Innovation in energy and water – Keeping out of the way or aiding experimentation: What’s an appropriate role for Government and regulators?

Sharon Darcy summarises the latest New Energy and Water Public Interest Network (New-Pin) thinking on innovation.

Innovation is a hot topic.  In this period of significant economic, social and political uncertainty, and powered by big data and new technologies, experimenting with new ways of doing things is in itself becoming the ‘new normal’ in many walks of life.

The energy and water sectors are not exempt from this change.  External and often global threats, driven by digitisation and evolving customer expectations but also demographic and climate change, means that the counter-factual to many new ideas is not necessarily the status quo.  To provide short and long-term affordability and resilience, new ways of doing things may be needed.

Innovation in energy and water poses some specific challenges.  Markets can help innovate in many areas in the sectors.  However, even markets need frameworks and rules.  On their own, markets are also unlikely to innovate around certain desirable public interest outcomes, including long-term resilience, fairness and place.  And when there are monopoly activities, and / or imperfect competition, as is frequently the case in energy and water, the extent of innovation may be limited.

Government and regulators have a difficult tightrope to walk here.  Innovation is not an end in itself and is frequently a journey of discovery.  Keeping out of the way may allow ideas to flourish but these may not meet public interest outcomes.  Intervene too early or too generously and accusations may follow of picking winners or actually creating new barriers to doing things differently.

Getting this right is difficult. Innovation will not always work and Government and regulators are acutely aware of the risks of failure in services that directly impact on consumer, environmental and economic wellbeing.  They also know that to get people to take innovative risks, they need to be rewarded.  The public don’t like monopolies in particular making profits and may not support them being given the time and space needed for experimentation.

Government and regulators recognise these challenges and are starting to address them through vehicles such as the Clean Growth Strategy. New-Pin has identified four questions that may be worthy of further consideration as they review their approaches to innovation in the sectors.

First, is appropriate focus being given to consumer facing, commercial and institutional innovation?  Much of the existing Government and regulatory focus on innovation is on technology (often still in terms of ‘grey’ assets). Given the recognition of the need for greater flexibility and a more active demand side in energy and water, encouraging consumer facing and commercial innovation is becoming increasingly important in itself, and as a way of enabling technological change.  Greater focus on institutional innovation may also be needed.  Energy and water provide services that are frequently connected and are part of more complex systems.   Change in one area is likely to impact on change elsewhere. Institutions may need to evolve if they are not to become a brake on new ways of doing things.

Secondly, given the potential distributional impacts from disruptive innovation, and the possible low public appetite for change, should Government and regulators play a more active role in innovation where this is the case?  Existing approaches to innovation have largely been successful at encouraging incremental innovation.  Such an approach may not be sufficient to deal with some of the significant future challenges facing the sectors.  In energy, there is sight of a burning platform – driven by the low carbon transition – which may require a more transformative approach to change.

If transformative innovation is needed, there are likely to be winners and losers, raising ethical questions for wider society.  This may mean that accountable Government and regulators may need to play a greater role in innovation in these areas.  Government and regulatory action may also be needed if the public appetite for disruptive change is limited given the essential services that the sectors provide.

Thirdly, what more can Government and regulators do to look at innovation ‘in the round’ and avoid duplication or confused / contradictory signals?  We’ve developed a New-Pin Tool Kit to help do this. This builds on existing thinking from the UK Regulators Network but looks at the roles and responsibilities of Government and regulators together rather than just focusing on regulation.

The New-Pin Tool Kit highlights the need for Government to frame the challenges, identify desired outcomes and signal priorities in a strategic way.  It proposes that

Government signals need to meet the test of Sustainability First’s ‘5 Cs’: culture of innovation supported; clear high level challenges and priorities flagged for short, medium and long-term; co-ordinated and joined up between Government and regulators; collaboration enabled with clarity as to when this can and can’t be done within competition law constraints; and consistent over time with an adaptive approach helping ensure any interventions are more ‘predictable.’

The Tool Kit goes on to explore the enabling frameworks that Government and regulators can create to facilitate transformative change in the sectors that can help simplify, clarify and better communicate the basic ‘rules of the game’ to help existing players seize the day and new entrants and capital come in.  It then examines the incentives and funding mechanisms that can support disruptive change. Lastly, the Tool Kit identifies that direct interventions to enable transformative change may be needed in certain areas if existing licences and vires for both monopolies and retail activities restrict innovation.

