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UTILITY Week 27th January 2017

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UTILITY WEEK | 27TH JANUARY - 2ND FEBRUARY 2017 | 19 Policy & Regulation Analysis L ike sharks sensing blood in the water, energy journalists in the national media used to swarm on the quarterly publication of the Supply Market Indicator (SMI) with voracious glee. The metric, in use until May 2015, used to forecast the profitability of energy compa- nies and was a regular source of ammunition for those keen to find evidence that energy companies are unfairly profiteering at the expense of customers. Of course, the SMI did not provide any robust view of the actual profits of energy companies, but that was an irrelevant detail to many commentators. In the midst of the Competition and Mar- kets Authority (CMA) investigation into the energy market, and aer relentless criticism of the SMI from suppliers and trade body Energy UK, it was withdrawn while Ofgem awaited the outcome of the CMA's work. Now though, in the wake of those find- ings and aer consultation with industry, the energy regulator has revealed its new-look SMI – the Supplier Cost Index (SCI). Will it avoid the pitfalls of its predecessor and pro- vide a useful measure of fair energy pricing? At a press briefing, Ofgem chief executive Dermot Nolan was hopeful and clear about what the metric is intended to be used for. Much to the chagrin of national reporters, he emphasised that the SCI does not pro- vide any information about energy company profitability (this is available in the Consoli- dated Segmental Statements) or a pounds and pence figure for what they ought to be charging. What the SCI does show, is a 12-month- ahead view of the expected cost of supplying the average UK energy customer, compared with historical levels. As quarterly updates are issued, Nolan said, the index should track the underlying costs of energy supply and make it clear if prices are following costs. Supply costs considered in the index include wholesale energy prices, network charges and the cost of government pro- grammes such as the Energy Company Obligation. Companies' operational costs, including metering and billing and any expenses associated with the smart meter The cost of doing business Ofgem's Supplier Cost Index may not give Fleet Street the simple measure of supplier profitability that it wants, but it does indicate the cost of supplying energy consumers, as Jane Gray reports. BREAKDOWN OF YEAR-ON-YEAR CHANGE IN SUPPLIER COST INDEX (JANUARY 2017) Note: +6.0 does not mean that wholesale electricity costs have risen by 6%, but that increases in costs represent 6 percentage points of the 14.5% increase in the SCI Percentage points Electricity Gas Electricity Gas Electricity Gas Wholesale costs Network charges Government obligations rollout, are not within scope – though Citi- zens Advice, who broadly welcomed the SCI's contribution to greater transparency in the market, urged Ofgem to consider how operational costs might be included in the future. The first index reveals that the projected cost of an average dual fuel energy bill in 2017 is 15 per cent higher than it was in 2016. However, over the longer term, this increased cost base is still about 10 per cent lower than the annual cost of supply recorded in January 2014. Considering the long-term hedging strategies most large sup- pliers employ to provide for the bulk of cus- tomers on standard variable tariffs, Nolan said he does not therefore see "any obvious reason" for suppliers to raise tariffs today. He added that the annual cost base increase recorded in the first SCI is "far from unprecedented" and that companies, espe- cially larger ones, ought to be able to offset the extra expense with efficiency measures. For most of the big six, Nolan's state- ments will not cause consternation. Many announced price freezes for their SVT cus- tomers before Christmas. However, EDF Energy has said that in March, its electricity prices for SVT customers will increase by 8.4 per cent – though when offset by a reduc- tion in gas prices, customers with dual fuel accounts will only feel a 1.2 per cent increase. Responding to Nolan's suggestion that price increases are unjustified when consid- ered in the light of longer-term reductions in the cost of energy, EDF Energy told Utility Week: "Our policy of buying electricity ahead of time has protected customers from the more recent volatility in wholesale price." However, "non-wholesale energy costs have risen and we have been honest with custom- ers about the future impact on prices". These non-wholesale costs are explained as costs to "ensure reliable supply though investment including in networks, renewa- bles and metering" – though according to the SCI, non-wholesale contributions to the energy supply cost base have been minimal over the past 12 months (see graph). Individual cases aside, the response to the SCI in the national press shows that sup- pliers can still expect the release of market data by the regulator to lead to a lashing. Headlines following the release of the SCI focused on Ofgem's "warning" to suppliers. However, suppliers have grudgingly wel- comed the metric as a boost to transparency in a market that sorely needs customer trust. Suppliers were no doubt relieved that this quest for openness did not once again seek to measure profitability, although this may be short lived. At Utility Week's Energy Cus- tomer Conference on 19 January, CMA energy investigation chair Roger Witcomb reopened the issue of energy company profitability say- ing that "incredibly opaque" and inconsistent reporting is a source of mistrust in the market. Ofgem has invited feedback on how it can improve the effectiveness of its many market metrics. It may well yet be required to revisit its methodology for measuring whether sup- pliers are charging more than is fair. +6.0 0 2 4 6 8 -2 -4 -6 -8 +6.6 -0.5 -0.3 -0.2 +2.9

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