UK government’s draft Energy Bill runs into criticism from parliamentary committee.

The UK parliament’s Energy and Climate Change Committee recently published its views on the government’s controversial draft Energy Bill. The Committee’s conclusions and criticisms centred on the proposed Electricity Market Reform (EMR), and specifically the role of Contracts for Differences (CfDs). Of the four parts of the EMR, the heart is a subsidy mechanism based on a feed in tariff (FiT) with CfDs for all low-carbon generation. The other parts include a targeted capacity mechanism, a carbon price floor, and an emissions performance standard (EPS). The Bill aims for a “secure, more efficient, low-carbon energy system in a cost-effective way”. To inspire the investor confidence required to achieve these goals, the Bill needs to be more transparent and precise.  Lack of clarity and complexity of the arrangements are the Committee’s main conclusions. The Committee described the Bill’s objectives as “vacuous”. To give the market confidence to make long-term investment in low-carbon generation, more precision is required on the design of the CfDs and of the capacity mechanism. Not only must the CfDs be more precise, they must be simple enough to outweigh the damage done until now by what the Committee calls “highly complex implementing arrangements”. A core problem of the CfD mechanism is who the counterparty will be. The White Paper preceding the draft Bill stated that the government would play the single counterparty role, in which it would underwrite the CfDs. However, the draft Bill contained a significant shift to a multiparty model where payments flow between suppliers and generators, with collateral posted by suppliers. Of note is the detrimental effect on the cost of suppliers under this option. Indeed, to reduce the cost of capital for investors, the Committee’s recommendation is for a single counterparty model underwritten by the UK government. The question is still undecided, with Department of Energy and Climate Change now considering a third model in which there would be a single counterparty that would not be underwritten by the government. This is an imperfect solution so the issue is essentially unresolved. As for the other parts of the EMR, the capacity mechanism, although recognised as being a good idea, is criticised for not being clear enough.Even stronger criticism was made by the committee of the Emissions Performance Standard. They called it pointless and a danger to the EMR’s goal of achieve low carbon generation, as it encourages new gas-fired generation. The committee also criticised the absence of demand-reduction measures and the heavy concentration on future generation. In addition, it suggested that including reference to carbon budgets would give confidence in the UK’s commitment to meeting its 80% de-carbonisation target by 2050. Despite these criticisms the committee emphasised that the EMR is not a lost cause but that it must be revised with haste. The challenge is now with DECC to meet its timetable and to provide more detail and an impact assessment on its choice of counterparty model.  A full energy bill is due later this year and a law is planned to reach the statute book by mid-2013.

Written by Yasmin Valji.Analyst, Datamonitor Energy & Utilities

Centrica continues its acquisition strategy outside Europe

Centrica has extended its US presence with the purchase of Energetix and NYSEG Solutions.

Centrica's acquisition of US energy suppliers Energetix and NYSEG Solutions will add 245,000 customers to its existing commercial and residential base under its US brand, Direct Energy, in the states of New York and Pennsylvania. The purchase will take Centrica's US customer base to 5.5 million customers and is a further move in the company's aggressive strategy of seeking growth outside Europe. 

The acquisitions of Energetix and NYSEG Solutions are just the latest in a flurry of M&A activity at Centrica, the parent company of British Gas in the UK. Indeed, in March 2011, Centrica acquired Gateway Energy Services, a retailer based in New York; Vectren Source, a gas supplier based in Indiana; and First Choice Power, a utility based in Texas.

The acquisitions highlight Centrica's strategy to expand in US states with deregulated retail markets, such as Texas and New York. In addition to strengthening its business in the UK, Centrica is likely to continue to acquire utility and complementary companies in the northeast of the US, where retail markets are open to competition and where there is the potential to earn better returns.

For example, Centrica, through Direct Energy, acquired a home protection plan business in Illinois called Home Warranty of America (HWA) in November 2011. HWA offers whole-home warranty plans, including heating, air conditioning, plumbing, and electrical insurance cover. Although the combination of Direct Energy's services with HWA imitates British Gas's service offering in the UK (providing customers with a complete energy and protection plan service) this approach is relatively new in the US market.

Centrica has also undertaken vertical expansion of its Direct Energy subsidiary, having added two businesses to its upstream gas arm in Canada in March (in the Wildcat Hills region, Alberta) and December 2011 (Carrot Creek, Alberta), in addition to natural gas reserves in Alberta, Canada, bought in March 2011.

The strategy to move away from continental Europe was underscored when Centrica sold its Netherlands electricity and gas retail business Oxxio BV in March 2011.  The sale followed Centrica's exit from other continental retail markets as it had previously sold subsidiaries in Spain (Centrica Energia SL) and Belgium (SPE).

