Examination of Witnesses

Domestic Gas and Electricity (Tariff Cap) Bill – in a Public Bill Committee at 9:41 am on 13th March 2018.

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Dermot Nolan and Rob Salter-Church gave evidence.

We will now hear from Dermot Nolan, chief executive of Ofgem, and Rob Salter-Church, acting senior partner for consumers and competition at Ofgem. For this session, we have until 10.45 am. Will the witnesses please introduce themselves, although I may have already done that?

Dermot Nolan:

Thank you, Chair. I am Dermot Nolan, the CEO of Ofgem.

Rob Salter-Church:

I am Rob Salter-Church, the interim senior partner for consumers and competition at Ofgem.

Photo of Bim Afolami Bim Afolami Conservative, Hitchin and Harpenden

Q Assuming that the legislation passes unamended, how do you intend to set this cap?

Dermot Nolan:

We have already commenced the process in the sense that last Thursday, after Second Reading, we put out an open letter specifying our processes over the next few months. Yesterday we released one of a series of discussion papers that looks at certain elements of the cap and how it might work. We will do that over the next month or so. We will gather information, consult as widely as possible and issue a more formal consultation while the Bill is still passing through Parliament. That will try to tie together the various proposals that we will put in place and look at a potential framework for the cap. After Royal Assent we will issue a statutory consultation, which we are required to do, so we can put the cap in place as quickly as possible.

Photo of Bim Afolami Bim Afolami Conservative, Hitchin and Harpenden

Q Is Northern Ireland and how a cap works there your starting point? Is that something that informs you, or is there something about that to make you think that we need to do it in a different way this time?

Dermot Nolan:

It certainly informs us, as indeed do the designs of price caps around the world. We have caps in place for pre-payment meters and particular tranches of vulnerable consumers, and they will inform us. Given the statutory duties as we interpret them, though, we will I think have to design the cap ourselves while being informed about others. One point about the Northern Ireland cap is that it was designed specifically for one firm, for the previously dominant firm, so it may not be exactly wise to take it off the shelf for the cap in GB.

Photo of Bim Afolami Bim Afolami Conservative, Hitchin and Harpenden

Q Just on this precise point, in all parts of the House there are people who are concerned about Ofgem’s ability to get this right—not through lack of effort, but simply methodologically. Are you confident that we can get this right?

Dermot Nolan:

I am confident. I am confident that it is a difficult task. There are statutory objectives, and we have to be mindful of them all. It will require a lot of analysis, which we are already commencing on, a lot of evidence and, ultimately, a degree of regulatory judgment to get it right, but I am confident that we can do it. It is an absolute priority for the organisation, and for my board and me.

Photo of Bim Afolami Bim Afolami Conservative, Hitchin and Harpenden

Q If you did not think that you could get it right, would you have communicated that already to the Department for Business, Energy and Industrial Strategy?

Dermot Nolan:

Yes, I certainly would have. I will be responsible if I do not get it right, so I would have communicated that.

Photo of Vicky Ford Vicky Ford Conservative, Chelmsford

Q The previous panel spoke about the need for transparency in this process. How do you intend to ensure that, during the consultation, transparency is achieved? Will you be consulting all suppliers equally, for example? Recently, it was pretty cold, so can you assure us that the price cap will be ready by the time next winter comes?

Dermot Nolan:

We will consult as openly as possible. We will issue consultation documents, because that is the nature of what we are required to do, but we will also hold workshops which are open to all and we will try to get views from every possible supplier. Not only that, however—I want to be very clear on this—we will want views from stakeholders far beyond suppliers. I think your next session is consumer groups, and we will try to consult as extensively as possible with them. In fact, being blunt, we are both required to and want to listen to as many as we can hear over the next few months, to inform any decision.

Regarding next winter, as you say, it was cold recently, but I have said before and I repeat again very clearly here that we will have the cap in within five months of Royal Assent. We will have it in place and affecting consumers by that point.

Photo of Vicky Ford Vicky Ford Conservative, Chelmsford

Q With the people who come to those stakeholder meetings and attend those consultations, is that public information?

