Ofgem has proposed introducing six-month default tariffs for customers, similar to fixed mortgages, as a possible adaptation to the price cap.
In a call for input, published as part of the regulator’s plans to strengthen supplier resilience, Ofgem outlined three potential changes that could be made to the cap methodology, ensuring more resilience to extreme volatility as seen in recent months.
The regulator said while the cap has delivered “significant benefit” to consumers, the current design could result in higher costs for customers in the longer term unless it is amended to allow suppliers to better manage risk and costs.
Under the option for a six-month default tariff, there would be a window when each contract renews when a customer would be able to either switch away or select a different tariff. Outside of this window, exit fees would apply.
Ofgem said the exit fee could be set at the economic cost determined at the point the customer leaves, meaning it would decrease in amount over the contract period.
The wholesale component would be the observed price of the six-month hedges during the month prior to the start of the default tariff. This price would be fixed for the duration of the contract, but a new price would be set each month for new customers.
The other components could be updated on a six-month cycle, as they are currently.
Furthermore, Ofgem added, this option could also be configured based on 12-month contracts and/or with the price cap level set using 12-month forward prices, which would deliver more price smoothing for consumers and remove the seasonal impact.
The regulator said this option “significantly reduces” supplier volume risk as retailers would be able to purchase energy for customers as they take up their default tariffs with a high degree of certainty over demand levels for the coming six months.
Other options suggested in the document include a “circuit breaker” which retains the existing methodology but includes an enhanced ability to adjust the cap in extreme circumstances. Ofgem is already consulting on a potential price cap re-opener, enabling it to adjust the price cap level outside of the current six-month cycle.
A stronger version of this could potentially be introduced, with criteria specified in advance such as a specified gap between the standard variable tariff and market prices, in either direction, that would trigger a change in the cap level.
According to the regulator, this option would provide market participants with greater certainty and could potentially enable the price cap level to be changed more quickly.
A further option being proposed is to update the wholesale cost components of the cap quarterly using the existing cap methodology and the average forward prices for energy delivered in the coming year.
Instead of the current six-month observation window, a three-month observation window would be used. Non-wholesale costs would be updated every six months, although there is the potential to also update some volatile policy costs such as for Contracts for Difference or the Interim Levy Rate to the same three-month cycle.
Ofgem is calling for responses to be submitted by 13 January at the latest.
A policy consultation will be published early next year which will propose one, or possibly two of the options before a statutory consultation with proposed licence condition changes later in the year.