The terms of reference for this report concern the UK gas distribution and supply sector, comprising the downstream activities of supply to the industrial, commercial and domestic sectors.

A number of industry specific phrases are used in this report which are defined below:

Beach gas: Gas available at an onshore reception terminal after arriving from offshore production.

Interruptible gas sales: Sale of gas at reduced prices, where supply can be cut off for a number of days each year to assist in the balancing of peak supply and demand.

Kilowatt: One thousand watts.

Megawatt: One million watts (one thousand kilowatts).

Gigawatt: One thousand megawatts.

Terawatt: One thousand gigawatts.

One billion refers to one thousand million.

Some numbers in tables may not add due to rounding.

Total capital expenditure includes total capital expenditure and repex (replacement expenditure for mains and services).

Reports are researched and written by MBD’s in-house, specialist business-to-business consultants. Research is based on both an analysis of official information and on original trade research, providing both a quantitative and qualitative view of the market. MBD’s unique range of frequently updated reports provide an integrated body of ongoing research, enabling deep understanding of the prevailing trends and of the drivers of these trends based on trade opinion.

The following abbreviations have been used in this report:

From 1st October 2001, under the Utilities Act, gas pipeline companies have been able to apply for their own National Gas Transporter Licenses, so that they can compete with Transco (now National Grid Gas). In some areas, low pressure spur networks had already been developed by transporters bringing gas supplies to new, mainly domestic customers. In addition, some very large loads (above 60 GWh) are serviced by pipelines operated independently, including by North Sea producers.

In January 2005, the Gas and Electricity Markets Authority gave approval for the sale of four gas distribution networks by National Grid Transco for £5.8 billion. The four networks have been bought by various consortia, including Scottish & Southern Energy and United Utilities.

The North of England distribution network has been sold for £1.4 billion to a consortium headed by Cheung Kong Infrastructure Holdings that also includes United Utilities. The South of England and Scottish networks have been acquired by a consortium including Scottish & Southern Energy for £2.3 billion. Finally, the Wales and West Utilities distribution network has been purchased by a consortium led by Australia’s Macquarie Bank for £1.2 billion.

The distribution networks retained by the National Grid include West Midlands, London, North West and East of England. The restructuring programme focuses on bringing overheads into line with the smaller size of the retained business.

The sale of four gas distribution networks represents the biggest change to the gas industry structure since privatisation. This has implications for companies that directly use the network to supply gas to householders and businesses. It has created four independent networks that will have to interact with each other and National Grid’s high pressure NTS to ensure the continued smooth running of the gas system.

Ofgem has worked with the new independent distribution networks and National Grid in defining their roles and how they interact with the NTS, ensuring that security of supply is not diminished by the sale. The roles of the distribution networks are as follows:

• investing and maintaining their networks

• operating their networks on a day-to-day basis and responding to gas emergencies

National Grid remains responsible for the maintenance, investment and operation of the NTS system and will continue to buy or sell gas to keep the British gas network in balance.

Ofgem’s role is to ensure that all arrangements create a fair and level playing field between the independent networks and National Grid’s retained distribution networks and its NTS system. All distribution networks will remain natural monopolies subject to regulation by Ofgem. Each distribution network will be subject to a regular price control review (once every five years), which determines the allowed revenue that can be recovered through transportation charges. The separate ownership of the gas distribution businesses should enable Ofgem to compare the performance of distribution networks through this price control process.

In July 2005, NGT changed its name to National Grid. In October of the same year, Transco also changed its name to National Grid Gas.

Due to gas companies operating local monopolies, Ofgem regulates firms in the sector via price controls, which determine the amount of revenue that companies are allowed to recover from customers. The price proposals are based on historic and forecast cost assessments of the companies. Ofgem sets price controls on the four companies that operate the country’s eight gas distribution networks: National Grid Gas, Northern Gas Networks, Scotia Gas Networks, and Wales and West Utilities. The last Gas Distribution Price Control Review (GDPCR) ran between 1 April 2007 and 31 March 2013. It was replaced on 1 April 2013 by the RIIOGD1 price control. This sets out outputs that Gas Distribution Networks (GDNs) need to deliver for their consumers and the associated revenues they are allowed to collect for an eightyear period until 31 March 2021.

