The current market-wide price cap on energy tariffs should be replaced with a social tariff for the most vulnerable customers and a relative price cap for the rest of the market, the Business, Energy and Industry Strategy (BEIS) Committee has argued.
In the meantime, the government must “immediately update” its support package for low-income households which is “no longer sufficient” for the price cap increase now expected in October.
These were just a few of the long list of recommendations in the committee’s report on its inquiry into the energy retail market, which was launched following the failure of dozens of suppliers over the last year.
Regulatory failures
The report was damning in its assessment of Ofgem, saying the authority had “proved incompetent” as a regulator, allowing suppliers to enter the market “without ensuring they had access to sufficient capital, acceptable business plans, and were run by individuals with relevant expertise.”
“The regulator enabled poorly capitalised suppliers to be overly reliant on customer credit balances and operate with inadequate hedging, leaving the market ill-equipped to absorb wholesale price increases,” it added.
The report described Ofgem’s delay to its Supplier Licencing Review, which could have addressed some of these issues, as “unacceptable and inexcusable”.
The committee said the independent review into its performance, which Ofgem commissioned from Oxera, “raised serious and fundamental questions about the regulator’s ability to carry out its primary duties.” It said Ofgem failed to understand both the business models of the suppliers it was regulating and the incentives created by its own regulatory regime.
“That important decisions on tackling risky supplier behaviour were taken by operational teams rather than the board, demonstrates a complete failure in corporate governance,” it added.
The report continued: “Even when matters of poor practice and potential breaches of licence conditions were directly reported to Ofgem, the regulator repeatedly failed to use its enforcement powers in any meaningful way…
“Telephoning a supplier to tell it to stop using customer credit balances to drive business growth is neither an appropriate nor formal enough action from a regulator which, given its repeated unwillingness to use its enforcement powers effectively, rendered itself futile.”
Despite receiving reassurances during its hearing from current Ofgem chief executive Jonathan Brearley that changes are now being made, the committee said it remains “deeply concerned that such negligent behaviour was able to take place for so long.” It said if the regulator’s former boss Dermot Nolan was still in post, the committee would be calling for his dismissal.
Given these concerns, the committee called on Ofgem to make “full and proper” use of its power to clamp down on rule-breaking by suppliers. It said said the regulator should work with government to ensure it has the “necessary complement the necessary complement of qualified staff working on its enforcement and compliance teams”.
The committee demanded that Ofgem provides it with a detailed strategy on how it will improve enforcement and compliance activity, including timelines. It said starting from this financial year, the regulator should provide a breakdown of the resources it has allocated and a summary of the actions it has taken on annual basis.
The committee drew particular attention to the case of Avro Energy, whose directors were found to have “consistently enriched themselves, despite the company accruing heavy losses”.
The report said the company “improperly used customers’ money, including siphoning off customers’ cash to different businesses in the directors’ names, issuing loans to the directors and paying poorly performing executives an unreasonably high salary.”
Meanwhile, the directors also “failed to operate the energy company with a prudent hedging strategy and were negligent in managing financial risks”. The report said the total costs associated with the company’s failure are expected by Ofgem to amount to £700 million.
The committee called on the administrators of Avro Energy to request that the Insolvency Service considers taking action against the former directors of the company. It said the government should look at whether regulators such as Ofgem should be given new powers to bring enforcement action against company directors for unfit conduct given the limited scope of the Insolvency Service to do so.
The report criticised the government for prioritising competition over effective market supervision and “failing to recognise the fundamental importance of energy supply and maintain sight over Ofgem’s actions.”
However, the committee said it also believes Ofgem did not properly highlight to government or Parliament the risk that a deregulatory approach to promoting competition could undermine the financial resilience of energy suppliers.
It said the regulator should therefore begin regularly reporting to the BEIS department how it is meeting its duties and inform ministers and Parliament of the risks and consequences associated with delivering the government’s strategy.
Meanwhile, the government must urgently publish its “long-delayed” Strategy and Policy Statement to Ofgem to clarify the split of responsibilities between the regulator and BEIS and help Ofgem to manage political and distributional trade-offs.
Protecting and supporting customers
The report said another contributing factor to the market turmoil was Ofgem’s design of the price cap, which had the unintended consequence of “suppliers subsidising customers.” It said Ofgem “failed to properly stress test its design against a range of scenarios or consider how it interacted with its other regulations.”
The committee noted that the recently tabled Energy Security Bill contained provisions to extend the price cap beyond 2023, but will not chance how the price cap functions.
“Neither the government nor Ofgem has undertaken an evaluation of its costs and benefits, nor considered alternative forms of price protection, including a social tariff which could provide deeper price protection for vulnerable, fuel poor and low income households,” it remarked.
The committee said Ofgem should conduct cost-benefit analyses of both the price cap in general and its plans to move to a quarterly period. In the case of the latter, the committee said Ofgem should pay particular attention the impact on vulnerable customers when the price cap is first updated on a quarterly basis in January 2023.
