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Markets & Trading businesses and higher margins in generation have fuelled suspicions of dodgy accounting and cross-subsidy. Prestwich does not subscribe to "conspiracy theories". He says: "The big six are generally set up with their trading experts in the generation department precisely because the generation is the most flexible. It just makes sense that those areas of the business are looking for more opportunities to make money. The retail businesses are not as flexible with their portfolio, so they are price takers." It may not be a conspiracy, but Prestwich does see vertical integration as a problem when it comes to liquidity, because internal trades leave less available for the market. The volume of trades in the UK power market is just three or four times the physical product, around one-third the churn of Scandinavia's Nordpool. That makes it hard for small players to hedge, in particular. Smartest Energy is in favour of a self-supply restriction to force trades into the open. It would "effectively split the big six" and be "a fairly easy change within the industry", says Prestwich. Ofgem's answer to the problem, a licence condition, is "a step in the right direction" but will not fully address the issue. aggressively priced tariffs to new customers, cross-subsidised by "sticky" customers inherited at privatisation. As a new market entrant, launched in 2009, Ovo offers the same tariff to all customers, old and new. Griffin says: "One of the problems we see in the marketplace is that they [the big six] have a large proportion of customers who have standard tariffs that roll on each year that are more expensive they put in the marketplace for new customers. If you are switching, you get very good deals, which might even be below cost. That is one of the things we think stifles competition in the industry." Ofgem's Retail Market Review, which restricts suppliers to four tariffs, "can only have a positive impact" but "I don't think it is quite strong enough and I don't think it really addresses the issue", says Griffin. Nor is he particularly impressed with the regulator's intervention to improve liquidity. "To date, we have not found liquidity to be an issue. I would not say [Ofgem's proposal] is pointless – increasing liquidity can only have a positive benefit. I would only say it is not the biggest issue in the marketplace for the moment. "Right now, I think [Ofgem's] time and resource could be better spent dealing with other issues around improving the competitive market as a whole." On the aggregation side of Smartest Energy's business, there is Electricity Market Reform (EMR) to contend with. The company was founded in 2001 as a buyer of power generated by the independent sector, from lone community wind turbines to industrial combined heat and power engines. It now claims to cover 30 per cent of the UK's embedded renewable capacity, across 614 sites. Under EMR, renewable generators will get support through contracts for difference with a "strike price", in place of the Renewables Obligation. The market "reference price" will be topped up to a rate set for each technology. That changes the nature of power purchase agreements (PPAs) and the renewables lobby has raised concerns that small players could struggle to access the market. They say renewable generators will not actually attain the reference price, because they sell through PPAs at an increasing discount. As a business that helps small generators sell their power, Smartest Energy does not see this as a problem and argues that heavier discounting is an inevitable trend. "The problem is that this guaranteed strike price has raised expectations," says Prestwich. "The wind generators will start to see, as time goes on, a greater discount, and that would happen with or without EMR." Clarke explains: "Increasing generation from wind will mean that low price and wind generation will become more coincident. Over time, their generation will be worth less because they are generating most when prices are low." In other words, at times when your wind turbine is generating most, it is likely others will be too. The marginal cost of wind generation is close to zero and a glut of wind power suppresses the wholesale price. Over any given period, wind generators are likely to earn less than the average wholesale price for their power. "There are different risks associated with the PPAs under EMR because they are not the same structure as under the Renewables Obligation, but there has always been a discount to reflect risk," says Clarke. "Any hedge is going to require a risk premium and a margin. These are not charitable endeavours." Aside from a self-supply restriction, Prestwich would like to see as little intervention in the market as possible. He says: "We are on a bit of a road to intervention that is difficult to stop, but we are firm believers in competitive markets." 1,500 1,000 500 0 Nov 11 Customer bill Snapshot net margin May 12 May 13 Nov 12 VAT, operating and other costs Rolling average net margin Nov 13 Wholesale energy cost Ofgem's supply market Indicators suggest the wholesale cost of a typical household's annual energy use has risen by 3 per cent over the past two years to £610, with minor fluctuations. Other costs have been on a steadier upward trend, increasing 6 per cent to £1,265. Meanwhile, the rolling average net margin has more than tripled, from £30 to £105. The figures are based on a hypothetical hedging profile and do not necessarily match the actual costs faced by suppliers. They do not yet take account of government's recent policy changes to cut around £50 from the bill. UTILITY WEEK | 13th - 19th December 2013 | 27