Ofgem has set three separate price controls to different areas of energy transportation for the control period, with a planned mid-term review after four years. The new term RIIO has been adopted, which stands for revenue = incentives + innovation + outputs. In addition to the economic considerations of price controls and the impact that they have on consumers’ energy bills, Ofgem considered a number of other strategic issues:

• the uncertain role of gas networks in a low carbon energy sector;

• the requirement to improve asset management to ensure leastcost service provision;

• ensuring the gas distribution networks play a full role in facilitating the move to a low carbon economy;

• and addressing social issues, notably fuel poverty and carbon monoxide (CO) poisoning incidents

The final determinants are broken into a number of areas reflecting the various aspects of both the gas and electricity sectors:

• Transmission (RIIOT1) – This price control relates to the high voltage transmission of electricity and the high pressure transmission of gas for the period 2013 to 2021. Gas transmission accounts for around 2% and electricity transmission around 4% of consumer bills.

• Gas Distribution (RIIOGD1) – This price control relates to the period 2013 to 2021 for companies that transport gas at a lower pressure to homes and companies for both domestic and commercial use. Gas distribution accounts for around 16% of consumer gas bills.

• Electricity Distribution (RIIOED1) – This price control relates to companies that transport electricity at a lower voltage to homes and companies for both domestic and commercial use for the period 2015 to 2023. Electricity distribution accounts for around 16% of consumer electricity bills.

The customer base for gas supply is diverse, as with any utility supply. While industrial and commercial users are able to exert a degree of purchasing power, taking advantage of increased competition in the sector, domestic customers are in a weak position to affect prices, although the regulator ensures that switching costs are low to sustain competition.

Gas supply has been divided, as a result of regulation, into the domestic and non-domestic markets. A domestic customer is defined by the Gas Act 1986 (as amended by the Gas Act 1995) as a person who is supplied with gas to particular premises at a rate that is reasonably expected not to exceed 2,500 therms a year. The domestic market comprises approximately 20 million customers and includes virtually all households in Great Britain that use gas, as well as approximately 400,000 commercial and industrial customers whose demand falls below this threshold.

The non-domestic market comprises those customers expected to take more than 2,500 therms a year, nearly all of whom use gas for commercial, industrial or power generation purposes.

Within the non-domestic market, contracts that do not allow for interruption of supply are known as 'firm'. The 'small firm' segment includes all premises where anticipated demand is between 2,500 therms and 25,000 therms a year, while the 'large firm' segment covers premises where anticipated demand is more than 25,000 therms a year. Certain large contracts are 'interruptible', allowing the gas supplier and/or National Grid to suspend supply for limited periods of time in certain circumstances. Customers may contract for an interruptible supply of gas if they have alternative sources of energy that can be accessed at short notice and because of the price advantage it offers compared to firm supply. Gas suppliers can offer lower prices for interruptible gas due to increased flexibility in balancing daily supply and demand, as well as lower transportation costs.

The power generation sector is usually considered a separate segment within the non-domestic market. Generators purchase gas using a combination of long-term (up to 15 years) and short-term contracts, which can be either firm or interruptible.

Homes and businesses across the UK have traditionally relied on gas as the most dependable form of energy. Approximately 20 million gas consumers have grown accustomed to instant, trouble-free delivery whenever they turn on a gas tap. Due to continued dependability, most did not notice the way the gas industry reinvented itself until the roll out of domestic competition. Competition has now been firmly established at the point of supply. From March 1996, the Transco Network Code was the legal hub around which the transportation of gas operated in Great Britain, owning and operating all of the major gas networks. However, this changed in May 2005 with the introduction of a Uniform Network Code, which allowed for gas networks to be owned by companies other than Transco.

The code is a legal document that forms the basis of arrangements between gas transporters and the shippers whose gas they transport. Each gas transporter is required by the terms of its Transporter’s License to prepare Network Codes and to publish a summary.

There are currently more than 220 companies that hold a gas shippers licence in the UK. The licence allows the licensee to arrange with a gas transporter for gas to be introduced into, conveyed through, or taken out of a pipeline system operated by that gas transporter. In all instances, the purpose of the gas movement should be for the supply of gas to premises. Only suppliers licensed by Ofgem can sell gas. The following activities must be undertaken by a new licencee, and only once these prerequisites are in place can it become a shipper:

• understand its rights and responsibilities under the Uniform Network Code and organise itself to operate in that environment

• arrange shipper services according to its framework agreement

• sign customers and register their premises with the relevant transporter

• arrange gas supplies. Some shippers play a trading role and choose not to book capacity

• book entry capacity from NTS and/or obtain it on a secondary market

• learn to use supporting computer systems

Transporters are allowed by Ofgem to earn a specified level of return on their assets. The large cost of building and extending these assets relates to the capacity they provide, with transporters aiming to raise a significant percentage of revenue from capacity charges. Transportation capacity is booked by shippers in three places:

• at entry to the NTS from a sub-terminal or on-shore field (entry capacity)

• at all NTS exit points (NTS/LDZ offtakes and direct connects) (exit capacity)

• and within the LDZ capacity

Shippers obtain entry capacity by bidding for it through a series of capacity auctions, ranging from a long-term release to on-the-day assessments.

