is our first comprehensive annual assessment or time-consuming to find a new tariff or supplier. of the state of energy markets in Great Britain. It covers the period since the Competition and Markets Authority (CMA) concluded its investigation into the energy sector in 2016, and sets a baseline for future reports. 6 State of the energy market report The CMA remedies, intended to improve rate of fuel poverty, while pensioners are now the least competition and outcomes for consumers, are likely consumers to live in fuel poverty. The proportion being implemented and are starting to show of energy consumers in debt to their supplier is at its results. From April 2017, we implemented a cap on lowest level since we started collecting data in 2006, prepayment meter (PPM) tariffs. Prices fell by around but some still face very high debts. £60 for a typical dual fuel PPM consumer, though Households use 20% less energy than 10 some of the cheapest tariffs are no longer available. years ago, which has helped reduce their bills. We are also trialling measures to improve consumer Improvements in energy efficiency play an important engagement, for instance by communicating cheaper role in driving down consumption. Under the offers to disengaged customers.