Is Ofgem’s limited price cap the best remedy for the energy market?

Ofgem has paved the way for a limited energy price cap for the most vulnerable customers in the market, but is this the best way to remedy consumer detriment? David Blackman investigates.

Energy utilities have got used to being in the last chance saloon, ever since ex-Labour leader turned Radio 2 disc jockey Ed Miliband pledged to freeze energy bills in 2013. And it looks like their stay will be extended after Ofgem kickstarted moves to introduce a limited cap on bills.

The regulator provided scant details of how it is planning to respond to business, energy and industrial strategy (BEIS) secretary Greg Clark’s call for ideas on how to better safeguard vulnerable customers. However, the regulator’s chief executive Dermot Nolan has provided a few hints of how it might work, suggesting that the recently introduced cap on bills for customers on pre-payment meters could be extended to everyone who qualifies for the warm homes discount. Ofgem will be holding a summit with consumer groups next week to discuss its next steps, which could take up to another year to be implemented depending on the level of push-back from the industry.

First Utility managing director Ed Kamm is frustrated that the debate over energy bills appears to have gone full circle since two and a half years ago, when Ofgem referred the energy market to the Competition and Markets Authority. “We’ve had two elections and we’re still in the same place,” he says.

The good news for the industry is that an across-the-board cap on household bills is off the table, for the time being at least. Energy investors expressed their relief following Nolan’s announcement as share prices rose.

“Focusing on the vulnerable is the right starting point: it’s the group that we should be most concerned about,” says Kamm.

Tim Ham, former head of pricing at British Gas, agrees: “In a market where input costs are so variable, fixing price levels is extraordinarily risky so as a general approach it’s not great. You don’t need to protect everyone because the market isn’t functioning so badly and people aren’t making excessive profits.”

Ham, who now runs his own consultancy Ham Pearson, argues it is right to target warm home discount beneficiaries because this is the group most likely to have trouble paying their bills.

“If we believe that we need to look after the poor, this maintains an effective market while protecting the people that need protecting so it’s quite a good balance.”

And Ryan Thomson – a partner at consultants Baringa Partners – argues that a targeted cap can be implemented much more quickly than a more broadbrush one could be.

The beauty of using an existing scheme is that the government has a record of who is eligible for the discount, he adds. “Those customers are well defined and identifiable: applying a safeguarding tariff to that sub-group of customers is easier than trying to ringfence another group of customers who haven’t been identified. This appears to be a good solution. It provides protection specifically where it’s needed rather than the market as a whole.”

Kamm agrees: “We know who are paying warm homes discount and we can apply something to that group.”

Ofgem’s intervention also starts to address what he describes as a “crazy anomaly”, whereby warm homes discount customers are effectively subsidised to stay on poor value for money standard tariffs.

“We are giving £140 off through the warm homes discount to that group, who are more likely to be on the standard variable tariff. As a society, we are saying this group needs help but they are more likely to be overpaying,” he says, adding that warm homes discount customers should arguably be put on the cheapest tariff available.

The flipside is that those who stand to benefit most from the targeted cap are the more affluent and tech-savvy customers, which are likeliest to be signed up with smaller suppliers not obliged to contribute to the discount because they have fewer than 250,000 customers.

Kamm says: “We have to solve the anomaly that more well-off customers are the ones who are switching and they are more likely to be with small suppliers who are not paying into programmes like warm homes discount. It’s a crazy situation where well-off people, who are more likely to switch, are not even contributing to the warm homes discount. It’s a regressive tax: the people who are paying for it are the people who can’t afford it.”

However, from Ofgem’s perspective, another big advantage of the more targeted cap is that it lessens the likelihood of a confrontation between regulator and industry. Opting for a market-wide cap could put Ofgem at loggerheads with the CMA, which explicitly ruled out such a move in its report on the energy market published last summer. The consumer watchdog judged that the disadvantages of a broadbrush cap outweighed the potential benefits. “They would have to take on the CMA and explain why they got it wrong, and that’s not straightforward,” says a senior regulatory source.

Thomson says that Ofgem could leave itself open to a legal challenge by aggrieved energy companies if it went against the CMA’s recommendations. “Given that the CMA ultimately rejected the idea of a market wide price cap, it would have been easy for suppliers to appeal back to the CMA without legislation. They could have referred it back to the CMA for another investigation.”

Added to which, the industry source says there is limited appetite in Ofgem for the kind of broadbrush cap mooted by May in the run up to the general election, says the senior industry source. “(Ofgem) has never shown any enthusiasm for imposing price controls and seemed perfectly content with the CMA’s rejection of price controls on SVTs.” By contrast, he points out that the CMA opposition to the warm homes discount extension was rooted in the practicalities of the move, which makes it potentially easier to contest.