The relationship between the volume of gas and its energy content is important to all gas pipelines designed to move a certain volume of gas. Shippers must therefore specify the calorific value of gas when they nominate how much they intend to input to the network each day. Calorific value is measured by calorimeters, which are situated at terminals and other strategic points around the network.

The NTS is considered the most efficient way to move large quantities of gas over long distances in a large diameter pipe at high pressure. This method is used to take gas between terminals, storage facilities, several very large consumers of gas and specific regional sites for subsequent local distribution. The high pressure network contains approximately 6,000 km of pipeline.

Gas leaves the high pressure system either via a NTS/LDZ offtake into an LDZ or directly to a consumer connected to the NTS (a direct connect). Following passage through an NTS/LDZ offtake, gas goes through a series of pressure tiers until it reaches the consumer or connected network. Each tier progressively reduces the pressure to the level required for safe operation of consumer appliances and to meet legislative requirements.

A fundamental element of the Uniform Network Code is the daily balancing regime that provides appropriate price signals to shippers so they stay in balance. This is important as if shippers are more than a pre-determined percentage out of balance, additional charges are raised.

Due to the weather, unplanned gas production restrictions and other uncertainties, it is not feasible to require every shipper to be in balance at all times. Therefore, the Uniform Network Code assigns responsibility as follows:

• National Grid is responsible for ensuring the physical balance of the total system

• Each shipper is responsible for the costs incurred to manage an imbalance in its supply and demand or a difference between its gas nominations and actual flows

National Grid is financially incentivised to take efficient system balancing actions in the on-the-day commodity market. The incentive encourages National Grid to buy or sell gas at close or better than the average price traded on the on-the-day commodity market for that gas day.

Initial estimates for Q4 2013 indicate that GDP grew by 0.7%, slightly lower than the 0.8% recorded in both Q3 and Q2. It indicates that full year growth for 2013 was the strongest in six years, but the magnitude of the economic downturn, and the flatness of the subsequent activity, means that even with such growth the economy is still 1.3% below the level of output in the first quarter of 2008.

The ONS reported that Britain’s services sector grew by 0.8% in Q4 2013, sustaining the pace of the previous three months. Production grew by 0.7%, up slightly on Q3. However, despite reports of a pickup in house building, construction contracted by 0.3% in the final three months, following strong growth in the second and third quarters.

Services contributed 85% of the Q4 growth. Within the sector, the strongest growth came from business services and finance.

The Treasury’s official forecaster, the Office for Budget Responsibility, expects growth of 2.4% in 2014. The average estimate of other major forecasters is for 2.7% GDP growth.

The UK inflation rate measured by the Consumer Prices Index (CPI) fell to 2% in December 2013 from 2.1% in November of that year. This is the first time the inflation level has reached the government set target of 2% since November 2009. The fall in December was mainly attributed to slower increases in food prices. Most economists are now expecting inflation to remain at close to the 2% target for a number of months in 2014, and this will ease what was mounting pressure on the Bank of England to raise interest rates in the light of the recovery now evident in the UK economy. While inflation was above the target, the Bank of England resisted pressure to increase interest rates, stating that it would wait until the unemployment rate falls to 7%. In December 2013, unemployment stood at 7.4%

Inflation measured at the Retail Prices Index (RPI) rose to 2.7% in December 2013, from 2.6% in the previous month.

The Bank of England's Monetary Policy Committee (MPC) continues to hold interest rates at 0.5%, and has done since March 2009.

Bank of England governor Mark Carney has said that before interest rates can rise, the unemployment rate needs to fall below 7%. That stipulation is part of Mr Carney's policy of giving forward guidance. The idea is to create more certainty for businesses and individuals about the course of interest rates, which may encourage borrowing and investment. He has forecast that it will take about three years for unemployment to reach his target, suggesting no rise in interest rates before 2016.

Consumer spending in the UK increased marginally to £244,918 million in Q2 2013, from £243,765 million in Q1 2013. This followed a substantial increase of 6% from Q4 2012, when spending was at £229,089 million, to Q1 2013.

