Retail Market Review Distribution Charging Methodologies Forum Dena Barasi 5 April 2012

2 Outline Reasons for launching the Retail Market Review Key findings Proposed remedies –Tariff simplification –Interaction with distribution charging Questions / discussion

The Retail Market Review

4 Why we launched the Retail Market Review Response to earlier remedies appeared patchy –Minimalist approach to compliance? –Little action on Standards of Conduct? Ongoing questions over Big 6 behaviour –Continuing similarity on pricing and hedging behaviour? –Sharp rise in margins – indication of concerns? Significant concern: is market working for consumers?

5 Tariff complexity – the theory Behavioural economics highlights two relevant consumer biases: –Limited capacity: the range of limitations on consumers to assess the goods and services available to them. –Status quo bias: tendency of consumers not to change from what they are currently doing unless they face strong reasons for doing so. Loss aversion and time inconsistency may also have an impact

6 Tariff complexity – the evidence (1) Limited capacity Complexity Complex domestic pricing more common in energy supply than any other sector 1 Office of Fair Trading (2010) Advertising of Prices Annexe N: Consumer survey data tables Number of tariffs

7 Tariff complexity – the evidence (2) Status quo bias Switching Roughly 60% of domestic consumers claim that they have never switched supplier 43% of switches in 2010 were made after talking to a salesperson Only 16% via price comparisons sites Evergreen contracts 75% of gas and electricity domestic consumers currently on standard evergreen products

8 Our research shows consumers want: greater simplicity tariffs to be comparable for there to still be choice and scope for innovation Consumer preferences This implies: structural remedies clearer information balance between simplicity and choice

9 Suppliers margins and pricing behaviour Gas margins have increased sharply but from a negative base Electricity margins positive but declining since 2006 Higher margins on single fuel customers relating to legacy business New evidence of asymmetric price response

10 Summary of RMR findings Based on our evidence we still believe there are incidences of persistent consumer harm in the retail market that are being driven by features of the market. We believe the most important market features are that of sticky customers and the advantages of the vertically integrated incumbents. Our evidence also tells us that limited or complex information and poor comparability between suppliers lowers engagement and leads to poor switching decisions for some.

RMR: Proposed Remedies

12 Core tariffs proposal For standard tariffs All suppliers limited to one standard tariff per payment method for single rate and E7 meters Compulsory standardised element set annually by Ofgem and identified separately on consumers bills All other revenue recovered through a single unit charge, set on a p/kWh format Save by switching Supplier A – 13.75p/kWh Supplier B – 14.25p/kWh For non-standard tariffs No restriction on number of fixed term products No auto-rollovers or adverse unilateral contract variation terms Price information presented in a standard equivalent (p/kWh format)

13 Setting the standardised element Key component of approach for standard tariffs National standing charge will cover fixed network costs (i.e. DUoS fixed charge) Other categories of cost may be included in standing charge (e.g. environmental costs, metering…) Majority of network charges recovered through unit rate, reflecting charging methodologies Unit rates differ between regions, reflecting network charging methodologies

14 Standard tariff structure - options

15 Standing charge (both options) and regional adjuster (option 1 only) The regional adjuster will be set annually (1 June) and we propose to change network charges only once each year. However, Ofgem would monitor actual costs incurred by suppliers and may propose a change if we observe significant mid-year changes to network costs. Illustrative annual cost for average consumer (£) Recovered through standing charge Recovered through unit rate Gas transmission 6 x Gas distribution 122 x Electricity transmission 19 x Electricity distribution 81 (£13) (£68) Energy Company Obligation* 29 (gas), 29 (elec) x Warm Home Discount* 7 (gas), 7 (elec) x Metering* i 23 (gas), 15 (elec) x Other supplier fixed costs* 25 (gas), 25 (elec) x * If included in the standing charge. i Metering cost estimates are based on traditional meters, not smart meters.

16 Standing charge and regional adjuster National standing charge in both options –Fixed networks charges recovered via standing charge –Proposed treatment in licence: Schedule of numbers for early years + automatic adjuster thereafter Regional adjuster in Option 1 –Consumption-based network charges recovered via regional adjuster –Historical consumption current consumption –Proposed treatment in licence: formulae Electricity DUoS unit rate TNUoS unit rate (peak charge*peak percentage) Unit rate * consumption Gas Distribution unit rate (tariff/load factor) National Transmission System (NTS) exit capacity unit rate (tariff /load factor) Unit rate * consumption ElectricityDUoS fixed charge (£/MPAN) GasN/A

17 Next steps Review consultation responses –December consultation on domestic proposals –February consultation on standardised element Re-assess proposals in light of responses Further research and analysis Next publication during summer 2012

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