In addition to the Tool Kit, New-Pin has identified ten principles for Government and regulators to consider when considering an appropriate and holistic approach to innovation in the sectors:

  1. Innovation activity needs to be focused, inter al, on the desired long-term public interest outcomes.
  2. Incentives for innovation need to align with these outcomes.
  3. Interventions for innovation activity need to incentivise collaboration across and between systems.
  4. The outcomes sought should be framed in terms of tomorrow’s problems, not todays and focus on long-term objectives.
  5. Access to innovation support, incentives and funding needs to be transparent, simple, clear and coordinated.
  6. The timing, form & durability of any innovation interventions need to be clear. Any interventions should be time limited.
  7. To enable evaluation, innovation activity needs to be measurable. It is important to be able to: identify the counterfactual (the world doesn’t ‘stand still’); and honestly assess the positive and negative quantitative and qualitative impacts of the innovation activity (including around cultural change / lessons from failure).
  8. The potential distributional impacts of any innovation interventions need to be recognised and taken into account by Government and regulators.
  9. Clear red lines are needed of where interventions for innovation do not serve the wider long-term public interest / are outside the public ‘risk-appetite’ for change.
  10. Government/regulators need to be able to articulate what success/failure look like in terms of innovation in the sectors.

The final question that New-Pin’s work has raised is whether sector specific factors fully explain the differences in approach to innovation in energy and water. BEIS and Ofgem are together allocating significant funding to innovation in energy and have a range of mechanisms to support transformative change in the sector (eg the Innovation Link and the Network Innovation Competitions).  Much of this is due to the need to prepare for the low carbon transition and the fact that the energy network and retail market are nation wide.  Water is clearly in a different place here.   Significantly less funding is being allocated to innovation in the sector. If it too faces a burning platform, however, particularly in resource-constrained areas, calls for a different approach to innovation may grow.

A New-Pin workshop on innovation was held in November 2017. The resulting briefing and discussion papers on this topic can be found on the Sustainability First website.

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With board effectiveness under the spotlight, how should energy and water companies respond?

Future success for an energy or water company depends on the board’s firm grasp of consumer and wider stakeholder requirements today – and a clear future view of how those needs are changing given more flexible, responsive and decentralized models of service delivery.  

 Sharon Darcy shares the key conclusions from Sustainability First’s latest review of how energy and water companies bring the long-term public interest to the board table.  Part of our New-Pin programme, this work draws on interviews with 26 senior colleagues in the energy and water sectors.  It includes a ten-point check-list specifically designed for energy and water companies to assess how effective their board is in meeting future customer and wider stakeholder needs.

Corporate governance is very much a live issue across the economy.  Twenty-five years after Cadbury, there is growing concern that many UK companies still give too much weight to short-term interests.   Current approaches to board effectiveness are also being disrupted by wider societal change.  Diminishing trust in business in general, and the particular complexities this poses for regulated sectors, adds to this challenge.

Change is afoot.  The Financial Reporting Council is carrying out a fundamental review of the Corporate Governance Code and updating their board effectiveness guidance.  In August, BEIS promised secondary legislation regarding Section 172 of the UK Companies Act.  For some time, Section 172 has provided a lever for listed companies to address wider stakeholder needs and focus the business on long-term stewardship.  The proposed changes will increase the pressure on all large companies to review their corporate governance arrangements and ask how effective they are in delivering wider stakeholder outcomes.

These issues clearly have a particular resonance in energy and water where companies deliver essential services and are stewards of critical infrastructure.  A focus at board level on meeting future customer and wider stakeholder needs, including those of the environment, is therefore vital.

Boards will clearly behave in their own fiduciary interests.  However, those that fail to adapt will not be able to maximise the opportunities of the new ‘smarter’ world and even risk failure.  A more proactive stance by boards that seeks to shape and influence technological and structural change in the sectors is therefore essential.

Companies are already doing much good work in this area and there is good practice out there.  However, societal and political demands are increasing. There is a distance to go before some can provide sufficient evidence that they are ‘doing the right thing’ in terms of long-term public interest outcomes. Regulation is also evolving, with PR19 in water, the introduction of Principles-Based Regulation and price caps in energy retail and early thinking on RIIO2 for energy networks.

