Giving the FD power to shop around

By the end of next year the Thatcherite vision of a fully competitive energy market in the UK will be realised. Businesses and households of all sizes will have the freedom to “shop around” for the best deals on gas and electricity, taking advantage, in theory at least, of cheaper prices and improved quality of service.

Not only will electricity consumers be able to choose from among existing companies, but new suppliers to emerge may include supermarkets, insurance and oil companies.

So far, an estimated 90% of medium to large energy users have made savings of up to 20% on their energy bills as well as benefiting from other service improvements as a direct result of competition. With full competition in both gas and electricity markets being gradually phased in over the next 18 months, small businesses and domestic consumers can also look forward to substantial savings.

But the deregulation of the energy markets has not been without its problems and there is concern among consumer groups that the electricity industry is not ready to cope with the expansion of the open market from 55,000 to 22 million consumers.

Don McGarrigle, chairman of the Major Energy Users Council’s electricity group, warns of the potential for “mayhem” when the regional electricity companies (RECs) face up to the vastly expanded market. He believes there is a danger that many of the teething problems with metering, registration and billing systems which occurred when the market was opened to 100kW consumers three years ago could resurface.

Frank Moss, energy manager of the 280-store retailing chain B&Q, agrees.

“Part of the problem during the opening of the 100kW market was the sheer volume of data the RECs needed to process,” he says. “We are talking about half-hourly meter readings – 18,000 readings a year – compared with just 12 monthly ones previously. With the market increasing to 22m consumers, I can’t believe that size of step is not going to be without its difficulties.”

Apart from the cost reductions already apparent in the energy markets, supporters of deregulation can point to the tremendous success of the opening of the telecommunications market to argue their case for fully open competition. Since 1984 over 200 companies, many of them US cable companies, have been granted licences to provide telephony services in the UK.

British Telecom is understood to be losing between 50,000 and 55,000 customers a month to competitors such as AT&T, Energis, Ionica and WorldCom.

At the same time BT has been successful in luring back several thousand customers a month by broadening its range of service options to customers.

For consumers this has meant reductions in tariffs of 50% across the board over the past 13 years and better facilities, while the telecom companies have been forced to become more innovative, efficient and responsive to customer needs.

Competition in the electricity market dates back to 1990 when the market was opened for the UK’s 5000 1MW-plus consumers, including large concrete, steel and chemical manufacturers. In 1994 100kW-plus users – whose annual bills are typically above #12,000 – were also given the freedom to choose a second tier supplier, that is a supplier other than their local REC.

From April 1998, households and small businesses will join the market.

It is expected that competition will be phased in across the country in several stages on a system of nominated postcodes. Corporate users who already have sites in the 100kW market will be allowed to participate fully in the first wave of sub-100kW competition in respect of their remaining smaller sites. In other words, a brewery which owns a network of pubs or a retailer with many small stores will be able to negotiate a package with a single supplier to cover all premises from next April.

In terms of gas purchasing, consumers of 25,000 therms and above have been able to pick and choose between British Gas and over 40 competing suppliers since 1986, while the market for consumers of between 2,500 therms and 25,000 opened in 1992 (2,500 therms roughly equates to an annual gas bill of at least #1200). Competition for domestic and small business consumers in Cornwall, Devon and Somerset was introduced on a trial basis a year ago and this was extended to Dorset and Avon last month and will include Kent and Essex from 7 March.

One of the yardsticks used to measure the success of deregulation in electricity and gas is the “churn” rate – the number of customers who have switched suppliers.

With British Gas locked into costly long-term take or pay contracts which restrict the reductions they can offer to customers, independent gas suppliers have stormed the market. According to Ofgas, independent gas suppliers now account for 71% of the commercial and industrial consumer market.

While the savings achieved by companies will vary depending on the discounts and terms negotiated with suppliers, Ofgas statistics show that the average price paid by industrial and commercial consumers has fallen from 29.79p per therm in 1988 to 13.63p per therm last year. Last month the regulator indicated the number of domestic consumers switching supplier should reach 150,000 in the next few months.

According to the Electricity Association (EA), a trade body representing all the major electricity generation, transmission, distribution and supply companies in the UK, the “churn” rate in the electricity market has also been high. It estimates that of the 55,000 consumers in the 100kW-plus range, more than half have switched to a second tier supplier. In terms of savings, EA statistics show electricity prices to industrial customers have fallen by up to 26% over the past six years, after allowing for inflation.

But representatives of major energy users, who have been frustrated with what they see as the monopolisation of prices by the Electricity Pool and the loss of the pre-privatisation discounts they had enjoyed for efficient management of energy loads, question whether the price cuts have gone far enough. The Electricity Pool’s position, reiterated recently by chairman Neil Bryson, is that the pool operates “to provide a wholesale market for electricity which aims to be fair for all participants, and to customers, including large users and individual domestic households”.

Lisa Waters, of the Energy Intensive Users Group, an umbrella body of trade associations, says the deregulation process has been “absolutely infuriating”.

