The standard variable tariff is dead, long live the default tariff.
That’s one of the myriad messages in Professor Dieter Helm’s review of energy costs, which was published a fortnight ago.
In the chapter of the 240-page long report devoted to supply, the Oxford University professor of energy policy challenges the accepted wisdom that smart meters will encourage switching, the premise underpinning the government’s plans for a temporary price cap. He argues that the devices “will not in themselves add much to the incentives to switch”.
Therefore, Helm argues that default tariffs will continue to be required to “cater for those with better things to do than trawl the internet trying to comprehend the myriad deals and offers”.
Moves by the likes of Eon to scrap SVTs “miss the point” because many customers currently on them will merely shift to another default tariff, says the review: “They cannot simply disconnect customers who take no action – and if they did there would be a justified outcry.”
The report outlines Helm’s own proposal for a default tariff that he believes would better expose the underlying costs driving energy bills.
He proposes that this default tariff would consist of six building blocks. These include distribution, supply transmission and wholesale costs. In addition, the tariff would encompass green levies and subsidies such as via capacity auctions.
“These proposals are unrealistic in the context of the timelines the government is suggesting.”
Ryan Thomson, partner, Baringa Partners
Ofgem could set the form of the default tariff, which would focus competition on the more limited terrain of the supplier’s own margin rather than the cost of the overall bill, he writes: “Customers simply need to select the lowest offered margin. It is simple, transparent, and pro-competition.” The virtue of Helm’s proposals, in his own eyes, is that suppliers would compete on the costs they control rather than those they have to pass on.
Helm takes a pot shot at another sacred industry cow by rejecting the idea that competition should be the over-riding goal of policy if this means suppliers are overcharging most bill payers in order to lure more footloose customers by offering cut price deals. “It requires customers to pay excessive costs in the interim until the arrival of a fully competitive market.”
But his own proposals offer a quicker route map to a more sustainable market, Helm believes: “By focusing on any fat margins that exist, the default tariff will accelerate, not impede, the development of competition.”
So does Helm’s package offer a template for the government’s price cap?
Ryan Thomson, a partner at consultants Baringa Partners, sees merit in the academic’s analysis of the supply market. “Rather than being billers and cash collectors, we are asking them to be social engineers. If you stripped a lot of that out, you would make the role of the supplier a lot more transparent and would potentially reduce costs. We have the most complex supply market in the world and it’s not getting any simpler. It would be good for the regulator to take note of the complexity of what suppliers have to manage on top of getting billing right.”
Things get more complicated when it comes to Helm’s solution though. Tim Yeo, former chairman of the House of Commons energy and climate change select committee, says the proposal bears the hallmarks of Helm’s work as an academic economist. “It’s quite complicated and I’m not certain how it would work. I would like to see a bit more clarity.”
Helm’s proposed default tariff would be “very difficult in practice” to introduce, Thomson says: “These proposals are unrealistic in the context of the timelines the government is suggesting.”
“Transparency wouldn’t matter if people got good prices.”
Greg Jackson, founder and chief executive, Octopus Energy
Thomson suspects that with competition restricted to margins, which make up a small slice of the average bill, there will be little incentive for customers to switch or for suppliers to persuade them to.
In this scenario, he believes the energy market will become more like fixed line broad band where competition is not focused on the core service but on value added offers instead.
The outcome will be a reduction in the number of suppliers operating in the market, one academic suspects: “There will almost certainly be some exits from this market which is not necessarily a bad thing: you protect competition not competitors. If they (suppliers) are there because profits are expensive you want them to leave.”
And what will investors think? Thomson says: “If it simplifies the business model and reduces their risk, investors might be willing to apply a lower discount on the margins that suppliers make. The chance of making margins becomes more certain.”
Greg Jackson, founder and chief executive of Octopus Energy, says Helm’s focus on transparency is misplaced though because if the industry can get the price right, customers don’t really care how they do it.
“Transparency wouldn’t matter if people got good prices. At Tesco or Aldi, I am pretty confident I am getting good price. I have no idea what the cost of their supply chain looks like, but it doesn’t matter because that market appears to deliver good value to consumers.”
“This is the critical thing the energy market has to deliver. Otherwise we may end up with forms of constant tinkering that make things ever more complicated rather than solving the core problem of giving consumers good value.”
Read the first in the Utility Week’s series of analyses looking at the Helm review here