All aboard the price control roller coaster

While price controls have been implemented in the water sector since 1989, the energy supply market has had a much bumpier ride.

Some five years ago, when the Big Six companies controlled almost the entire UK energy supply market, there were virtually no price controls in place.

Yet five years later, when there are around 70 companies in the market (eight seem to have departed already this year) extensive price controls are in place.

Perverse, methinks.

Indeed, such a scenario turns conventional economic thinking on its head.

However, in its own way, it sums up the erratic nature of price controls in the utilities sector – save for water, they come and they go.

When British Telecom (BT) was privatised in 1984, there was – by today’s standards – a very ad hoc RPI-3 pricing formula, based on a weighted average of local calls, business and residential line rentals, and trunk calls.

As mobile telephony emerged, with Vodafone undeniably in the van, this regulatory model began to erode. Apart from Openreach, many of BT’s business streams are no longer price regulated.

For Ofcom, the planned rollout of a nationwide broadband investment programme, using a fibre – not copper – network, will be immensely challenging.

Whether other players, such as Vodafone and CityFibre, among others, participate – and under what terms – is not clear.

Twists and turns

However, it is in the energy sector where the policy of imposing price controls has ebbed and flowed.

Following the high-profile flotation of British Gas shares in 1986, various complex algebraic pricing formulae were deployed, which were subsequently removed in the 1990s.

At the time, they gave British Gas invaluable protection against higher gas input prices, which – in effect – could be simply passed through to its customers.

Indeed, the gas cost issue was crucial to British Gas and to the demerged Centrica, whose weighted average cost of gas figure was highly price sensitive – so much so, they stopped publishing it.

Electricity price controls went down a slightly different route. When the 12 regional electricity companies were floated in 1990, similarly complex supply formulae were applied.

It soon became apparent to any discerning sector analyst or investor that the financial driver of the regional electricity companies was the distribution revenue segment, whose prices were set every five years.

By contrast, supply revenues, though far larger, were both very low margin and risky. And the returns from the ‘white goods’ shops were depressing.

To kick-start competition in the supply business, pricing caps were progressively lifted. In 1990, all sites with a minimum 1MW of demand could strike deals with alternative suppliers.

It did lead to some delightfully Pythonesque disputes as to what was a 1MW site. If the site were split by a narrow path, it surely constituted a single site; if it were bisected by a wide A-road, it was less clear-cut.

In any event, by 1994, the 1MW minimum had been reduced to 100kW, thereby taking in many small commercial premises.

Energy price cap reintroduced

By 1998, energy price controls, with the exception of a few ‘back-stop’ provisions, had been in effect abolished – for ever, or so we thought.

Following proposals to reintroduce energy price controls by former Labour leader, Ed Miliband, in 2013, which proved quite popular, Theresa May, the former Conservative Party leader, subsequently hijacked this policy.

She argued that Middle England felt aggrieved at rising energy prices, which were often accompanied by increasing controversy about the questionable activities of some utilities.

The new energy price cap focuses primarily – though not exclusively – on default tariff customers; they are quaintly defined as “a dual-fuel single-rate customer paying by direct debit using a typical amount of energy in annualised terms”.

The initial cap, covering the first three months of 2019, was set at £1,137. For the next six-month period, which has recently ended, it was raised to £1,254.

It is peculiarly ironic that a price control – specifically designed to deliver lower energy prices – has risen by more than 10 per cent within a few months of being introduced.

Water sector prepares for price cuts

Price controls in the water sector have been firmly established since 1989 and are an integral part of the quinquennial periodic reviews.

After a lengthy and complex regulatory process, Ofwat prescribes what prices a water company can charge. The crucial final determinations of Ofwat’s current review, covering prices for the 2020/25 period, will be announced on 11 December.

After a long period of price rises stretching back to 1989 – deemed as essential to fund the pronounced investment uplift – swingeing price cuts are expected.

For example, if Northumbrian Water agrees Ofwat’s assumptions, there will be an approximately 25 per cent cut in water charges in real terms there by 2025 – Northumbrian has already proposed meeting more than 80 per cent of that figure.

While price controls on the waterfront seem to be a fixture, the forthcoming general election could result in yet another U-turn over energy price caps.

The price control roller-coaster continues.