Consumer spending averaged £124,156 million from 1955 until 2013, its current level being a record high, while the record low was £48,610 million in August 1956.

According to Barclaycard, consumer spending grew by 3% in September 2013, a level in excess of inflation for the sixth consecutive month, driven in part by strong retail spend as families continued to feel more positive about the future. Restaurant spend performed particularly well in September, with growth of 11.2%. Online clothing spend also performed strongly, as consumers updated their wardrobes for autumn and sought out the latest fashions online in advance of them hitting the high street. Men’s and women’s clothing were up 38.0% and 36.1% respectively.

Gross fixed capital formation (GFCF) is reported to have increased by £0.8 billion (1.5%) compared with Q3 2013. This reflected a significant 27% increase in investment in transport equipment in Q3, while investment in other machinery and equipment rose by 1.3%; dwellings investment remained largely unchanged; investment in other buildings and structures increased by 0.8% and other intangible fixed assets by 0.4%.

Within this, business investment rose by 2% to £30,072 million in Q3 2013, but this remained below the £31,764 million in Q3 2012.

A range of factors can be identified as affecting the market for gas supply in the UK.

The drivers of demand in the domestic sector are complex. Inevitably, the average winter temperature has a strong impact. This is outside the control of suppliers, who face difficult conditions in growing a mature, overall market. Household construction drives new opportunities, yet this is marginal in terms of the total market. Rather, penetration is already high in areas where gas is available and products such as domestic central heating enjoy high uptake, limiting opportunities to grow consumption. Moreover, there is tacit pressure on suppliers to reduce energy consumption in houses, through their own energy efficiency initiatives and from other building regulations. This has encouraged greater thermal efficiency of houses and effectively reduced average unit consumption. These factors have conspired to generate a situation where sales growth is largely achieved through supplier switching, leading to a highly competitive market. The development of the internet has also enhanced access to product information and provided a platform for price comparisons. This has contributed to the increasingly competitive trading environment in the gas supply industry and has increased pressure on profit margins.

The long-term decline of heavy industry in the UK has reduced industrial demand for gas over the long term.

In line with most utilities, the gas supply sector tends to be only moderately affected by the economic cycle and as such represents a low risk sector in terms of revenue generation. While in the most extreme downturns there tends to be a reduction in industrial demand, the industry is mostly immune to economic variation.

In the 1990s, the UK relied almost entirely on its own production of gas to satisfy demand. Gas was sourced from the UKCS, a body of water surrounding the UK over which it exercises sovereign exploration and exploitation of natural resources rights. The market was isolated from other countries and was oversupplied, keeping prices low.

However, this changed in 1998 with the opening of the UK-Belgium interconnector. For the first time gas could flow in and out of the country. The original aim of the interconnector was to enable the UK to export excess production from the UKCS to Europe. Unlike in the UK, gas prices in Europe are oil-indexed. This had a considerable impact as oil prices increased significantly at the beginning of the 21^st century, leading to a substantial volume of gas flowing out of the country as producers looked to benefit from higher prices on the Continent.

The UK’s increased reliance on gas imports

UK natural gas production has been decreasing since 2000. In 2013, UK output was some 40% less than in 2009, reflecting the maturity of existing natural gas fields. This means that the UK has become increasingly reliant on gas imports, and the country became a net importer in 2004.

As UK natural gas production has declined in recent years imports have increased, except for a temporary decline of 6% in 2012. Imports of Liquefied Natural Gas (LNG) have grown substantially, particularly since two new LNG terminals and an extension at the Isle of Grain terminal became operational in 2009. As a result, LNG’s share of total gas imports increased from a moderate 2% in 2008 to a significant 25% in 2009, 35% in 2010 and almost 47% in 2011. However, in 2012, the share of LNG fell to just less than 28%, with the volume of shipped LNG falling by 45% during the year to 147,879 Gwh. This was due to a combination of factors, such as the decline in UK gas demand in 2012 and strong competition for LNG in the global market, especially Japan following the closure of its nuclear facilities in 2011.

Total UK gas demand decreased by around a fifth in 2011 to less than 1000 TWh for the first time this millennium. Lower demand reflected warm weather – in contrast to a particularly cold 2010 and reduced demand from electricity generators. In 2012, UK demand for gas declined further, as demand from the electricity generation sector fell by a significant 30%. This was due to a recent rise in electricity generated from coal, mainly at the cost of gas-fired generation, reflecting falling carbon prices and emissions allowance costs.