Sustainability First’s analysis shows that energy and water company boards face three major challenges in meeting future needs:

Challenge 1 – How to demonstrate that total returns are ‘acceptable’

The monopoly characteristics of the sectors and short-comings with retail competition make this the key challenge for board effectiveness in energy and water.  Boards need to be able to demonstrate to regulators and the wider public that they have heard the views of their stakeholders and responded appropriately, that they understand the fast changing societal and ecological context in which they operate and that ‘future customer’ requirements sit at the heart of their decision-making.  Acceptable returns ensure a fair balance of interests across different stakeholders; in business plan submissions to regulators for monopolies and when considering pricing strategies for a particular geography / country for retailers.

Challenge 2 – What boards can do to build better regulator/company relationships

The complex, and sometimes disputed, web of responsibilities in the sectors along with opaque group structures can lead to an undue compliance mind-set and company inertia.  Relationships between companies and regulators need to mature.  Companies that can demonstrate they are ready for more autonomy should be given more space to lead. Energy and water regulators should work with the Financial Reporting Council and investor groups as they implement the BEIS corporate governance reform programme and re-set the framework for company / regulator dialogue to focus on strategy and the ‘big’ picture.

Challenge 3 – The important role of the Non-Executive Director

Around the energy and water board table, NEDs have a key role in providing assurance on the delivery of long-term customer outcomes, fulfilling fiduciary duties and dealing with political and regulatory risks. These risks are already high as companies face a step change as they adapt to climate / technological transition.  This needs more board level focus.  Chairs and NEDs need to be able to show that they have responded in a fair, transparent and accountable way to future customer requirements to ensure their approach to governance is fit for the future.

Sustainability First energy and water ten point check-list: How effective is your board in meeting ‘future customer’ & wider stakeholder needs?

Sustainability First has developed the following ten point check-list for the boards of energy and water companies to use to assess how far they meet future customer and wider stakeholder requirements:

  1. Within your corporate structure, is it clear where responsibility sits for current and future UK customer needs across each part of the ownership chain?
  2. How does your TopCo (or equivalent board) demonstrate due consideration to ethical / fair behaviour and conduct and how to deal with different interests – current / future consumers, the natural environment, different communities in which you operate etc?
  3. How are you strategically engaging with your customers and wider stakeholders to ensure your board risk appetite is appropriately aligned with the public interest and your risk framework captures any resulting issues?
  4. Does your board have an agreed set of criteria as to what it means to be a ‘respected corporate citizen’ in the water or energy sector (eg in terms of gearing, tax etc) and does it assess how it measures up against these?
  5. What is your board doing to ‘reclaim strategy’ and move from an undue focus on compliance and to demonstrate that you are embracing the spirit of Section 172 of the Companies Act (even if not listed), acting as long-term stewards for the company and the sector?
  6. Where appropriate, are you developing ‘safe spaces’ for board/regulator and board/sector dialogue, to discuss difficult issues such as the level of regulatory intervention / company autonomy and wider sector responsibility?
  7. What is your board doing to create effective feedback loops to link the different parts of the complex system in which you operate?
  8. Does your board have the appropriate skill-mix to understand current and future customer and wider stakeholder needs and does director induction sufficiently cover these issues?
  9. How does your board set ‘the tone from the top’ to ensure that public interest values percolate down throughout your business, that staff are engaged on these issues and that reward and recognition practices take these into account?

The public is increasingly open to radical and new ideas for the energy and water sectors.  How does your board address not just opportunity, but also ‘difficult’ risk (eg public ownership, difficult relationships)?

Why we need a blueprint for Tomorrow’s World

Stine Wilhelmsen, Common Vision Energy and Water Millennial Working Group

What will citizens need and want from future energy and water systems, and what changes are required for their expectations to be met?

This heading set the scene for ‘Tomorrow’s World’ – a one day workshop jointly led by Sustainability First and the National Infrastructure Commission – in which the speakers did their best to set the scene despite the plethora of known unknown clouding the horizon. What will the regulatory landscape look like post-Brexit? In what ways will smart technology continue to revolutionize the utilities industry? How will climate change impact our water and energy security?

When Common Vision invited me to come along to the workshop I was intrigued by the opportunity to hear how representatives from the water and energy sector, regulators, and organisations representing rural communities, low-income households, and the older generation viewed future opportunities and challenges.

Minutes into the first panel, I was struck by the fact that there’s no one-size-fits-all solution for future energy and water demands. People will continue to need and want different things, depending on where and how they live. Whereas millennials growing up in the digital era might get excited about the premise of smart technology controlling their heating, a pensioner could get equally worried about the demise of familiar services. To avoid leaving anyone behind the water and energy industry needs to provide affordable, tailored solutions for all pockets of society.

