Energy price cap – pros and cons

The energy price cap – good thing or bad thing?

Before we start this is just to let you know that your energy prices are getting hiked by £100 (give or take) in…

….too late, you’ve just been thumped with a £96 energy price hike.

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Introduction

The energy price cap, first introduced on 1 January 2019, has been now been around for a little over 2 years. There is now enough of a history to be able to do a proper analysis of its performance in order to answer this basic question.

We won’t labour on what the Energy Price Cap is. You can read all about that in our Energy Price Cap Guide. Here we are primarily concerned with what impact it has actually had on consumers, energy prices and energy suppliers. Basically, is it working?

In a pros and cons type analysis one would usually start by listing the positives. However, when we drew up our list of issues, we found one side of the argument dominated by a wide margin. So, we have listed the Cons first.

First we present our summary.

Summary

We are not going to beat about the bush. As far as we are concerned, the energy price cap has been a complete and utter failure on a spectacular scale by any standards (even those involving UK energy policy).. Our reasons are;

  1. The energy price cap has failed catastrophically in its principal objective, which is to protect energy consumers on Standard Variable Tariffs (SVTs) from overpaying on their energy bills.
  2. It reduces the incentive for consumers to switch (that is when it works, which admittedly is rarely).
  3. The cap has increased volatility in domestic energy prices.
  4. It has wiped out all competition in Standard tariff pricing.
  5. Energy suppliers are no longer being punished or rewarded for their pricing decisions – as those decisions are no longer theirs.
  6. Ofgem’s messaging has led many millions of consumers into believing that they are actually being protected.

And the pros? Well there is one, but we’ll get to that at towards the end of the article.

The Cons

Energy users are worse off than if the energy price cap had never been introduced!

What do we mean by this?

Firstly, we need to go back to basics and identify why the price cap was introduced and what it was supposed to achieve. Regulators rarely speak in readily understandable language so some de-coding is required. Please bear with us.

This whole shitshow kicked off back in October 2017 when, at a Tory Party conference, Teresa May promised to bring an end to rip-off energy prices once and for all.

Once the legislation passed, it fell onto Ofgem to put the framework into place and then to implement and administer the price cap.

From Ofgem’s consultation on the energy price cap, and other Ofgem documents, we know the following.

Why are we doing this?

We meaning Ofgem. Emphasis is our own. The quote is from Ofgem.

“We want to make sure consumers are protected and get a fair deal at all times.

Our research has found the energy market is not working for all consumers and those who have not switched tariff or energy supplier are losing out. More than half of UK consumers have never switched or have only switched once, and are on more expensive default and standard variable tariffs as a result. These customers overpay by around £320 a year compared to the cheapest market deal.

Price caps are temporary measures. They ensure that if you are less active in the market you don’t get left behind and pay a fairer price for your energy.”

Why was it introduced?

“The energy price cap was introduced to make sure that if you don’t shop around, or have fewer tariff choices because of your type of meter, you don’t pay an unfair price for your energy.”

So, what can we conclude from this fuzzy regulator-speak?

From Ofgem’s statements we know that;

  • Customers who do not switch are losing out (=unfair).
  • They are losing out because they overpay by around £320 a year compared to the cheapest market deal.
  • The price cap was introduced to make sure that….”you don’t pay an unfair price for your energy” (ie you don’t lose out).

Applying some basic propositional logic to these statements.

If being on an SVT means you are losing out because you are overpaying compared to the cheapest market deal, then it follows (by reversing the signs) that not losing out means you are not overpaying compared to the cheapest market deal. Or you are overpaying by less.

So, how do you overpay by less?

On the basis of Ofgem’s implied logic, overpaying by less means that the energy price cap must reduce the difference between the cost of SVTs and the cost of the cheapest market deal. That is the only way it can happen.

Got there in the end!

So, has the energy price cap worked?

Has it b*ll***s! And now we will show you why it hasn’t.

How much do loyal energy customers overpay?

To determine this, we need to establish a benchmark against which we can measure performance.

The most important thing with a benchmark like this, is that it satisfies a number of important criteria. These are;

  • Firstly, it should be representative of the sample (in this case customers who have rarely or never switched).
  • Secondly, it can be accurately and consistently tracked over time.
  • Thirdly, it is not subject to significant distortions.

And that is all.

We created a benchmark based on these principals, so that we would track the performance of the energy price cap over time.

The detail of the benchmark, and how it is constructed is explained more fully in How much can I save by switching energy supplier?. In a nutshell, we track the average price of a basket of the Standard Tariffs of the Big 5 energy suppliers against a basket of one of the cheapest market deals. We do not necessarily use “the cheapest” market deal. Instead, we set certain minimum qualifying criteria for a tariff to qualify, in order to eliminate distortions arising from, for example, “unsustainable” pricing, incomparable products, or even potential market manipulation.

Using this data, we calculated the level of overpayment in the 12 months prior to the price cap coming into effect. By overpayment we mean the difference between the basket of Standard Tariffs of the Big 5 energy suppliers less the price of the representative cheapest qualifying tariff. We then track the level of the overpayment over time. If the level of the overpayment falls then the energy price cap is working (customers are overpaying by less). If the level of the overpayment increases the price cap is failing (customers are overpaying by even more).

How has the energy price cap performed?