Potential for shale gas extraction

The coalition government is very keen to reduce the UK’s reliance on imports and ultimately final gas bills for consumers. In a bid to move away from imported gas, the coalition government gave shale gas drilling the go ahead in 2011. A recent report from the Institute of Directors (IoD), estimated that natural gas from shale could reduce UK gas imports to 37% in 2030 from the current 76%.

Shale gas drilling, also known as fracking, is the process of extracting natural gas held in rock using hydraulic fracturing. This involves drilling into rock with a rock hammer via a secure well. Once penetrated the shale rock releases high pressure water with sand and chemicals. The process has proved highly controversial, due to concerns that the method can contaminate ground water or cause high levels of greenhouse gas emissions. However, the government gave shale gas drilling the go-ahead following an enquiry that found no evidence to support the concern that UK water supplies would be put at risk. The British Geological Survey estimates that the UK’s onshore shale gas resources could be as large as 150 billion m³, equivalent to roughly 1.5 years of total UK gas consumption.

In his 2012 Autumn Statement, the chancellor laid out plans for tax breaks for the industry and a new government office to look after shale gas. In one of the first industry deals, Centrica bought a 25% stake in a shale gas licence in Bowland, Lancashire in June 2013, bringing it into partnership with current operators Cuadrilla. Centrica paid a reported £40 million for the licence stake and has committed a further £60 million for exploration and appraisal. It is expected that drilling will occur in up to six locations in Lancashire over the next few years, commencing in 2014.

In December 2013, the government published a potential fracking map revealing that two-thirds of the UK’s land will be made available for fracking companies to licence. Ministers said major energy companies had expressed interest in new shale gas licences and up to 150 applications were expected, which could cover about 15% of the UK. Furthermore, the government commissioned a strategic environmental assessment for further onshore oil and gas licensing, which suggested that a major fracking effort would deliver about 25% of the UK's annual gas needs in its peak years in the 2020s. However, there is a high degree of uncertainty regarding the future of shale gas production, as test drilling has to first take place at potential sites to assess commercial viability. Thus the UK’s shale gas potential remains largely unknown.

National Grid Gas supports shale gas exploration and is willing to work with shale gas developers to find the most effective way to connect to the transmission and distribution network. The company is also keen to engage with shale gas producers to understand their requirements and develop a coordinated approach for allowing efficient access to the system for these new potential sources of supply. However, the gas transmission network owner has also stated that it does not yet possess enough information about the potential requirements for connections and future flows from proposed sites to assess the impact of shale gas production on the network.

Wholesale gas prices

Rising wholesale gas prices have resulted in the main gas suppliers announcing a number of price hikes in recent years. Many consumers have switched suppliers to get on a cheaper tariff in response to rising energy bills, making the gas supply industry more competitive, although the sector continues to be dominated by the ‘big six’ energy firms. The following table provides an overview of the development of wholesale gas prices over the last 10 years.

Table highlights:

• Wholesale gas prices have increased significantly since 2002, although some strong annual fluctuations are evident. Consistent annual growth was recorded between 2009 and 2013, with wholesale gas prices rising by a significant 88% during the four-year period. Previously, price spikes were also evident in 2005, 2006 and 2008.

The gas market was inevitably strongly affected by the political decision to privatise the sector and introduce competition to the former monopoly. This has been the most far reaching factor to affect the market in recent years and was supported by legislation through the Gas Act.

The impact of legislation continues under the guise of the regulator Ofgem, which is charged with ensuring that the needs of the consumer are met and that no single company abuses its market position. This involves the establishing of price regimes, which in turn affect investment levels in the industry.

The gas industry is partly affected by environmental concerns but has tended to fare well in public perception and government policy compared to other fuels. Gas-fired power stations have gained share from less environmentally friendly coal-fired stations, for example, although a reversal of this trend has been evident since 2010 as electricity from coal-powered stations has become cheaper due to falling carbon prices.

However, gas is still a fossil fuel and therefore faces pressure from renewable fuels as environmental concerns grow, although there has been little large scale economic competition in the UK to date. A brief description of some of the legislation affecting the gas market is provided below:

Climate Change Programme (including Climate Change Levy, Agreement and efficiency measures)

The Climate Change Programme is a comprehensive strategy to reduce greenhouse emissions across the UK, including measures to encourage energy efficiency. The UK government’s target, as agreed at Kyoto, was to reduce emissions of harmful greenhouse gases to 12.5% below 1990 levels over the period 2008 to 2012. The government also set a separate domestic goal of reducing carbon dioxide emissions to 20% below 1990 levels by 2010. In the 2008 Climate Change Act, the government set longer-term targets to reduce the UK’s greenhouse gas emissions by at least 50% (from the 1990 baseline) by 2025 and by at least 80% by 2050.