Generation rent

This rings equally true for initiatives aiming at engaging people in reducing water and energy consumption – a vital aspect of meeting carbon emissions targets. Campaigns encouraging people to invest in energy and water efficiency measures such as insulation is likely to fall flat on an audience of Generation Rent-ers used to moving house every 6 – 12 months.

As an additional 1.8 million households joins the pool of private renters by 2025, finding ways to a) support renters in making their rented properties more energy and water efficient, and b) incentivising landlords to invest in long-term solutions, becomes increasingly important.

The muggy minefield of renting means that many tenants will be deterred from investing in efficiency measures. Even in our group discussion we were unsure about what rights renters had when it came to switching energy providers, or installing a water meter. By 2025, more than half of 20 – 39 year olds will be faced with this issue.

Considering that 90% of households will still be older properties in 2030, the government and the industry should both take responsibility for informing renters of their rights and incentivising landlords to improve the energy and water efficiency of properties.

A millennial perspective

Despite the improbability of ever owning a property, all is not lost for the millennial generation. As the first generation to grow up as digital natives we’re more likely to accept new technological solutions such as smart meters and appliances. This technology bears promise of more personalised services and more efficient use of resources.  In fact, energy demand has fallen by 7% in the last decade, despite population growth. This is promising news for a generation faced with the looming threat of climate change’s impact energy and water security.

This brings me to the third take-away from the day. It is predicted that we’ll see an average temperature rise of 2°C in SE England by 2040 if emissions are not reduced. This means more unpredictable weather; wetter winters, drier summers, as well as increased risk of flooding, drought and heat waves. With this in mind, we need industry leaders to present blueprints for a decarbonised, secure energy and water sector, or plans for innovative behaviour change campaigns. The speakers at the ‘Tomorrow’s World’ workshop did a good job of painting a picture of the challenges ahead, but we still have a way to go in finding solutions to these.

Luckily, there’s loads of simple things we can all do to become a more “ideal” energy and water household, while we wait for the industry and regulators to come up with solutions.

Here’s the 3 things I’ll start with so please join me in shaping tomorrow’s world:

  • Be smarter. Luckily, we’re all responsible for the energy we use in our homes. Figures such as 150 litres of water per day, or 34.82 MWh (3 tonnes of oil equivalent) of energy per year, can be hard to comprehend, but what’s worth remembering is using less energy and water can be fun, simple and save you both money and time. Go through your daily routine & choose some hacks that works for you. This might be ordering a free water saving shower head from your water supplier or switching your lightbulbs to LED. A quick Google will lead you to loads of tips, or get started at waterwise.co.uk or www.energysavingtrust.org.uk.
  • Make the switch to a green energy provider. Even if you’re renting this is super simple, and can help save you money too. There are several 100% renewable energy providers out there, including Good Energy, Ecotricity and Bulb. Visit thebigdeal.com to find out more.
  • In line with the ethos of “Tomorrow’s World” workshop, a solution shared, is a solution doubled, so speak to your flatmates, friends, family, and get them involved in curbing their water and energy use.

 Sustainability First has produced a consumer focused check-list for change for use by energy and water companies, regulators and Government when engaging with stakeholders and planning future services.  The check-list,  ‘Tomorrow’s World for Energy and Water: What will consumers and citizens want in 2030?’  is now available on the Sustainability First website.  Two Common Vision videos from the Tomorrow’s World Workshop can also be viewed from the website: ‘Energy and water in 2030: Different groups and different needs’; and ‘Building citizens awareness of energy and water: A view from millennials’.

Tomorrow’s World: A sustainable future for the next generation?

Rachel Taylor, Common Vision

What do customers and citizens need and want from future energy and water systems, and what changes are required for their expectations to be met? This was the topic of an event hosted by Sustainability first and the National Infrastructure Commission in July 2017, for which Common Vision convened a “millennial working group” to participate.

To ensure that we are able to continue using energy and water which meets our evolving needs and requires minimal lifestyle changes by 2030, we must begin enacting change now. These sustainable alternatives must take into account the challenges posed population growth, an aging population and climate change – to name a few examples.

Our energy and water systems provide us with the essentials we use and need in our everyday lives, from powering our mobile phones and heating to our showers, baths and drinking water. The provision of energy and water affects all groups in society regardless of background, income or age bracket yet, different groups do have different needs; all of which must be addressed when designing our plan for the future.

