At today’s (4 October 2017) Tory Party conference, Teresa May promised to bring “an end to rip-off energy prices once and for all.”
“The energy market punishes loyalty with higher prices and the most loyal customers are often those with lower incomes, the elderly, people with lower qualifications and people who rent their homes. Those who, for whatever reason, are unable to find the time to shop around.”
“That’s why next week this government will publish a draft bill to put a price cap on energy bills, meeting our manifesto promise and bringing an end to rip-off energy prices once and for all.”
So how will it work and what will it mean for consumers?
While details are still to be discussed and agreed, it is currently expected that the cap will apply to customers on Standard Variable Tariffs (SVTs) and will be administered by Ofgem.
As a reminder, Standard Variable Tariffs are those tariffs which customers who have never switched are placed on. They are also the product onto which a customer who, having switched and come to their tariff end date, will be placed onto unless they make a proactive decision to move to a different product or to switch supplier.
They spark controversy for 2 main reasons.
Firstly they are expensive, often the energy supplier’s most expensive tariff.
Secondly, because of widespread disengagement and low switching rates in the energy market, the majority of customers (current estimates show 60%+) are on these expensive SVTs.
These criticisms are of course justified. We have never been a fan of SVTs and indeed that is why we set up an energy comparison and switching site. You can switch away from an expensive SVT in just 5 minutes and bag yourself an annual saving of over £300. Why wouldn’t you? Yet the majority, for whatever reason, don’t and so Government has chosen, rightly or wrongly, to intervene.
The good news for consumers
A wide ranging price cap for all Standard Variable Tariffs will capture somewhere around 15 million households. Assuming each gets a price reduction of £100 (£50 per fuel), then that amounts to an aggregate saving of £1.5 billion.
On the flip side, the energy industry will take a hit of equal and opposite magnitude.
The not so good news for consumers
It leaves £250 on the table
Picking up a £100 saving for doing nothing may sound like easy money and, of course, it is. But compared to switching, even after a £100 energy bill cut, customers will still end up being £250 worse off than they would have been if they took the 5 minutes it takes to switch.
It will take time to implement
If, as expected, Ofgem is tasked with implementing the energy price cap, then it could take time to come into effect. Under law, Ofgem is required to follow a statutory consultation processes and while this could be done in months, the complexity of this particular proposal could take a lot longer, particularly as it will be important to implement the cap in a robust and rigorous way to ensure it is not open to legal and judicial challenge. Indeed at a practical level, Ofgem may need to ensure that it does not end up bankrupting energy suppliers in the process. There are suggestions that Government is pushing for a quick fix before this winter; however it may be prudent to allow up to a year before the cap properly kicks in.
It will not stop energy bills going up.
According to the CMA, in their energy market investigation, they reported…
“On the basis of current announced plans, DECC estimates that climate and energy policies will add 37% to the retail price of electricity paid by households in 2020.”
37% on a £500 electricity bill is £185.
Government, having put in place policies that are pushing energy bills up, is now trying to offset the impact of its own policies by passing the buck onto Ofgem, and the pain onto the energy industry. Figures.
It will certainly not end “rip-off energy prices once and for all”
The practise of sucking in new customers with loss leading tariffs and then bumping them onto expensive SVTs is by no means unique to the Big 6. It is a feature of the energy industry with virtually all suppliers engaging in the practise – even those that claimed they never would. It seems unlikely if not implausible that loyal customers will end up paying less for their energy than serial switchers any time soon.
It will dampen competition and consumers are likely to suffer in the long term
If energy consumers are dis-engaged when there is a quick and easy £350 annual saving to be had for 5 minutes work, what will the effect be on customer engagement when the saving falls to £250 or even £150?
The price cap is likely to lead to a false sense of security among consumers further dampening switching levels and competition. Furthermore, the cheapest deals in the market will likely have to rise to compensate for loss of revenue and the increased risk associated with the cap. Finally we expect energy suppliers will need to take compensating measures to offset the revenue loss, many of which will not be good for consumers (discussed below).
How will energy suppliers respond?
In assessing market interventions, governments and regulators need to asses unintended consequences – what impact their decisions have that are not the desired effect. These consequences may be unintended, but they are usually quite predictable (to everyone except the regulators it seems). As such, we have listed a few of our predictions of the impact of a price cap below.
Profits and revenues dented – some energy suppliers could go bust
Firstly, the Big 6 will take a big hit to revenues and profits in the short term. But, while the criticism over expensive SVTs is being implicitly levied on the apparent “oligopoly” of the Big 6, it is important to note that the BIg 6 are not the only one’s captured by this policy. Many energy suppliers will be affected and in particular those whose SVTS are priced at or around the level of the Big 6 and who have a meaningful proportion of their customers on SVTs. In this situation a draconian cap implemented quickly would severely financially damage, if not bankrupt, certain suppliers.
Cheapest deals will increase in price
To compensate for the lower margin on price cap regulated tariffs, and for the increased risk associated with a price cap, energy suppliers will be less inclined to offer deeply loos leading tariffs in the hope of making money on the flip up to standard.
Standard Variable Tariffs will get phased out
Energy suppliers will start to phase out SVTs in order to escape the regulatory price cap. British Gas and ScottishPower have long been pushing for SVTs to be abolished and E.ON recently announced it is phasing out SVTs, initially for customers switching to smart meters.
The question of whether this is good or bad news for consumers obviously depends on which tariffs customers are migrated to. We expect there will be a rush to migrate customers that are currently on SVTs onto longer term fixed price tariffs at a small discount to current SVT rates (premium to price cap levels). In this way suppliers will aim to lock in customers and margins and simultaneously creep out of the regulatory net. This, if anything, will dampen competition.
Door step selling likely to come back
With customer engagement falling, energy suppliers will need to find alternative ways to acquire customers. This may include TV advertising which would be a welcome development. However we expect many will resort to the tried and tested route of hassling consumers to switch on the doorstep.
Doorstep selling rarely ends with the consumer getting a good deal let alone the cheapest one and mis-selling was rife in this part of the industry before it effectively got shut down.
Joe Malinowski, founder of energyscanner.com commented.
“While a price cap may sound attractive, offering the prospect of a £100 reduction in fuel bills for many, it could take a while to arrive and is only a fraction of what is currently on offer in the market. The only sure way to bring an end to rip-off energy prices is to take 5 minutes to compare, switch and bag yourself an annual saving of £350.”