“The average reduction for electricity consumers has been 2%. Given that gas prices are down 50% and coal prices are around 70% lower, and that they have shed thousands of staff, where have all the savings gone? We should have seen far more significant savings but most are being passed on to shareholders. It’s just not good enough.”

While she does not expect the opening of the domestic markets to directly affect medium to large energy users, Waters is concerned that the pre-occupation with 1998 means other issues – such as the Pool’s pricing policy – are not being addressed.

Don McGarrigle says the frustrations of big energy users must be seen in the context of the proportion of energy bills to overall operating costs.

“A big retail company might have an electricity bill of #50m-100m but that could represent just a couple of per cent of total operating costs, whereas you might have only a #10m-20m bill but that could be 20%-30% of operating costs,” he says.

“Generally speaking, if you are a customer below 5MW your costs currently would be about 15%-20% lower than they would have been prior to privatisation,” says McGarrigle. “But if you are an energy intensive consumer, say between 10-20MW, you would be still running at costs higher than what they were before privatisation.”

His view is shared by rival lobbyist Bob Spears, electricity technical adviser of the Utility Buyers Forum. “Many companies, especially those who couldn’t manage their loads and therefore didn’t get lower prices before privatisation, have unquestionably had real benefits but it has been much more mixed for the really big companies.

“Not only have we seen falls in coal and gas prices, but there has been a major improvement in nuclear performance. There have been enormous cost savings achieved but the question one has to ask is whether the customer had the full benefit of these savings?”

But the price for substantial cost savings to most companies is an even greater responsibility to monitor and manage energy contracts.

B&Q is one of many companies to have benefitted from “double digit” cost savings in its gas and electricity bills since 1994 and hopes its remaining 160 stores outside the 100kW market will achieve comparable reductions.

“There has been a reduction in the price of the commodity but an enormous increase in the workload in dealing with the negotiation of contracts, setting up accounting and billing systems and administration,” he says.

Companies which do not have in-house energy management expertise may find they need to create the role or outsource energy management. For many companies, “it is no longer so simple as staying with host supplier and waiting for the bills to roll in”.

Derek Curran, partner in charge of electricity services at Ernst & Young, believes full competition requires enormous cultural change for both customers and suppliers. On one hand customers have to come to grips with more sophisticated metering and billing systems and the concept of purchasing energy from a bewildering array of suppliers across the country. On the other, suppliers can no longer look at consumers in their regions as a captive market.

They must innovate to try to retain existing customers as well as luring others from further afield.

“At present there are still sufficient warnings signs around that 1998 will come too early,” says Curran. “The whole concept of a change of attitude to customers requires a richness of information that has never been there before, combined with the development of whole new systems. The industry is coping with a lot and I think that is sometimes overlooked. There is cultural change for the suppliers as well as for the customers.”

One whisper in the electricity industry is that a Labour government would postpone the 1998 entry date for full competition to avoid being associated with the chaos and confusion that might occur if competition is introduced before RECs are fully ready.

And while some believe the RECs would be secretly relieved if the final phase of competition was put back a year or two, the electricity companies insist they are raring to go.

London Electricity echoes many other electricity companies when it says it is “quietly confident” that it will have the systems in place to meet the challenges of 1998.

Derek Salter, corporate communications manager, maintains that apart from the technical changes, companies such as his are working to transform the traditional faceless customer-supplier relationship into something more akin to a partnership.

“What we are trying to do at London Electricity is build up longer term relationships,” says Salter. “We are moving away from a situation where customers were seen as account numbers. We now have dedicated account managers who know their customers and understand their business needs.

“As well as offering competitive prices we offer advice on energy management in the long term. We are not just saying you take the juice, you pay the bill.”

But as Graham Ward, deputy chairman of Price Waterhouse’s world energy group, points out, price continues to be the single most important factor for customers in choosing an energy supplier ahead of other considerations such as customer service or energy advice. In recent Price Waterhouse research 61% of the European electricity users surveyed said price was the major influence in selecting an electricity supplier.

“After all, the quality of the product doesn’t depend on the supplier.

Gas is gas wherever you buy it from. So it is the price and the service you receive from the supplier that will concern consumers.” Even with energy management, customers do not necessarily have to buy that service from their electricity supplier.

From the suppliers’ point of view, there may be limited attraction in winning over their rivals’ small business and domestic customers given the cost of the acquisition of a new customer (estimated at u100-u120) and the relatively slim profit margin achieved on the supply – as opposed to the distribution – side of the business.

Those who fear disorder in the open markets of 1998 might also be over-estimating the enthusiasm of small businesses and householders to switch from the “safe” option of their traditional supplier to a rival company.

After all, only about 18% of domestic consumers in the southwest of England have taken advantage of the opportunity to move away from British Gas despite the lure of cheaper bills. As 1998 looms, apathy and resistance to change of smaller users may prove to be the emollient the industry needs to ensure a smooth transition to full competition.