For low-income groups, the so-called ‘poverty premium’ is a major concern whereby the poorest in our society often end up paying more than higher-income households for essential goods and services. It is not surprising then that the primary needs for low-income groups were affordability and tariff consistency. Organisations such as the Joseph Rowntree Foundation have been active in this area, calling on the government to do more to help identify and tackle poverty premiums where they arise, especially in light of forecasted inflation. The elderly, as well as those living in rural areas across the UK, have in some cases also fallen victim to the poverty premium if, for example, they are not online and lack the means to acquire the information which would help them explore cheaper or greener options. This clearly demonstrated the need for better information provision, both online and offline, for these affected groups.

As well as this, the increasing life expectancy of the elderly population in the UK is indeed a cause for celebration but it also brings challenges which require us to ensure our future world is adaptable to the physical and mental ailments of this group. We must also not forget that those living in the countryside are the ones often subjected to the impact of new infrastructure developments which need its extra space. It is therefore important to listen to the insights and needs of this group in designing non-intrusive alternatives for the future.

Amongst these different views and voices, what perspectives do millennials bring to the table? Millennials are not only the leaders of tomorrow, but are increasingly, the leaders of today which leaves them with a critical role in shaping the future of energy and water. Not only will they be consumers but will also be leading energy and water companies and systems going forwards. The priorities of our millennial group for in designing these future systems were centred around sustainability, affordability and capacity.

Firstly, millennials are seen as being more environmentally conscious and driven by their personal values when it comes to making choices about utility providers, purchasing certain brands and choosing an employer. This is where in catering to the needs of millennials, energy and water companies can make gains in terms of business benefits.

Secondly, affordability is an issue for many young millennials who are still finding and settling into their careers or living in expensive cities with high rents. Exacerbating this, research suggests that millennials are earning less than the previous generation, an unprecedented trend. Considering these factors, it is important that we ensure there is not a trade-off between sustainability and affordability in choosing a utility provider especially where the common goal is to work towards a more sustainable world.

Thirdly, a common theme which emerged throughout our discussions was the capacity for millennials to act upon their environmentally-friendly values. The high instances of renting among this cohort was cited as the biggest barrier. In a society with increasing costs of living, inflated house prices and lagging wages and job opportunities, getting a foot on the housing ladder has become an impossibility for some. At least, it is not as easy a task as it was for their parents’ generation. This has led to the creation of ‘Generation Rent’ and the number of people under the age of 40 living in rented accommodation is only expected to continue increasing between now and 2025. Those living in rented accommodation have a lot less freedom and incentive to invest in energy and water saving measures such as installing smart meters, insulation, solar panels or low-flow water fixtures. In addition, and is especially the case for many student properties, in flats or houses where bills are included in the price of rent, it is likely the tenants will not even be aware of their provider much less have the motivation to investigate the sustainability policies of these providers. It is unlikely that ‘Generation Rent’ will transform into ‘Generation Buy’ any time soon, therefore, a possible solution to this could be to create incentives for landlords to ensure their rented properties meet certain standards. Undoubtedly, implementation of this would require the attention of policy-makers and the introduction of new government legislation and regulations.

Aside from this, for millennials, choice and trust were also important. This requires better information provision from both suppliers and government as well as being reliable and actively responding to the needs and values of the consumer.

In addressing the needs of all groups, there appeared to be space for collaboration between sectors in ensuring consumers have access to affordable, sustainable and user-friendly services. Meanwhile, technology has also begun to play a role in innovating the way we use and consume energy and water from smart meters to local level initiatives. However, there is still a long way to go in ensuring that the provision and levels of consumption of energy and water are future-proofed and respond to the needs and expectations of our diverse society. To ensure this journey continues, we must engage and respond to the needs of all sections of society from poorest to the richest, urban inhabitants to rural inhabitants, the old and the young.

Sustainability First has produced a consumer focused check-list for change for use by energy and water companies, regulators and Government when engaging with stakeholders and planning future services.  The check-list,  ‘Tomorrow’s World for Energy and Water: What will consumers and citizens want in 2030?’  is now available on the Sustainability First website.  Two Common Vision videos from the Tomorrow’s World Workshop can also be viewed from the website: ‘Energy and water in 2030: Different groups and different needs’; and ‘Building citizens awareness of energy and water: A view from millennials’.

