Energy Bill Caps: A Series of Unintended Consequences?

Energy Bill Caps: A Series of Unintended Consequences?

The U.K. is in the throes of going to the polls yet again — this time for a general election. With recent increases in domestic tariffs, energy will again be high profile.

Indeed, within the last week plans have been mooted to introduce a cap on household energy bills after the election. Some worry that the market isn’t working for consumers and requires some state intervention to limit bill rises.

U.K. energy suppliers operate in a competitive market, where households can choose the best provider and switch freely between them for the best deal. Suppliers also collect charges on behalf of a number of other parties, such as grid companies, metering firms and tax authorities; their contract offer to the end user includes most of these costs ‘bundled’ together in a tariff alongside the cost for the commodity. Typically, larger suppliers buy up to two years ahead in the commodity markets to make sure their customers’ needs are covered and to keep bills as simple as possible at the household level.

The hot topic is that some suppliers have increased standard electricity tariffs by as much as 18 percent over the last few months, driven partly by higher wholesale markets and partly by the results of government policy. Renewable subsidies, warm home discounts and rising grid costs are being passed through on most end users’ bills.

What will this proposed price cap mean? Details are still unclear, however, the plan is for OFGEM (the regulator) to calculate a cap on standard tariffs, taking into account wholesale prices and other costs. This may work in a similar way to the already-announced cap on prepayment meters. So if wholesale prices rise, bills could too, but constrained by the overall cap calculation.

So what’s the issue? Essentially, there is a two-speed energy retail market. Roughly one third of customers shop around for the best deal, and switch freely among the 50 or so registered suppliers when their deal ends. However, around 7 out of 10 are on standard ‘default’ tariffs, mostly with the Big 6 energy companies. These standard tariffs are £200-400 a year more expensive than the best ‘dual fuel’ offers, with some outlier cases paying £500 over the odds.

So a cap is a no-brainer for consumer protection, right? Not necessarily…

1. Are the 70 percent of households on standard tariffs vulnerable? There are strong arguments for protecting vulnerable customers (as has been done with prepayment meters already), but perhaps these are less clear for the average consumer.

2. Is the market really broken? There are 50 suppliers, a plethora price comparison websites, and other tools allowing people to compare prices and switch. Almost 8 million people changed their energy suppliers last year. Over the last 5 years, the proportion of customers with the Big 6 has fallen from 99 percent to 85 percent. The major energy companies are strong, but independents are picking up a big share of those consumers that engage with the market and that the number continues to increase.

3. Introducing a cap on standard tariffs could actively penalise the very customers that have been encouraged to switch suppliers — the theory being that reductions in ‘default’ tariffs would have to be funded by an increase in the price of competitive deals available.

4. Increased regulation of prices might hard the competitive market, by reducing the ‘spread’ between standard tariffs and the cheapest offers on the market. If the available savings are small, customers may decide there is no point in switching. If customers don’t switch, new independents don’t enter the market and smaller suppliers arguably suffer, hurting consumers in the process through reduced competition. The Competition & Markets Authority did, after all, spend two years investigating the energy market and argued that price caps would be counter-productive. It did suggest other remedies to improve matters, but stopped short of price regulation.

5. Finally, suppliers argue that state intervention and price controls are likely to dissuade current and potential market participants. Investors don’t like uncertainty and are less likely to invest and innovate as needed. They argue a reduction in choice would be bad for consumers in the long run.

The subject is emotive and complex. On the one hand, suppliers are clearly charging inactive standard tariff customers over the odds while fighting for more savvy consumers’ business at lower margins. To the extent that this disadvantages some groups, there is an argument for protection, as has already happened in the prepayment sector.

It’s been suggested by one energy supplier that a better approach may be to end standard tariffs completely, with customers moving from one fixed price deal to the next at the end of their contract, similar to the way people buy cars or home insurance.

For the market in general, the arguments are more nuanced and a set of unintended consequences could potentially emerge that hurt consumers in the long term.

Article written by David Hunter: Director of Market Studies of Energy & Sustainability Services for Schneider Electric

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