Dermot Nolan:

Yes, it would be on our website and we would make a specific—[Interruption.] Sorry, Chair.

No, no, I am sorry. I am just keen to get as many people in as possible. Alan Whitehead.

Photo of Alan Whitehead Alan Whitehead Shadow Minister (Department for Business, Energy and Industrial Strategy) (Energy and Climate Change), Shadow Minister (Business, Energy and Industrial Strategy)

Q I just want to be clear about the point on five months, Dermot, that you have mentioned. Could you briefly break down what that five-month period will consist of? And are you able to guarantee that there will not be any drift in that process, so that the five months is an absolute outside time rather than an approximate time?

Dermot Nolan:

I might ask Rob to answer that, but I may come back at the end.

Rob Salter-Church:

That five-month period will start with us issuing a statutory consultation, which will run for eight weeks, or two months. That is something that we are required to do by law as part of the due process that we go through. Thereafter, we would have a period to analyse fully the responses to the consultation. As we said, that will be a transparent process; there will be lots of information that we will need to review. Thereafter, when we publish our decision and the final drafting of the cap, it is subject to a 56-day notice period, which again is a legal requirement that we have to go through before the changes can take effect. When you add those various stages together, it gets to five months. Can I guarantee you that there will not be any drift? What I can guarantee is that we will have this as our absolute No.1 priority for Ofgem to deliver.

One of the things that is important for us to consider in ensuring that this cap is in place as quickly as possible is making sure that the due process is gone through. It would be unfortunate if, in trying to do something more quickly, we created a legal risk around process, and that could be exploited by somebody challenging it and seeking to delay the introduction of the cap. So, we are confident that we have a good, robust process and we will get through it as quickly as we can.

Photo of Claire Perry Claire Perry The Minister of State, Department for Business, Energy and Industrial Strategy, Minister of State (Business, Energy and Industrial Strategy) (Energy and Clean Growth)

Q We are all very much appraised of the need—cross-party—to get this cap introduced by the end of the year. For us, winter does not start in February 2019; it starts in November 2018. What is the opportunity to apply the cap retrospectively, particularly if there is any form of legal challenge?

Dermot Nolan:

Retrospectively, Minister, in the sense of—?

Photo of Claire Perry Claire Perry The Minister of State, Department for Business, Energy and Industrial Strategy, Minister of State (Business, Energy and Industrial Strategy) (Energy and Clean Growth)

In other words, reimburse customers who would otherwise be overcharged if for some reason the energy companies delayed the introduction of the cap through any form of legal challenge.

Dermot Nolan:

First, before coming back to that, I want to reiterate again that we want the cap in as quickly as you do. There will be no drift; we will make sure that we meet that timeline. I absolutely say that as clearly as I possibly can. So we will bring in the cap.

At that point, the cap would apply to all energy suppliers. If they were in breach of it, they would be in breach of their licence obligations and potentially they would be subject to fines, and ultimately to losing their licence. So, it is almost inconceivable to me that, if the cap was in place, a supplier was not in compliance with it. We would obviously use every single power we had at that point in time.

Photo of James Heappey James Heappey Conservative, Wells

Q On the last panel, Dermot, the price spike of two weeks ago come up. So, to follow on from Vicky’s questions, first, against your modelling, what event did we see two weeks ago? Was that a once-in-five-years event or a once-in-10-years event, in terms of the price spike it generated? Secondly, how do you model against the reality that there will occasionally be those price spikes, but at the same time that we will all urge you to take as much risk as you are willing to, in order to make the price cap a meaningful cap? It would be interesting to know how you strike that balance between the variability in the wholesale market, albeit that it happens very infrequently, versus our wish that you are as bold as possible with the cap.

Dermot Nolan:

Absolutely. Two points on that. First, regarding, the events of last week, it is difficult to be precise. I would say they are more the type of once-in-five-years spikes. I will note that, if I may sound very gnomic, there are spikes and spikes. This was quite an acute spike in the gas price, and then there was a spike in the electricity price, but it was not that long-lived. Forward prices for four or five days did not change dramatically, so it was an abrupt spike but a short one.