So, should the energy companies take what’s on offer from the regulator?

Ham believes that the mooted package could be the energy companies’ “best chance” of escaping a more swingeing price curb. “I would be jumping on these proposals as the solution and saying we need to protect the hard up in society because it’s a lesser of many evils. If I was in an energy company I would be doing what I could to make these proposals work.”

Thomson agrees: “It would be hard for the energy companies not to engage with this. It’s aimed at the more vulnerable and disengaged end of the market.” And the relatively limited nature of the cap means that energy companies will be able to slightly bump up prices across the board in order to maintain margins. Ham says: “You are going to have to subsidise a proportion of customers, but if you smear those margins on everyone else you are ok.”

He estimates that a 10 per cent cut in bills for the approximately three million customers who are eligible for warm homes discounts will raise bills by less than 1 per cent for the industry’s remaining 17 million customers. Given the number of moving parts that make up an energy bill, he suspects that any cut for warm homes discount customers can be managed.

Extending protection to the more vulnerable customers won’t have much impact on competition, given how past research has demonstrates that this is the section of the market which is more likely to remain loyal to its existing suppliers. “These are not customers that companies are particularly targeting,” says Baringa’s Thomson.

The senior industry source suspects that energy companies will swallow the targeted cap that is on offer. “The guess is that as they didn’t fight the prepay caps, they won’t fight a small extension.”

Whatever the energy companies do is unlikely to assuage broader public discontent with what are increasingly tarnished brands, says Ham. “They’re onto hiding to nothing at the moment: there is so much cynicism around the providers that whatever they do will be interpreted in a negative way. The market has got to a point that people don’t trust the energy providers. The minimum they can do is to satisfy the regulator and politicians.”

Utilities are unlikely, therefore, to ramp up prices while Ofgem prepares its package given how well they are hedged against fluctuations in wholesale prices, says Thomson, adding: “It would be a very brave supplier who would put in a significant price hike while this consultation is going on.”

Clark gave Ofgem’s proposals a lukewarm welcome, saying they were a “step in the right direction”. However, given the political backlash to Ofgem’s announcement, the weakened government will remain under pressure to act tough on energy bills.

Ham says: “Politicians are out to prove that they are protecting the consumers and that they care. A great way for them to move to the popular centre ground and to be aggressive and unpleasant to the energy providers is highly popular.”

Expect more political heat from the energy debate over the next few months.

Switching panel

Alongside moves to introduce a price cap for more vulnerable customers, Ofgem used last week’s announcement to unveil a series of moves which are designed to improve the functioning of the energy market.

In a bid to take the hassle out of switching, the regulator is changing the rules for price comparison websites to make it easier for people to switch to cheaper deals.

As it stands, once a customer has found a deal on a comparison website, they have to re-enter their details on the supplier’s own website. Ofgem has changed the rules so that customers will be allowed to sign up directly from the comparison site. In addition, they will still be able to see other deals that they cannot switch to directly by clicking a button on the comparison website, or by visiting the Citizens Advice website.

For customers who have been on poor-value standard variable tariffs for three years or more, Ofgem will trial a new online switching service – ‘check your energy deal’. This will enable customers to quickly see how much they can save by entering their address, including postcode, and name of their current supplier. In addition, Ofgem is conducting a separate trial to test whether writing to customers about cheaper offers from rivals prompts them to shop around and switch tariff.

Meanwhile for customers, who have to have a prepayment meter because they have run up a debt, Ofgem is proposing a cap on the installation costs they will have to pay.

Baringa’s Thomson points out that allowing customers to switch directly through to a supplier’s website runs counter to the CMA’s recommendation that websites should show the whole of the market comparisons.

First Utility’s Kamm says Ofgem’s measures will ‘definitely’ make switching easier. However, he says that the proposals miss the bigger picture, which is that a large chunk of the customer-base don’t even consider switching. “If they are not considering switching, then knowing that its faster doesn’t really help.”

He says the idea of automatically showing customers the cheapest available tariffs need to go beyond a trial. But he is less convinced about Ofgem’s proposals on capping pre-payment installation costs.

“Nobody likes to install a pre-payment meter because a customer has got into debt, but if you have to go through the whole process you could be running up more than £1,000 of costs. Everyone ends up paying for the sins of the few. If people were gouging profits, it would be a different matter, but we are talking about costs.”

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