Martin Cave speaks on fairness in energy pricing at Gill Owen Memorial Lecture

Sustainability First organised a memorial lecture on 17 July 2017 In memory of Gill Owen. The lecture was given by Prof Martin Cave OBE, a former Warwick Business School colleague of Gill. Martin’s very fitting, and highly topical, lecture subject was ‘Distributional and Competition Aspects of Energy Pricing’.

Starting from the essential nature of energy for households, the fact that energy accounts for a larger proportion of expenditure for poorer than for richer households and the estimate of detriment identified in the recent CMA investigation, he described a methodology for approaching distributional fairness.  He then went on to consider how innovation and smart meters could help vulnerable customers and to discuss responses to the CMA investigation, including proposals for demand-side remedies and price caps.

An internationally renowned economist, Martin specialises in competition law and the regulation of network industries, especially the communications sector. He is currently a visiting professor at Imperial College Business School and is also a member of the UK Competition and Markets Authority.

As many people commented at the event, the topic would have been close to Gill’s heart and she would have enjoyed immensely debating the issues with Martin.

Sarah Harrison, a Sustainability First Trustee and former Senior Partner at Ofgem responded to the lecture.

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Market magic in the energy and water sectors: all that glitters is not gold

Sustainability First’s New Energy and Water Public Interest Network (New-Pin) has been exploring how far market-led approaches can deliver our desired long-term public interest outcomes in energy and water.  Sharon Darcy shares some of the thinking from the recent New-Pin workshop on this topic.  Although energy and water are at different ‘moments’ in terms of their experience with markets, many of the lessons from the workshop are generic across the sectors.

Markets can deliver many benefits – they can reveal new information and bring in new skills and partners leading to innovation, efficiency, and more responsive and flexible services.  However, they are not risk free.  Markets by their very nature create winners and losers; whether this is individuals (who may or may not be vulnerable) who are expensive to serve and therefore less likely to be targeted by marketing departments or companies that in a dynamic competitive environment may quickly find themselves with stranded assets.

The New-Pin Network has identified six possible desired long-term public interest outcomes for the energy and water sectors: value for money; quality services; cleanliness; resilience; ‘place;’ and fairness.  Market-led approaches can deliver against most of these outcomes but not necessarily all of them.  And even when they can be beneficial, in these sectors, along with many others, they need clear frameworks and rules if their effectiveness is to maximised.

Working out how to capture the beneficial ‘magic’ of markets whilst also being prepared for the potential pitfalls requires clear thinking and careful communication. Given the fact that markets are unlikely to emerge spontaneously in these sectors, and will require some degree of oversight and planning, it is clearly important that market-led approaches are focused where there is a need, and opportunity, to do things differently.  Being clear about whether there is a case for change (such as new technologies coming on stream), and if there is consensus that there is a problem and what the possible solution is, is a first step.

Focusing market-led approaches where the net benefits are greatest is also important.  Although markets can have beneficial ‘trickle down’ and indeed ‘trickle up’ impacts, and can drive wider behaviour change across the sectors, not all ‘knock-on’ impacts will necessarily be beneficial.  And introducing market-led approaches can be tremendously time-consuming.  There is likely to be an opportunity cost involved.  Paying heed to where the greatest costs in the sectors lie would seem sensible when deciding where to target activity.

All too often, discussions about markets get stuck on questions of competition in the market and giving individual consumers the choice of providers.   There are clearly a far wider range of market-led approaches available in the sectors than the opportunity to switch suppliers.  These include competition for the market (such as auctions) – as well as approaches that enable local co-operation and collaboration.  Choosing the right mix of approaches to deal with each part of the value chain, whilst recognising the environmental and social externalities and systemic risks in the sectors, is important.

Markets struggle to deliver fairness and ‘place.’  It is therefore vital that policy makers and regulators are clear about what they will do about winners and losers in advance of introducing change.  The sectors, after all, provide essential services with very limited substitutes.  Understanding whether they will put protections in place up front, or only once problems emerge, can help manage expectations and enable all stakeholders prepare for change.

In the end, however, part of the magic of markets is that they are dynamic – a journey.  As no one knows what the final destination will be, building consensus on the rules of the road up front, and how to respond to the ‘bumps’ along the way as they emerge, is essential.  Stakeholders need to agree what the red lines and risk tolerances are and what they will do when events happen.