The whole point of how to set the cap, and over what time period, is a fundamentally important one. The Bill suggests that the price cap must be updated every six months or less. There is an inherent trade-off. One of the things I particularly want to hear about from consumer bodies is over what period people want their prices to change. All the evidence we have in many ways suggests that people like smooth energy prices. They do not like spikes in their own bill. If the cap is set every six months, and a one-week spike is smoothed out over that six months, there is an appeal to that—you get relatively sure prices over a six-month period.

At the same time, you find that if there have been spikes of whatever form during a six-month period—if there has been, say, a fall in energy prices after two or three months—people say, “Why is this fall in wholesale prices not being reflected in my bill? Why do I have to wait six months for it? Why can I not have it after three months?” If we did a three-month price cap, that would ameliorate that issue, but we might be a little bit more vulnerable to spikes and changes in prices. How we balance that is not straightforward and is one of the things that we would particularly want to hear from consumer groups on during a consultation.

Photo of Michelle Donelan Michelle Donelan Conservative, Chippenham

On that point, do you think six months is right? I know you have just described the trade-off between a three-month and a six-month period. Do you believe six months is the correct period? There are people that are concerned about flexibility and fluctuations. In the last panel, we heard that if everybody started buying their energy in advance, it could inadvertently cause a spike. What do you believeQ ?

Dermot Nolan:

I think six months is the maximum. If the Bill goes through as is, we will consult on it. I honestly cannot say what we would ultimately pick, because it would be an open consultation. Certainly, I cannot imagine, at this point in the way the energy market is, having prices change every week or month. I think it would be a consultation along the lines that I have already mentioned. There is no perfect number though. We would want to try to hear from consumers what they thought was best and what reflected their preferences.

Photo of Vicky Ford Vicky Ford Conservative, Chelmsford

Q One of the issues that has been raised is making sure that the price cap does not disincentivise investment in infrastructure. During the consultation, will you also be listening to infrastructure investors to take into consideration their views when setting the cap?

Dermot Nolan:

We will listen to everybody when taking views on setting the cap. However, the infrastructure should not formally be part of the price cap. It should not affect the way in which the price cap will broadly be set in terms of interactions with suppliers and the prices of the inputs they purchase. So although we will listen to everyone, I do not think infrastructure investors per se will be crucially involved.

I came in at the end of the last session and heard about smart metering. We will have to consider the smart metering costs, but only in the efficient cost. One of the difficult tasks in setting any level of cap is deciding a precise, efficient cost for the firms and ensuring that those efficient costs are passed on in the cap.

Photo of Stephen Kerr Stephen Kerr Conservative, Stirling

Q In the past, Ofgem has said that it accepts the outcome of the CMA’s energy market investigation, including the majority view that said a price cap would have a negative impact on competition. How are you going to manage that? You have accepted that a price cap can lead to a loss of competition in the marketplace. How will you know? How are you going to measure competitiveness in the marketplace, and what will you do in terms of pulling levers in order to rectify that?

Dermot Nolan:

The CMA view was split. We said we would go with the majority view, but one of the points about the process is that Parliament has now taken a decision. It is absolutely something that we will implement, because we are servants of Parliament, and we will implement it as quickly and as effectively as possible.

On the theme of competition, in my reading of the draft legislation, it seems to me that there is a desire to bring in a cap but also a desire to develop a more competitive market. There are a number of things that we are putting in place that we believe will help develop a competitive market further.

On smart metering, I know there were different views among the earlier panel, but smart metering is helpful. It is in some sense a necessary condition for, if you like, a digitised retail energy sector. There will be faster and more reliable switching processes. There are a number of remedies we have tested for prompts—ways in which people who have not yet been prompted to engage in the market will be prompted further. We have tested a lot of those already, trialled many of them and are going to roll them out in the next couple of years. There is the work on what we call midata, where we are going to push forward with a secure piece of your data that you can use in any price comparison website or any particular thing that will facilitate competition.

There are two more points—I know I am listing them off, but I want to be clear. One is that we think vulnerable protections will still be necessary if a full price cap is removed. We will look at whether any vulnerability price caps should be kept and, in particular, whether other forms and ways of protecting vulnerable customers, including things such as collective switches, could be used.