Written by Yasmin Valji.

Analyst, Datamonitor Energy & Utilities.

New entrant aiming to upset the Big Six's retention strategies, but will it make an impact?

Hudson Energy, a US-based supplier, is entering the UK SME energy supply market with the promise that it will offer what every customer wants and needs: faster, efficient, transparent, and cheaper energy supplies. However, with only a niche offering of instant service through brokers, it is unlikely to compete across enough of the customer base to truly worry any of the Big Six UK suppliers.

The business to business (B2B) energy supply market is a complicated place: customers vary hugely in size and in the services they require from their supplier, even in the small- and medium-sized enterprises (SME) category. While the number of suppliers operating in this space has traditionally been low, Hudson Energy has announced its intention to enter the fray.

Initially entering just the electricity market to avoid the seasonal volatility of gas prices, Hudson Energy aims to introduce practices to the UK supply market such as returning quotes to customers in "minutes" after being contacted online. It will also conduct the majority of its business through brokers, allowing the company to minimize costs – and, hopefully, prices – by not requiring significant numbers of sales and administrative staff.

But will customers see enough difference in Hudson Energy's offering to tempt them to switch and remain with it? Indeed, high customer service levels are already a standard offering in the B2B market, and existing suppliers offer dedicated account managers, something that Hudson Energy will not offer due to its use of brokers. Established suppliers also use social media to ensure that queries are dealt with quickly, competing directly with Hudson Energy's fast service promise.  

Hudson Energy's customer acquisition and retention strategy is fairly simple compared to those already active in the market. Research currently being conducted by Datamonitor Energy on utility retention strategies shows that while customers react most strongly to price strategies in the SME segment, strategies to enhance customer service can encourage customers to accept a price premium. Hudson Energy should be focusing on a price strategy, as acquiring customers through brokers will not allow it to develop the relationships needed to provide premium levels of customer service.

As such, it is unlikely that Hudson will cause a revolution in the SME electricity segment. The Big Six (EDF, E.ON, RWE npower, Centrica, ScottishPower, and SSE) have the resources to provide retention strategies to cover the entire market. Hudson Energy, on the other hand, will be targeting a niche, and although this will allow it limited success, the UK is unlikely to see the Big Seven any time soon.

Ofgem's City briefing throws up more questions than answers

Ofgem's City briefing throws up more questions than answers

On July 16, Alistair Buchanan, Ofgem chief executive, opened a briefing for City analysts on current regulatory issues. The briefing shed some light on current issues and outlined some key points of progress, but the Q&A session revealed a lot of suspicion on the part of the analysts, especially regarding the RIIO investment plan.

During the briefing, Ofgem's Retail Market Review was presented as an ongoing project that is already showing progress. The specific example given was SSE's decision to reduce the number of tariffs available from 68 to four and to offer free energy audits, but it was also pointed out that this pattern is being seen from all big suppliers in the UK.

The liquidity proposals were also highlighted as already bringing benefits to the market. The three objectives of the proposals are a liquid short-term market, access to products for smaller suppliers, and effective reference prices for energy. Ofgem claims that these points have already been addressed somewhat. The example given was the noticeable increase in day-ahead trading, which applies to the first two of the three objectives especially. Interestingly, Ofgem said that it intends to leave adhering to liquidity proposals to the market, and that a mandatory auction of up to 25% of energy is to be held back, only to be enacted if suppliers do not comply with the proposals' guidelines.

The mood of the presentation changed as capacity margin forecasts were discussed, including a slow growth forecast predicting that the margin would fall below 5% in 2016 and 2017. This dramatic fall in spare capacity will be caused by the Large Plant Combustion Directive. Indeed, 70% of allowed production hours have already been used because of favorable spark spreads, 10% more than Ofgem had predicted at this point.

Investment in new capacity is also being hampered by the spark spread situation, which is preventing investment in new gas plants. Ofgem also revealed that the expected increase in capacity margin from 2018 onwards is now looking less likely due to the uncertainty around new nuclear projects and the Drax/Siemens biomass facility, while the deployment of new wind capacity is below expectations.

Given that the majority of the audience was from investment banks, the financial aspects of Ofgem's "RIIO" (Revenue = Incentives + Innovation + Outputs) investment plan in transmission infrastructure were also questioned. The gearing ratio, cash flow risks, and return on equity were topics of discussion. Although it is clear that Ofgem is trying to be as transparent as possible, City analysts seemed skeptical whether inflation had been factored in to the right degree and some found the indebtedness was too high to accept, despite Ofgem citing the low cash-flow risk.

More light will be shone on the proposals in the near future when they are published in full, but for now, there are plenty of questions yet to be answered on how the investment in infrastructure will progress up to 2025.