Energy market outlook

As part of SSE’s Building trust initiative we made a commitment to publish information analysing the impact of wholesale market conditions and other costs on the retail price of electricity and gas. This includes an online 'tracker' showing the relationship between the different components of a typical dual fuel energy bill. Taken together, this information shows the changing components of bills so that customer can see the underlying factors influencing the price they pay for their energy. 

The information uses externally sourced data and projections for the next two years, combined with a longer term central scenario for later years. We update it approximately every three months.  

What are the components of an energy bill? 

There are a number of costs which feed directly into customers' bills. These include: 

• Wholesale energy – Suppliers have to secure electricity and gas through the wholesale markets and through bilateral contracts with electricity generators and gas producers. To secure the gas and electricity they need, suppliers will generally buy some of their energy ahead of time. If suppliers feel they will get a better deal for customers by buying ahead, they may buy up to three years in advance on forward markets. These markets are influenced by various factors, including geopolitical issues. Other wholesale energy costs include the cost of keeping electricity and gas systems balanced between supply and demand. 
• Use of system (UoS) charges – Suppliers have to pay to transport energy along wires, cables and pipes to where it is needed. The cost of using the networks is controlled through a regulatory formula managed by the industry regulator, Ofgem.  
• Government-sponsored schemes – The cost of environmental and social schemes mandated by the Government is recovered from customers through energy bills. These schemes include: Warm Home Discount (WHD), Feed-in Tariffs (FITs) and the new Energy Company Obligation (ECO). They also include the cost of Renewable Obligation Certificates (ROCs) – a subsidy to incentivise generation of electricity from renewables – the estimated impact of the European Union Emissions Trading Scheme (EU ETS) – a tax on carbon-intensive electricity generation – and, in later years, the estimated cost of Contracts for Difference (CfDs) – which will replace ROCs as the Government’s mechanism for incentivising low-carbon electricity generation. 
• Supply costs – Other supply costs include billing, customer service, metering, IT systems, bad debt, sales, marketing and other corporate costs. 
• VAT - Value added tax levied at 5% by the government. 
• Profit - Suppliers, like any business, will aim to make a profit. We expect our profit margin in energy supply to average around 5% and believe this to be a fair and sustainable amount.

The 'tracker'

The components of an energy bill are plotted on our 'tracker' graph.

The whole graph is a 'forward looking' view. Each point shows the energy cost issues relating to a customer as if they had signed a contract running for one year starting from the following month. Therefore January 2013 figures reflect the issues in respect of a customer from February 2013 through to February 2014.

The cost outlook is designed to reflect the expected path of costs. It examines the forward markets for electricity and gas and known future changes to other costs. For illustrative purposes, these costs are shown against the current level of the tariff.

The wholesale market cost is a forward-looking indicator while the accounts of the supply business will reflect the costs of past contacts. 

What the tracker is showing 

The graph shows how market-based costs and prices have evolved since January 2004 for a typical domestic dual fuel customer paying by Direct Debit. Our typical customer uses 3808 kWh of electricity and 14,159 kWh of gas a year and the tracker is based on this level of consumption.

Looking backwards, the trends from the last nine years are:

• Wholesale prices have historically been an important factor driving prices, with a lag reflecting that companies buy energy ahead of the customer using it. However other factors are becoming more important.
• In recent years, the costs of government-sponsored schemes and network (UoS) costs have increased significantly, adding to the cost of bills.
• Margins have varied, being both positive and negative at different times. Over the period since January 2004, the margin estimated on this basis has been -£2.13.

Looking forward over the next two years, our observations are:

• The current market does not indicate a strong upward pressure on costs from wholesale markets. The main risk of escalation is coming from non energy costs
• The costs of government-sponsored schemes and network (UoS) costs continue to rise and are becoming the main factor putting upward pressure costs
• Following our announcement of an increase in retail prices, effective from 15 October 2012, we have promised not to increase our energy prices again before, at least, mid 2013
• A line has been added to the graph for reference, to show how prices would move from their current level if they were indexed to the Retail Price Index.

Demand  

The size of a customer's bill is not just determined by the movements in prices. It also depends on the amount of energy actually used. The graphs below show customers have benefited from using less electricity and gas. Improvements in the energy efficiency of household technology and improved home insulation levels are important factors behind these trends.

The effect of this should not be underestimated. Using current tariff prices, bills would be £385 higher if customers continued to use the same amount of energy as they did in 2005.

Interestingly, much research into the relationship between wholesale and retail prices ignores the impact of reduced demand. This leads to an overestimate of profits as margin is attributed to sales that never happened.

The graphs show data for SSE customers. 

Outlook for demand

We would expect to see a continued reduction in gas demand over the next few years. This is as a result of energy efficiency measures installed by SSE and other companies, the efficiencies gained from the replacement of old boilers with more efficient condensing boilers, other more efficient household products and increased awareness of the cost and usage of gas.

Electricity demand is harder to predict as the impact of energy efficiency measures and increased cost and usage awareness is balanced against potential increases in demand due to increased electrical appliance usage. Electric vehicles could have an impact here if they become more widespread.

Clearly all energy demand is heavily affected by climatic and weather conditions.

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