Capping default tariffs sounds like a straightforward task, but a BEIS committee report has found it is anything but. David Blackman reports.

Ofgem will have its work cut out when it turns to the task of setting the mooted cap on household energy bills.

That’s the verdict of the Business, Energy and Industrial Strategy (BEIS) select committee, which last week published its report into the draft legislation that is designed to equip the energy regulator with the powers to cap all standard variable and default tariffs.

The committee was asked by Greg Clark, secretary of state for BEIS, to scrutinise the legislation after it was published last autumn.

The draft bill sets five tests for Ofgem to bear in mind when framing the cap. These are: protecting customers against excessive fuel bills, giving suppliers incentives to become more efficient, ensuring companies can secure sufficient finance, enabling effective competition and providing incentives to switch.

“Possible, if challenging”

Former energy and climate change committee chair Tim Yeo’s assessment of the five tests is blunt. “Some of these are in conflict with each other so they can’t do them all,” he says.

The committee’s verdict is that meeting the first three tests, based on experience of how the cap works in Northern Ireland, will be “possible, if challenging”.

Northern Irish experience isn’t necessarily the best guide to UK experience, cautions Ryan Thomson, partner at consultants Baringa Partners. “Northern Ireland is slightly different in that have you have one incumbent and a few new entrants trying to win business,” he says, adding that the market is “a lot more dynamic” on the UK mainland.

But meeting the switching objective may be more problematic, points out the report, given that the introduction of a cap is likely to reduce the incentive for customers to seek out a new deal.  “Switching rates may go down, at least at first, as a result of the cap being introduced.”

And defining an “efficient” supplier is potential legal minefield, argues the committee.

“Effective competition”

Pointing to past accusations that both Ofgem and the Competition and Markets Authority have miscalculated suppliers’ costs, a too explicit definition of “effective competition” risks opening up opportunities for judicial review by suppliers struggling to adapt to the new regime.

Efficiency is a slippery concept to measure, says one Utility Week source: “Everything else is pretty easily measurable in terms of wholesale prices, rolling hedges and network charges, but understanding what an efficient supplier is and the amount of headroom they require will be challenging.”

While arguing that the five tests are “not incompatible” the committee acknowledges that they are “challenging and may not all be achievable at once”. Therefore, it suggests ministers should make a choice about what Ofgem’s priorities should be when setting the cap.

In order to guard against potential legal challenges the committee recommends that the bill should be clarified so that Ofgem is not required to meet all five tests when setting a cap. The committee says the priorities when setting the cap should be consistent with the bill’s main aim, which is to reduce overcharging rather than increasing switching.

“Overly cautious and reactive”

The committee’s report also points towards Ofgem taking a much more hands on role in the market. Throughout the price cap furore, it says, Ofgem has “failed” customers by being “overly cautious and reactive”. The MPs are “unconvinced” by Ofgem’s argument that it required primary legislation to set a market-wide cap, adding that the risk of legal challenges should not have been a deterrent from implementing policies in line with its statutory duties to protect consumers’ interests. Specifically, it says the regulator should have acted sooner to remove suppliers’ obligation to move customers at the end of their fixed-term contracts onto default tariffs.

In the future, the committee urges the regulator to be “faster and more proactive” in using its “extensive powers” to protect customers against overcharging. And while the MPs want Ofgem to continue its efforts to promote customer engagement, they are sceptical about relying on this to deliver more switching and hence effective competition.

The report also marks a further breakdown in the pro-smart meter consensus that has prevailed across Westminster since the then secretary of state for energy and climate change Ed Miliband mooted their introduction nearly a decade ago.

Given the “slim” evidence that smart meters have a substantial impact on customer switching rates, the MPs conclude that it would be “unwise” to rely solely on the rollout of the devices to maintain effective competition in the market once the cap is lifted.

“Primary purpose”

The report is particularly sniffy about the chances of engaging lower income households, which are  disproportionately on default tariffs, once they have smart meters.

Thomson believes there are question marks over whether smaller suppliers will be able to remain under the price cap and remain in business, given their greater vulnerability to sudden shifts in the wholesale prices. It all adds up to what sounds like a subtle shift in Ofgem’s remit is being recommended.

“It almost changes their primary purpose in terms of consumer protection through avoidance of overcharging rather than through promotion of competition,” says Thomson.

For Yeo, the shift away from competition reflects the “short-term, rather muddled approach”, which has led to the cap being introduced in the first place. “If you want energy companies to stay in business, trying to control prices isn’t the best to way to achieve it.”

“You will get better results by making competition work better rather than by controlling prices: competition is always the best spur to keep prices down,” he adds. “Companies will always find a way to game a system that involves price caps.

“It reflects rather superficial thinking from the government to assuage some populist concerns. We’ve lacked for some time any long term strategy in energy policy, which is that we obviously need more investment.”

“Skewed by Brexit”

But whether he, and the energy industry more broadly, likes it or not, the committee’s backing for the bill’s overall thrust enhances its chances of receiving a fair wind in the House of Commons.

The committee wants the bill to be tabled in Parliament as soon as possible in order to ensure that the cap can be introduced by next winter.

Yeo thinks that this timetable will require some fancy Parliamentary footwork but is doable. “It depends on the priority they are willing to give it if they are prepared to allow it to jump the queue. The problem at the moment is that everything is skewed by Brexit, which is taking all the energy in Whitehall and the timetable in Parliament but if they are willing to do it is possible.”

No right of appeal

The government has set a ‘dangerous precedent’ by preventing suppliers from being allowed to appeal to the competition authority against Ofgem’s rulings on price cap levels, Energy UK has warned.

The select committee report backs the government’s decision in the draft price cap bill not to allow energy companies to appeal to the Competition and Markets Authority (CMA) against the regulator’s price controls decisions.

Under the legislation, suppliers will have to judicially review Ofgem in order to overturn these decisions.

The committee said that allowing a right of appeal to the CMA would ‘unnecessarily delay further the successful implementation of the cap’.

Lawrence Slade, chief executive of Energy UK, tells Utility Week that the body was “disappointed” at the government’s stance, which was out of line with the CMA’s powers surrounding other utility price control decisions.

He says: “It also sets a dangerous precedent if such decisions are no longer subject to challenge on their substance – it risks more arbitrary interventions in future and creating uncertainty that could spread to other sectors and companies.

“We still hope that when it takes forward the legislation, the government recognises that, as the expert body long established for this purpose, the CMA would represent a consistent approach and is also a more appropriate and effective way of reviewing these types of decision than judicial review.”

The committee also expressed concerns about the level of profits being made by the network operators.

The committee says it plans to “monitor closely” the next phase of the RIIO price control framework, hinting that it may investigate this area in the future.

The committee is right to put pressure on the network operators, says Yeo: “We should be getting Ofgem to crack down much more on transmission and distribution costs.

“The effective monopoly of the National Grid and the DNOs is a reason for tighter regulation in those areas. At least in retail, there is an element of competition because you can change suppliers.”