The Climate Change Levy (CCL) is a tax on energy delivered to nondomestic users in the UK. It aims to provide an incentive to increase energy efficiency and reduce carbon emissions. The levy was introduced in April 2001 and applies to gas, electricity, LPG and coal, but not fuel oil because this attracts UK Excise Duty. All UK businesses and public sector organisations pay the levy through their energy bills.

Climate Change Agreements (CCAs) allow eligible energyintensive businesses to receive up to a 90% discount from the Climate Change Levy (CCL) in return for meeting energy efficiency or carbonsaving targets. The current CCA scheme runs from 1 April 2013 to 31 March 2023, and is administered by the Environment Agency. Companies that have entered into climate change agreements will be able to use the Emissions Trading Scheme to help meet their emission targets. There is therefore an important link between the two initiatives. Renewables electricity is exempt from the Climate Change Levy.

Emissions Trading Scheme

Emissions trading is regarded as one of the most cost effective ways of reducing greenhouse gas emissions. The UK Emissions Trading Scheme was launched in August 2001 with the publication of a Framework Document, setting out the rules and what companies need to do to participate in the scheme.

Emissions trading works by allowing countries to buy and sell their agreed allowances of greenhouse gas emissions. Highly polluting countries can buy unused ‘credits’ from those that are allowed to emit more than they actually do. After difficult negotiations, countries are now also able to gain credits for activities that boost the environment's capacity to absorb carbon. These include tree planting and soil conservation, and can be carried out in the country itself, or by working with a developing country.

In January 2005, the EU Greenhouse Gas Emission Trading Scheme (EU ETS) commenced operation as the largest multi-country, multi-sector Greenhouse Gas emission trading scheme worldwide. The scheme is based on Directive 2003/87/EC, which came into force on 25 October 2003.

The EU ETS has been divided into a number of trading periods and is currently in Phase III, which runs from 2013 to 2020.

A number of changes were implemented for Phase III, including:

• A centralised EUwide cap on emissions. The cap will decline by at least 1.74% a year, so that emissions in 2020 will be at least 21% below 2005.

• The scheme will include the production of all metals (including aluminium). For some sectors, it will include the emission of other greenhouse gases in addition to carbon dioxide.

• DECC has introduced an optout provision for small emitters and hospitals in the UK, allowing them to move to a more lighttouch scheme with lower administrative costs (which hit disproportionately smaller companies). The optout will deliver an equivalent carbon reduction.

• At least 50% of allowances will be auctioned from 2013, rather than given to installations. Use of Clean Development Mechanism (CDM) allowances will be more tightly restricted to no more than 50% of the reductions required.

Combined Heat and Power

Combined heat and power (CHP) is a highly efficient process that captures and utilises the heat that is a by-product of the electricity generation process. By generating heat and power simultaneously, CHP can reduce carbon emissions by up to 30% compared to the separate means of conventional generation via a boiler and power station.

CHP technology is now in use in a growing number of locations in the UK. In 2012, some 1,929 CHP schemes provided 6,136 MWe of energy. Furthermore, around 69% of the total fuel used in CHP installations was natural gas, representing a small decrease compared with 2011. CHP schemes accounted for 9% of UK gas demand in 2012.

There are environmental gains from increasing CHP technology, including significant reductions in greenhouse gas emissions. Significant gains also come from the development of community heating networks, also known as district heating, which use CHP as their heating source. Although they have been well established in other countries, heating networks remain at the periphery of the UK’s heat supply, currently providing less than 2% of heat demand.

Renewable Generation Growth

The UK government is committed to meeting 15% of the UK’s energy demand from renewable sources by 2020. Renewable energy comes from continuously available sources that do not rely on exhaustible fossil fuels like coal, oil and gas. The main sources of renewable energy in the UK are wind (both on and offshore), the sun (solar photovoltaics), water (conventional hydro, and the developing technologies of tidal stream and wave) and biomass (including energy crops).

The Renewables Obligation (RO) is the main support mechanism for renewable electricity projects in the UK. Smaller scale generation is mainly supported through the FeedIn Tariff scheme (FITs). The RO came into effect in 2002 in England, Wales and Scotland, followed by Northern Ireland in 2005. It places an obligation on UK electricity suppliers to source an increasing proportion of the electricity they supply from renewable sources. This proportion is set each year and has increased annually. RO will remain in place until 2027 to provide a stable and long-term market for renewable energy.