Lastly, in order to maintain public trust in a changing market environment, it is important to engage those that will impacted on how you will monitor behaviour, enforce rules and explain decisions.  Communicating why you are doing things – even if it is a decision not to intervene – is vital for such essential services.  Learning the lessons from market-led approaches and transparently sharing these insights not only helps refine future approaches but crucially also builds public confidence and hence reduces political risk.

A detailed slide deck providing information on the theory and practice of market-led approaches in the sectors, different perspectives on the issue and spider diagrams illustrating how far market approaches can deliver on our long-term public interest outcomes is available here on the Sustainability First web site.

Being fair to ‘sticky’ energy customers – both now and in a ‘smarter’ future

Thursday’s backbench Commons debate on energy prices has prompted politicians and others to consider a number of possible alternatives to the remedies made by the Competition and Markets Authority (CMA), following their investigation last year into electricity and gas prices.  Around 70% of domestic energy customers remain on energy companies’ Standard Variable tariffs (SVTs) and could save up to £200 by switching to a cheaper deal, but nevertheless decline to switch.  In a new Sustainability First paper, I have argued that any potential solution to customer ‘stickiness’ needs to be measured against two key objectives  designed to ensure that any remedy adopted is fair to all customers.  My two ‘tests’ are:  (1) that the arrangements encourage companies to price competitively and to innovate to meet the changing needs of the market, and also (2) that they avoid particularly unfair pricing for any domestic customer or group of customers.

The CMA remedies broadly deliver on the first of my two objectives by removing some previous barriers to increased tariff innovation. But the CMA only delivers on the second to the limited extent of providing protection through a price cap to customers on prepayment meters.  For the roughly 50% of households that are able to engage in principle – but for whatever reason choose not to – the main CMA remedy is to provide those customers with more information about energy pricing and switching.  The CMA does not seem to have looked across to thinking from the Financial Conduct Authority, who recently said, in its Future Mission Statement:

‘Public policy makers have traditionally assumed that people will make the ‘right’ choice for their needs if they are given as much information as possible… Our own research has also shown that that too much information can confuse consumers’.

Customers are being encouraged by the Government and regulators to become more engaged not just in their energy bills, but in choosing their retail bank and making financial provision for their retirement, to mention just two.  But is this the right approach?  Each of these activities takes time and effort, and many people will want a ‘good enough’ solution, not necessarily the absolute best.  If people choose not to make the effort, does this mean we leave them to the consequences of their inaction, particularly where essential services are concerned? Or do we seek to avoid anyone being particularly unfairly treated or exploited?  This is why both of my key objectives are important  – both to encourage competitive pricing and to avoid unfairness.

None of the  solutions proposed so far to tackle customer ‘stickiness’ – either by the CMA or others –  fully meet my two objectives.  One that seems to me to come closest, assuming there are no radical changes in current market arrangements, is in two parts.  First, as proposed by Dieter Helm, energy suppliers offering an SVT should make public for scrutiny by customer watchdogs and other commentators the margin they anticipate making on it.  This would seek to deter companies offering cheap deals to engaged customers at the expense of those on the SVT.  Second, the evidence suggests that in reality many customers actually prefer an SVT and, if switching, would opt for their new supplier’s SVT.  But, in contrast to switching to a 12-month fixed price deal, no price protection is afforded in moving to a new SVT.  As we have seen in recent weeks,  price increases by one energy company tend to be followed fairly quickly by the others. It is possible for a customer to get caught out by switching to a company that has not yet put up its price but is about to.  In my paper, I therefore suggest that price comparison sites should also start to include the date on which the SVT was last changed.  Although far from perfect, it may, by  requiring transparent information on the last price increase, at the very least offer the consumer bodies some insight into whether a new price increase might be in the offing – and so might help confidence in the switching process.

There are also lessons for the future.  The Government’s plans for a new ‘smart’ energy world with smart meters and greater customer flexibility assumes that customers will respond to better information and greater price differentiation by changing their energy purchasing and usage patterns in response to time-of-use or other ‘smart’ tariffs.  If the experience of stickiness in today’s domestic energy market is anything to go by, this could be a hard sell with many customers.  More research is needed on the likely response of typical customers, and not just the enthusiastic minority.

The Sustainability First discussion paper – “Engaged, or just good friends? – An exploration of retail electricity and gas pricing and ‘sticky customers’” –  is available on the publications page of our website – www.sustainabilityfirst.org.uk.

Jon Bird
Associate, Sustainability First