It said the government should consider the introduction of “a social tariff for the most vulnerable customers and a relative tariff for the rest of the market, to be introduced once wholesale energy prices have stabilised.”
The report noted that a relative price cap, which would cap the difference between suppliers’ cheapest and most expensive tariffs, was backed by multiple large suppliers during its hearings. These included Eon, Octopus Energy and British Gas, which argued that a relative cap would address the address the issue of price volatility by returning control of hedging to retailers and giving them greater flexibility to manage risks, whilst still protecting customers.
In the short term, the committee said the government must provide an “immediate and better targeted” update to its support package for households, which was first announced in February and then revised in May.
It said the current version – comprising a £400 discount on electricity bills for all households, a £650 payment to eight million households on certain means-tested benefits, a £300 payment to eight million pensioners and a £150 payment for people on certain disability benefits, all of them one-off – will be “eclipsed by the scale and longevity of the price increases now expected.”
The report said the government should also create a scheme to help vulnerable customers accelerate the repayment of debt that they accrue as a result of the current crisis, whilst Ofgem should urgently improve its currently partial collection of data on self-disconnection and work with suppliers ahead of this winter to identify those at risk.
In its final conclusion, the committee said severity of the challenges ahead mean they cannot be dealt with by BEIS or Ofgem alone: “The responsibility to deal with this crisis spans across multiple government departments and the government needs to galvanise the resources and expertise at its disposal.”
“We recommend that the government urgently sets up a cross-departmental taskforce, like the Brexit taskforce, to respond to the energy price crisis and wider cost-of-living,” it recommended.
“This taskforce should meet regularly to support Ofgem and other arms of the government to do the work necessary to provide the best possible outcomes for consumers and stabilise the energy supply market.”
Committee chair Darren Jones said: “Once again, the energy crisis is racing ahead of the government. To prevent millions from dropping into unmanageable debt it’s imperative that the support package is updated and implemented before October, when the squeeze will become a full-on throttling of household finances and further tip the economy towards recession.
“We were told by a number of witnesses, ‘if you think things are bad now, you’ve not seen anything yet’. This winter is going to be extremely difficult for family finances and it’s therefore critical that public funds are better targeted to those who need it the most.
“It’s an injustice that the poorest households continue to pay higher energy costs because they’re on prepayment meters. This must end and a social tariff should be brought forward.”
He said: “Ultimately, ministers know that the long-term solution is to reduce our need for energy through insulation works that keep our homes warm in winter and cool in summer.
“If the government is really taking this energy crisis and the country’s net zero targets seriously it will come forward with a bold, fully funded, national home insulation program before the end of the year.”
Responses
Responding to the committee’s criticism, a spokesperson for Ofgem said: “While the unprecedented rise in global gas prices would have resulted in market exits under almost any regulatory system, we have been clear and transparent about the fact that suppliers and Ofgem’s previous financial resilience regime were not robust enough. This contributed to some of the supplier failures since August 2021.
“No regulator can, or should, guarantee companies will not fail in a competitive market but we are working hard to reform the entire market, as well as closely scrutinising and holding individual energy suppliers to account, to further strengthen the regulatory regime. We’re pleased the committee has recognised the major scale and reach of these reforms which are already driving positive change across the market on behalf of customers.
“We commit to working closely with the committee, government and industry to make sure the balance of trade-offs across the board are carefully considered so that customers are prioritised throughout the current crisis and they have access to the government support they’re entitled to,” the spokesperson added.
“We are also working with all parts of government and industry on the long-term solution to the energy crisis by moving us away from imports of expensive gas towards a more secure, reliable, home-grown energy system.”
Meanwhile a spokesperson for BEIS said: “No national government can control global inflationary pressures. However, we have introduced an extraordinary package of support to help households, including £1,200 each for the most vulnerable households.
“We are also investing £6.6 billion this parliament to improve the energy efficiency of homes, delivering savings of £300 a year on average.”
Energy UK director of regulation Daniel Alchin said: “With energy bills projected to rise by even more than had been predicted, the report is right to say that the government needs to look again at the existing support package and at what more can be done to help customers who are already struggling to afford their energy bills.
“Recent months have exposed the shortcomings of how the price cap currently operates so it is necessary to look at what we want it to deliver – particularly whether it provides the right protection to the most vulnerable customers.”
He continued: “As well as urgently reassessing the support available this winter – and with costs unlikely to fall significantly in the foreseeable future – we have long argued that the best way to help reduce bills permanently for customers would be through a comprehensive energy efficiency programme to upgrade our homes.
“Despite rising costs, energy suppliers continue to increase the support they provide to customers, including additional funding for customers in fuel poverty. They must also be able to operate sustainably so more costs aren’t added onto customers’ bills through supplier failure.”