Photo of Stephen Kerr Stephen Kerr Conservative, Stirling

Q Going back to the measures you mentioned earlier, which will underpin the competitiveness of the marketplace, those are things that can be done now. Yes?

Dermot Nolan:

Those are things that will be done over the next year to two years.

Photo of Stephen Kerr Stephen Kerr Conservative, Stirling

Q Tell us again how you will know that they are working. What are the features of a market to which you will say, “Yes, this is a competitive market.”?

Dermot Nolan:

Last year we published a response to the Competition and Markets Authority—which, going forward, will form the core of our report to the Secretary of State, as envisaged under the Bill—that we called a state of the market. It was a detailed look at the state of competition in the retail sector. It will look at a number of indicators; it will be on the basis of this suite of indicators—there will not be one perfect one. It will include the numbers switching, but also survey evidence, levels of satisfaction in the market, whether people feel more trust in the market, and whether the vulnerable, in particular, feel empowered to switch or still feel disengaged. We will focus on and continue to develop a suite of indicators that will form the basis of a report to the Secretary of State, which, as envisaged in the Bill, we will make on a yearly basis.

Photo of James Heappey James Heappey Conservative, Wells

Q I am keen to understand what you think a good market looks like. In a lot of other markets, we would consider happy customers who think that they are getting good customer service and a good deal to be a good thing. In the energy market we seem to be quite aggressively pursuing the absolute opposite. We seem to think that a good market looks like lots of people who are moving constantly to find a better deal.

I wonder how we do something in this price-capping process that, when energy companies go to war with one another over price, ensures that all of their consumers, including those who are loyal and seeing the benefits of good customer service, get rewarded, rather than simply perpetuating this view that a good energy market is one in which everybody is moving constantly and there is no incentive for companies to deliver good service.

Dermot Nolan:

Absolutely. When I talked about a suite of indicators earlier, I think one should not over-concentrate on switching. It is perfectly possible, as James Heappey has said, to have a market that is functioning relatively well, but, actually, observed levels of switching are slow. What is important is that the customer must have the ability to switch if treated poorly.

In that sense, what we have seen, particularly in the energy market over the past two years, as we have seen in other markets, is a divergence of outcomes—£200 or £300 between people’s bills. Some—not all, because more than 20% of our domestic residential customers now come from small suppliers—have the disengaged feeling of, “I don’t feel comfortable switching and don’t feel protected.” The reforms that I mentioned in the last question are about trying to create a situation where we go back to the engaged customer—in some sense protecting the disengaged—with less variation between the engaged and the disengaged as a result and with people feeling, “I don’t need to switch, because I am not going to get charged £300 or £400 more by my own supplier if I don’t switch.” That is the kind of market that we would revert to. I think the reforms that we have set out will get us in that direction.

Photo of James Heappey James Heappey Conservative, Wells

Q That is exactly the point. When Tesco and Sainsbury go to war with one another, they might compete over the price of Hobnobs, and that might make a small number of people switch their supermarket, but everybody who shops in those supermarkets gets the benefit of that price reduction. That surely must be the market that we are seeking to design.

Dermot Nolan:

That must be the market we are seeking to design. I would say more generally that new technology, through which we are buying goods and services in many areas, is such that that old area is, to some extent, breaking down. I do not want to go beyond the topic, but you will see people paying different prices buying online, and that is good in many ways, but it also has public concerns more generally. One thing about the energy market is that it will clearly not be successful if we are still seeing observed differentials of £300 in two or three years’ time.

Photo of Alan Brown Alan Brown Shadow SNP Spokesperson (Transport), Shadow SNP Spokesperson (Infrastructure and Energy)

Q You have already said that when the absolute cap ends, you still think there needs to be protection for vulnerable customers. Does that not suggest that the Bill is not doing enough to protect vulnerable customers? What protection do you think they need going forward?

