Ofgem seeks views on ending PPM premium

Ofgem has outlined a series of models on how costs for different types of energy customers can be spread more equitably across all payment methods.

Due to their higher costs to serve, prepayment meter (PPM) and standard credit customers face higher bills than those who pay by direct debit.

Under the Energy Price Guarantee (EPG), the government will temporarily level PPM and direct debit standing charges from 1 July this year to 31 March 2024. However, the Treasury has tasked Ofgem with making proposals for removing the PPM “premium” permanently after the EPG ends.

In its call for evidence, Ofgem said there are two components of the price cap through which levelisation can be achieved: unit rates and standing charges. Both can be looked at in isolation or at the same time.

By levelising unit rates the regulator said the savings, or costs, from levelisation of each payment method would be greater for customers with high consumption and smaller for lower consuming customers.

Meanwhile by levelising standing charges, costs and savings would be constant across different consumption types.

“Overall, for an average consuming customer, the costs and savings via this mechanism will be lower than if unit rates were levelised,” said Ofgem.

It highlights how research from the Department for Energy Security and Net Zero shows how fuel poverty and vulnerability levels differ between customers on different payment types.

Proportionally, the percentage of households classed as fuel poor are higher for PPM and standard credit customers than those on direct debit. However, of households in fuel poverty, a much higher proportion pay by direct debit than those paying by standard credit and PPM.

The regulator is seeking views on five models which seek to make payment charges more equal or equitable by socialising PPM and/or standard credit costs across direct debit customers.

Ofgem said no one model of the five it has outlined will see all consumers benefit from levelisation equally, compared to the status quo.

As a base case scenario, Ofgem has used unit rates and standing charges contained within the current price cap period (1 April to 30 June 2023), updated as if a recent code modification which would significantly reduce a large disparity in wholesale gas costs between PPM and non-PPM customers had been implemented in April 2023.

Case 1: Levelise Standing Charges

Under the first model, Ofgem levelises standing charges across all three payment types. This increases direct debit costs, while lowering PPM and standard credit costs.

Under this scenario, PPM is the cheapest payment method and standard credit remains the most expensive however by a smaller differential compared to the baseline.

Case 2: Levelise Standing Charges & Bad Debt

The second model sees Ofgem levelise PPM to direct debit standing charges, when the standing charge for PPM is more expensive, and then levelise standard credit bad debt through unit rates and standing charges to direct debit.

Under this scenario PPM would be the cheapest payment method and standard credit the most expensive but by a smaller differential compared to the baseline.

Case 3: Levelise Unit Rates and Standing Charges

Ofgem said levelising direct debit, PPM and standard credit unit rates and standing charges will increase direct debit and PPM costs whilst lowering standard credit costs.

“PPM costs are increased due to the higher previous standard credit costs. The result of this levelisation is that the cap level for all payment methods is equal at TDCV (typical domestic consumption values),” it said.

Case 4: Levelise Standing Charges and Unit Rates

In the fourth model, Ofgem levelises PPM to direct debit standing charges, and finally levelises standard credit unit rates to direct debit unit rates. This would increase direct debit costs whilst lowering PPM and standard credit costs.

In this case, PPM is the cheapest payment method and standard credit is the most expensive but the differential against direct debit is smaller compared to the baseline.

Ofgem added that case four shows that while levelising standard credit unit rates results in more savings for these types of customers, it results in much higher direct debit costs compared to case one where only standing charges are levelised.

Case 5: Levelise Standing Charges and Partially Levelise Unit Rates

The fifth model investigates the effect of partial levelisation. This case sees Ofgem levelise PPM to direct debit standing charges, and finally partially levelise standard credit unit rates to direct debit unit rates. It said this has the effect of increasing direct debit costs while lowering PPM and standard credit costs.

In this case PPM is the cheapest payment method and standard credit is the most expensive method but the differential against direct debit is smaller compared to the baseline.

“This case shows that by partially levelising the unit rate difference, standard credit customers can make similar savings to PPM whilst reducing the cost to direct debit customers compared to Case 4,” Ofgem said.

Modelling undertaken by the regulator showed that suppliers will be affected differently by levelisation depending on the proportion of customers on each payment type.

It found that in all cases, the supplier with a majority of direct debit consumers experiences an increase in revenue whereas the supplier with a majority of standard credit and PPM sees a decrease.

“This could pose a significant risk to standard credit and PPM supplier stability if implemented without a reconciliation mechanism,” it added.

Ofgem has therefore outlined potential mechanisms for supplier reconciliation to enable payment method levelisation between customers

As well as suggesting a new, custom built mechanism the regulator suggests potentially introducing an additional component for all customers on network charges which would then be disbursed to support PPM and standard credit customers.

Alternatively, it added, network charges could be used to reconcile costs but suppliers would claim incurred costs directly because of levelisation through Ofgem, similar to how Supplier of Last Resort costs are recovered now.

An Ofgem spokesperson said: “This is at a very early stage and the trade-offs are difficult, as it involves moving costs between payment types, protecting the most vulnerable households balanced with suppliers being able to fund costs of serving different customers.

“There is no solution where all customers will pay less – though we are clear that any option needs to be fair and transparent for all households.”