It could have been worse. That seemed to be the verdict of the stock market in the wake of Ofgem’s long-awaited announcement earlier this month setting the level of the cap on standard variable tariffs (SVTs).
On 6 September, Ofgem revealed that the draft cap has been set at £1,136 for the typical dual fuel default tariff, lopping an estimated £75 off the average dual fuel customer’s SVT.
Perhaps surprisingly, energy suppliers’ share prices rallied on the day. The market leader, Centrica, saw its share price rise by 5 per cent.
“It suggests they and the analysts were expecting something tougher,” says one energy boss. “At some of the suppliers, they were popping the champagne corks.”
However, the shine came off this rally the following week when SSE issued an unscheduled profits warning, which identified the looming cap as one of the factors weighing on the company’s earnings expectations. Centrica’s share price at the end of last week was 143p, back to where it had been before the cap was announced.
Alongside the figure of £1,136 itself, Ofgem published the methodology that it has used to calculate the magic number.
The cap will be updated each April and October.
These six-month periods reflect industry practice, says Ofgem, pointing to how the large suppliers have updated their SVT prices on average between once and twice a year since the energy market was liberalised in the 1990s.
The biggest variable in the formula is the cost of wholesale energy, especially in the current volatile market. The regulator is using a half-year snapshot of wholesale prices, the cut-off for which will be two months before the April and October cap updates.
Ofgem’s paper says that this timeframe will mean that large suppliers will “most likely” already have bought much of the energy SVT customers will use.
In the current market climate, says the paper, a more up-to-date gauge of wholesale prices would expose customers to the risk of paying “significantly more” than suppliers’ underlying costs.
The other big factor Ofgem takes into account is suppliers’ operating costs. The regulator has said it will work these out with a benchmarked sample of operators’ costs in 2017. The operating costs allowance in the formula will be based on the lower quartile of costs provided by suppliers.
The regulator has then lopped off another £5 for dual fuel customers in a bid to “create better incentives to improve efficiency”, says the paper.
More uncomfortable reading for suppliers was the regulator’s decision that the smart meter rollout costs should be wrapped up into this operational allowance. This is because the regulator judges that smart meters are fast becoming an “intrinsic and integrated part” of suppliers’ operations. Ofgem has however promised to carry out a review of the smart meter rollout costs and benefits well before the October 2019 update of the cap.
And suppliers have an added bit of leeway in the form of a £12 allowance for “headroom”.
Greg Jackson, chief executive of challenger supplier Octopus, believes the methodology is still “much too generous” for inefficient suppliers, giving as an example this headroom allowance. “There is lots of room for companies to be more efficient than the cap suggests,” he says.
Robert Buckley, head of retail at Cornwall Insight, disagrees. He says the consultancy’s cap tracker, launched in early August, estimated that it would be set at £1,150 per annum, £14 more than the figure spat out by Ofgem.
He doesn’t expect to see the regulator significantly shift ground now on the proposals outlined in the consultation paper.
The introduction of the price cap will increase pressure on relatively small new entrants, says Jackson, who argues there will be less incentive for companies to run what he describes as “crazy loss-leader pricing”.
“Fixed price deals for new customers are hugely loss-making. Lots of people saw it as an opportunity to get rich quick but competition for customers is so brutal that they are looking for an escape route.”
This could create scope for further consolidation at the lower end of the market, says utilities sector analyst and Utility Week correspondent Nigel Hawkins.
He says the problems of those companies already struggling will intensify as wholesale prices go up: “We may end up with a few suppliers. The smaller end of the market may see some consolidation.”
Overall, though, Jackson believes the cap will prove to be a bit of a damp squib.
“The numbers on default tariffs will continue to drop but not by a lot. Fewer people will be on default tariffs but not that much fewer. It won’t have a massive impact.
“We won’t see as much change as we would have hoped.”
Cornwall estimated last month that the electricity element of the safeguard cap alone, which mirrors the broader level of SVTs, is due to increase by £53 to £650 by next summer, which would wipe out much of the hoped-for savings from the tariff. The consultancy was updating these forecasts when Utility Week went to press.
Hard-pressed consumers expecting to see actual reductions in their energy bills are likely therefore to be disappointed.
“Bills are going to be higher than they were before, which surely will be a political risk,” says Jackson.
“It won’t defuse the arguments around the general level of energy bills,” says Buckley.
The worry for utilities is that rather than quelling the disquiet about energy prices, it will merely be a preamble to an even more fundamental reordering of the market.