Dermot Nolan:

I think there are already 5 million people who are vulnerable under price cap protection. If the Bill was not going forward, we would have extended that, anyway, to another tranche of vulnerable customers. Regardless of whether there is a price cap or not market-wide, the regulator is likely to have price caps for vulnerable customers going forward. I might be wrong on that, but it will be an absolute priority for the regulator to do that, which we believe we can and already are doing under our own powers. Obviously, I want as much protection as possible for vulnerable customers. Any regulatory body, given the statutory duties that it has, will take on that itself. If it does not, it will be messing up. So I feel there will be protections there from the regulator in any case.

Photo of Alan Brown Alan Brown Shadow SNP Spokesperson (Transport), Shadow SNP Spokesperson (Infrastructure and Energy)

Q I have a supplementary question. This is slightly tangential, but there is a proposed amendment that the Bill should aim to make sure that each SVT customer saves £100. Would an amendment that sets an absolute value within the Bill help or hinder you as a regulator?

Rob Salter-Church:

At this stage it would be difficult to say exactly how much money a customer would be able to save through the price cap that will be put in place. We can say that—indeed, the Bill requires this—our first and primary objective is to think about protecting consumers, but we need to make sure that in setting the cap we also take account of the other factors that we need to consider, which is ensuring there are incentives for customers to switch and ensuring that suppliers are able to continue to finance their activities and fund things such as the smart metering roll-out. Although we are keen to ensure that we can save consumers as much money as possible, ultimately it would potentially create some unintended consequences to fix that amount at this stage in the Bill.

Photo of Michelle Donelan Michelle Donelan Conservative, Chippenham

Q I want to go back to the competition point. Some members of the previous panel supported a relative cap as well as an absolute cap in order to stop the cross-subsidisation that is happening between consumers. What are your thoughts on that? Would that be helpful?

Dermot Nolan:

Is this a relative price cap and an absolute price cap co-existing at the same time?

Dermot Nolan:

I have only heard that recently. I am sceptical for a number of reasons. First, I think it is always difficult, and it is undesirable, to tell a company it cannot charge a price below a certain level, which is what a relative price cap might do. I would always be reluctant, personally, to endorse something like that. More generally, the absolute price cap will, to be candid, have an effect on the larger companies. It will drive down the prices at which they charge standard variable tariffs. They will react to that, hopefully, by becoming more efficient and so on, but it seems likely that, for the larger companies, it would reduce the differential between their standard variable tariffs and their fixed tariffs. The idea that they would then be able to cross-subsidise seems unlikely, so I do not see the need for a relative price cap on top of an absolute price cap.

As I said earlier, I think that anything that involves telling a company it cannot charge a low price is not a great thing. Further, if I may say, it complicates the cap. We can figure out an absolute price cap. It will not be easy to set, but we will muster every fibre we have to set the right cap. To complexify it further with a relative price cap strikes me as undesirable.

Photo of Michelle Donelan Michelle Donelan Conservative, Chippenham

Q You would say that getting this entire process put through simply will foster competition, and that is one of the goals you believe should be in the Bill.

Dermot Nolan:

I think it will have an effect. We have a prepayment meter cap already. I said that switching is only one aspect of competition; I want to be clear on that. After the prepayment cap, we saw that some of the cheaper deals left the market, but not all of them did. Some stayed, including from existing suppliers, and there were still cheaper deals from some of the smaller suppliers. I think that is likely to occur. There might be a measured drop in switching for a period of time, but as long as the mechanisms are put in place, this can facilitate competition over the medium and long term.

Photo of James Heappey James Heappey Conservative, Wells

Q This is similar to the question I asked at the end of the previous session. What does effective competition look like to you as the regulator? Are you looking at measuring this in terms of engagement within the market and net fall in the number of SVT customers? Is it based on some differential between SVTs and introductory or promotional prices? Alternatively, is this an opportunity for transformation? We bring in the price cap, but in the process we look at what has been wrong with our old energy system and what the innovation and disruption is likely to be that leads to something for the future, and whether this is your opportunity to deliver that.

Dermot Nolan:

I think it is an opportunity for transformation. I have talked about some of the short to medium-term things we will do. Over the period of the price cap—this would probably be a legislative thing, working with the Department and ultimately with Parliament—it represents a chance to perhaps radically recast the supply market.