National Emission Ceilings Directive

This directive, which came into force on 27 November 2001, sets upper limits for each EU member state for the total emissions in 2010 of four pollutants responsible for acidification, eutrophication and ground-level ozone pollution (SO2, NOx, VOCs and ammonia). However, the ruling leaves it largely to member states to decide the measures taken to comply. The UK's annual limits for 2010 were:

• Sulphur Dioxide (SO2) 585 kt

• Oxides of Nitrogen (NOx) 1167 kt

• Volatile Organic Compounds (VOCs) 1200 kt; and

• Ammonia (NH3). 297 kt

Member states were obliged to report each year their national emission inventories and projections for 2010 to the European Commission and the European Environment Agency. They also had to draw up national programmes twice to demonstrate how they were going to meet the national emission ceilings by 2010. The UK is compliant with its 2010 national emission ceilings for air pollutants. The UNECE Gothenburg Protocol now sets national emission reduction targets, including for fine particulate matter, to be achieved by 2020.

Carbon Emission Reduction Target (CERT) and Community Energy Saving Programme (CESP)

The Carbon Emission Reduction Target (CERT), previously known as the Energy Efficiency Commitment (EEC) programme, forms part of the government’s Climate Change Programme and Fuel Poverty Strategy. The CERT programme was first introduced in 2002 (then known as EEC programme) and ran until December 2012, when it was replaced by the Energy Companies Obligation (ECO) and the Green Deal.

CERT required gas and electricity suppliers to achieve targets for the promotion of improvements in energy efficiency in the household sector, with a particular focus on helping low-income consumers, such as those on benefits, also referred to as priority groups. In CERT 2008-11, the over-75s were also included in the priority group. Ofgem is responsible for the apportionment of overall EEC/CERT obligations across suppliers, each of which is set a target for promoting energy efficiency improvements. This is apportioned based on the number of domestic suppliers, with allowances in place to reflect the potentially higher unit costs incurred by smaller companies. Critics have argued that this represents something of a confused political aim between reducing fuel poverty and meeting the environmental pressures of the Kyoto agreement on carbon emissions.

The first EEC programme, known as EEC1, ran from 2002 to 2005. The programme was extended with two separately targeted programmes: EEC2, which ran for three years from 2005 to 2008; and EEC3, which became known as CERT, running from 2008 to 2011 (subsequently extended to 2012). The target for 2005 to 2008 was around 130 terawatt hours of fuel-standardized lifetime–discounted energy benefits, more than double the target for EEC1. In May 2007, Defra published a consultation proposal on Cert 2008-11.

In the consultation paper the government proposed to:

• impose the CERT mechanism to 2011 at around double the activity of the current EEC 2005-08

• extend its scope to include, in addition to energy efficiency, microgeneration and other measures for reducing the consumption of supplied energy

• introduce new approaches for innovation and flexibility

• maintain a focus on low income consumers

The government proposed that the total CERT obligation on all suppliers for the period 1 April 2008 to 31 March 2011 should be lifetime savings of 42 million tonnes of carbon (MtC). In 2009, the CERT target was raised by 20%.

The Community Energy Saving Programme (CESP) was created as a key part of the delivery mechanism for the Home Energy Saving Programme. The CESP came into force in September 2009. Like the CERT programme, the CESP requires gas and electricity suppliers and electricity generators to deliver energy saving measures to domestic consumers in specific low income areas of Great Britain. The CESP obligation period ran from 1 October 2009 to 31 December 2012.

Following the change in government in May 2010, the Conservative-Liberal Democrat coalition announced in June 2010 that CERT will be extended from March 2011 to December 2012 with a higher target and a greater focus on supporting insulation, which will provide an additional 107 MtC in carbon savings. At least two-thirds of the increase in target must be delivered through professionally installed insulation measures, while the government has also renewed efforts to ensure that more vulnerable households receive support. Suppliers were already required to meet 40% of their total target by delivering measures to a priority group of vulnerable and low-income households, including those receiving eligible benefits and pensioners over the age of 70. The new government introduced an additional target, requiring that 15% of savings be achieved in a ‘super priority group’ of low-income households considered to be at the very highest risk of fuel poverty.

ECO replaced the CERT and CESP programmes in January 2013. Similar to the two previous programmes, ECO places legal obligations on larger energy suppliers to deliver energy efficiency measures to domestic energy users, with a particular focus on vulnerable consumer groups and hardtotreat homes. The ECO scheme operates alongside the Green Deal, also launched in January 2013, which is designed to help people make energy efficiency improvements to buildings by allowing them to pay the costs through their energy bills rather than upfront.

Under the rules of ECO, energy suppliers are obliged to help improve the energy efficiency of domestic customers’ buildings in three distinct areas:

• Carbon Emissions Reduction Obligation

Under the Carbon Emissions Reduction Obligation, energy companies must concentrate efforts on hardtotreat homes and measures that cannot be fully funded through the Green Deal. Solid wall insulation and hardtotreat cavity wall insulation are the primary focus under this target. Other insulation measures and connections to district heating systems are also eligible if they are promoted as part of a package that includes solid wall insulation or hardtotreat cavity wall insulation.

• Community Obligation

Under the Carbon Saving Community Obligation, energy companies must focus on the provision of insulation measures and connections to domestic district heating systems supplying areas of low income. This has a subtarget, which states that at least 15% of each supplier’s Carbon Saving Community Obligation must be achieved by promoting measures to low income and vulnerable households living in rural areas.

• Home Heating Cost Reduction Obligation

Under the Home Heating Cost Reduction Obligation, energy suppliers are required to provide measures that improve the ability of low income and vulnerable households (the ‘Affordable Warmth Group’) to heat their homes. This includes actions that result in heating savings, such as the replacement or repair of a boiler.

During 2013, rising household energy bills gained much media attention and became an important political issue. The ‘big six’ energy suppliers partly blamed green levies imposed on them by the government for rising bills. British Gas stated that around £112 of the average household bill is used by suppliers to pay for environmental and social costs imposed by the government through programmes such as ECO. In response to the price rises, the chancellor George Osborne announced in his autumn statement in December 2013 that the ECO scheme would be rolled back to cut household bills. The government has agreed to give suppliers four years, rather than two, to achieve targets under the scheme, with the existing support in ECO for low income and vulnerable households maintained and extended from March 2015 until March 2017. The cut means that the number of homes insulated under government energy efficiency programmes will fall from 80,000 in 2012 to 25,000 in 2014, according to the Association for the Conservation of Energy (ACE). In response to the roll-back, the ‘big six’ energy providers announced price cuts in January 2014.

The take up of loans under the Green Deal was low during the programme’s first year of operation, with just more than 1,600 households signing up in 2013. The government announced a number of proposals and changes to the Green Deal in December 2013 to boost the adoption of energy efficiency measures by both households and the public sector. The proposed new incentives and support include funding of £150 million annually for the three years from 201415, which will be designed to reward new, rather than replacement, energy efficiency improvements, dovetailing with the Green Deal to leverage private finance.

This package will include:

• A stamp duty rebate worth at least £1,000 from the government to spend on important energysaving measures – equivalent to half the stamp duty on the average house – and up to £4,000 for more expensive measures like solid wall insulation This is designed to encourage a wholehouse approach and help around 180,000 households over three years.

• Targeted investment for more energy efficient homes within the Private Rented Sector (PRS), designed to help landlords meet the minimum standard (EPC E rating) that will be required under the PRS Regulations from April 2018. Landlords will be encouraged to bring properties up to higher energy efficiency levels faster than the upcoming standards require.

• £90 million to be set aside to improve the energy efficiency of public sector buildings, including schools and hospitals, where an additional £30 million will be made available in each of the three years from 2014/15. This builds on the existing public sector loans programme.

These new schemes are due to start in April 2014.

The government also introduced some immediate changes, including the quadrupling of money available to English local authorities this year to £80 million to promote Green Deal on a street-by-street basis. Alongside the Green Deal cash back scheme, which stays open, it will incentivise the delivery of hard-to-treat cavity and solid wall insulation.

Ofgem Retail Market Review

In 2010, Ofgem launched a Retail Market Review due to concerns that the energy market was not working effectively for consumers. Following the review, a number of reforms were introduced, including binding Standards of Conduct to ensure suppliers treat consumers fairly and rules to remove complex tariffs from the market. From April 2014, new rules to improve supplier communications, such as bills and annual summaries, will also come into effect to ensure consumers have the information they need to make informed and accurate comparisons.

Ofgem also recently announced changes, effective from 31 March 2014, which should make it easier for new suppliers to enter the market and for smaller companies to compete with the ‘big six’. New rules include the ‘big six’ having to trade wholesale energy with small suppliers “fairly” or face fines, including publishing wholesale prices two years in advance, fully auditing the accounts they give to Ofgem and publishing annual statements sooner after yearly results.