The supply market has become quite complex. I am not saying that the system of suppliers acting as vehicles for delivering the various obligations has not worked—in many ways, it has—but we see a situation in which a host of new suppliers will be entering the market in three to five years. These might be quite large ones that do not currently provide energy, and they could come in selling energy in a bundled product with other goods.

We will see electric vehicles being rolled out, and a price cap will have to deal with issues such as electric vehicle charging and how people are charged for them. I see a situation in four to five years’ time in which the energy market could have changed radically. The key point of the price cap is that it has to be flexible to any changes and fulfil its basic role of protecting consumers. With great respect to the suppliers in this room and suppliers already out there, I would hope that we could see radically different sets of people providing energy in five years’ time.

Photo of Alex Norris Alex Norris Labour/Co-operative, Nottingham North

Ofgem said to the Department for Business, Energy and Industrial Strategy Committee when this was being considered that the cap ought to be temporary. How do you feel about 2023 as the sunset clause? What should Members in 2023 have seen to be assured that the cap would be unnecessary?

Rob Salter-Church:

It is right that everyone is focused on what happens at the end of the price cap. It is important to us that if the price cap is removed, then all consumers get to benefit from the new competitive market that we are seeking to create.

We are comfortable with how the Bill is currently drafted. It requires us to have a comprehensive report from 2020 on the state of competition, and whether we believe that the conditions for effective competition that benefit all consumers are in place. Every year, we will be providing recommendations to the Secretary of State.

We are confident that, as the Bill is drafted, there is sufficient opportunity for the Secretary of State to determine whether there is a future role for an overall price cap, or whether there are things within our powers that we should be doing. Earlier on, Dermot mentioned the likely ongoing need for vulnerable consumer price protection. More broadly, we will be able to report on the progress made by us in creating what is ultimately a more effective form of competition where everyone benefits, whether you choose to switch or whether you choose to stay with your current supplier.

Can I bring in Vicky Ford?

Photo of Vicky Ford Vicky Ford Conservative, Chelmsford

Q In my view, 2023 is the sunset clause: a window to get the competition in the market working. If you bring in measures such as faster switching, prompts and Midata, I am sure we will see more innovation with smart appliances that feed off smart meters and therefore there is smart consumption. Are those the measures that you would write into your report in 2020 for us to be able to decide come 2021 that the competition had maybe already been achieved? You said it could be done in a couple of years. Why do we need five years?

Dermot Nolan:

I hope we do not, frankly. We will do our very best to bring competition as quickly as possible.

Photo of Alan Whitehead Alan Whitehead Shadow Minister (Department for Business, Energy and Industrial Strategy) (Energy and Climate Change), Shadow Minister (Business, Energy and Industrial Strategy)

Q I just wanted to reflect the fact that there is a sequence in the Bill, which is that Ofgem carries out a review as to whether conditions are in place for effective competition, and then you have just one requirement to put into your review, which is the vision of smart meters. The Minister then has to make a statement following the report, but it is all sequentially based on your report in the first instance.

Are you happy with what appears to be an almost complete lack of pillars on which your report might be based? Is that something that you can live with easily, or would you prefer or welcome further pillars in the report to ensure that your understanding of the report was in line with what was required to bring competition back into the market?

Dermot Nolan:

It is a fair question. I am personally content with the drafting, but I respect the fact that it is a matter for Parliament. I think we have a reasonably clear idea, and I hope we have given some of it today, but I assure you that we will spend a lot of time preparing an analysis of whether we think competition is working effectively in the market.

If further areas are to be put in, that is a matter for Parliament. I am slightly worried that putting specific targets and measures directly into legislative language now, in a market that will change radically over the next five years, might be somewhat distortionary. All I can say is that on the current language we will do as comprehensive a job as we can and look at all possible indicators to give an overall assessment to the Secretary of State of whether we think the market is working for consumers.

Order. I am very sorry, but that brings our session to an end. I thank the witnesses for giving their evidence and I ask the next panel to come forward.