Here are the details (to end Jan 2021)

  • In the 12 months before the price cap came into effect, the price differential between a basket of the cheapest deals and the basket of the Standard tariffs of the Big 6 was £288. That is what the household with average energy usage would have saved themselves, each year, if they had switched their energy.
  • The energy price cap has been in operation for 25 months.
  • In those 25 months the cap has reduced the price differential in only 7 monthly periods (28% of the time).
  • 72% of the time the price differential has been greater than it was without the price cap. That is the price cap has been making the situation worse for consumers, not better.

On the evidence, Ofgem’s policy intervention in this area has genuinely been an absolute disaster. It actually made things worse for consumers.

Think about that for a moment because it is quite an achievement. The expected result was an implied saving of £75-£100 per year. The actual result was to make things worse (consumers overpaying by even more). How could that even be possible?

On the numbers, as opposed to fictional “what might have been” Ofgem scenarios, energy consumers are worse off than they would have been if the price cap had not come into effect.

In conclusion, the energy price cap has been an abject failure in its single over-riding objective – to protect (certain) consumers from over-paying for their energy. On this evidence we rest our case.

There are another 5 energy price cap cons (excuse the pun), but we assure you, these will be covered succinctly.

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The energy price cap increases price volatility of energy bills

The latest energy price cap, that kicked off on 1 April 2021, is the 6th price change in 28 months – that is one change every 4.7 months. Prior to the energy price cap coming into effect standard variable tariffs would increase annually, if that. Consumers now face greater uncertainty over their energy bills. Nice job!

The energy price cap reduces incentives to switch (when or if it works)

This is an classic quote from Ofgem. Feel free to link to this page to keep it for reference. We won’t be moving it.

“We expect that under a cap, switching levels would have been lower, by up to 50%.”

Ofgem, Statutory Consultation – Default tariff cap – 6 September 2018

For most of the lifetime of the price cap that hasn’t happened. Why? Because the energy price cap hasn’t been working for consumers. As we explained above, because savings under the energy price cap were greater, most of the time, than they would have been without it, switching levels weren’t affected.

However, as savings have dropped, so too have switching rates, with recent data showing year on year declines in energy switching. Paradoxically, when the energy price cap actually starts to do its real daytime job (albeit pitifully), consumers stop switching and therefore lose out on the benefits of a competitive market. When the energy price cap doesn’t do its job (which is most of the time) more consumers switch but, those that don’t switch, lose out to a greater extent. Either way, consumers as a group are stuffed. It’s a classic LOSE-LOSE situation. Fewer customers switching when savings are lower means each consumer loses less, but the overall pool of customers affected is greater.

We haven’t done the research but our gut reaction would be that, net net, the adverse effect on (non-switching) customers probably varies little irrespective of what the energy price cap does. We would hazard a guess that Ofgem probably has done the research. It certainly has the data. We suspect the findings don’t suit Ofgem’s narrative, which is why we haven’t seen anything from Ofgem published on this.

The energy price cap has wiped out competition in Standard tariff pricing

Concerns over price collusion and the level of competition between the standard tariffs of the Big 5 (or Big 6 as it was previously) energy suppliers had been a hotly debated topic for years. That is, before the energy price cap came into effect. However, whatever competition there was between Standard tariffs, has been killed stone dead by the energy price cap.

Consider this. The spread between the cheapest and most expensive SVTs of the Big 6 on 31 Dec 2018 (the day before the energy price cap first came into effect) was £60.64 (5.2%). Today it is a whole £1.03 (less than 0.1%). It has contracted by a factor of 59.

And it not just the Big 6. Many of the mid-tier and smaller energy suppliers also have their Standard tariff prices at or converging on the cap.

Energy suppliers are no longer being punished for their pricing decisions

Back in the day, if British Gas put through a 9% price hike all hell would let loose. The media would descend on the company like a pack of hounds baying for blood. Consumer groups would all be “outraged” (obviously). Consumers would leave British Gas in their hundreds of thousands. And the cycle would be repeated as each of the Big 6, in turn, put through their own energy price hike not to be left out. As predictable as these responses were, even if somewhat exaggerated and unfair against the energy suppliers, they provided a useful trigger for the market. They got the message out to consumers that paying ridiculously high prices for your energy was a choice. These press articles prompted consumers to review their energy bills and to take action to switch. They got the competitive market moving.

However, when the regulator announced the latest price hike of around £100, you could hear a pin drop given the deadly silence from (most of) the mainstream media.

Energy suppliers no longer take any flak for their price changes. Now it is no longer their decision. Now it is all down to a regulator who, irrespective of which direction the energy price cap is moving, will tell you they are still “protecting” you and that the price is “fair”.

The energy price cap story is complicated and tedious. We understand that. It has been painful just writing this article. A “greedy” big energy supplier is an easy target. Ofgem (who most consumers have never even heard of) not so much. An energy price cap story will rarely, if ever, makes the editor’s cut. The market trigger is lost. Competition wanes; consumers lose out.

Which brings us neatly to the final con (disadvantage).  

Ofgem’s messaging around the energy price cap is deceptive and results in bad outcomes for consumers

Messaging matters. Poor, inconsistent, contradictory or false messaging on the subject can, and will, put consumers off engaging in the market. And Ofgem’s messaging has frankly been terrible.

When the energy price cap is going down, even modestly, the messaging has tended to sensationalise the price cuts.

When the energy price cap is going up, the messaging has become defensive; often making excuses and passing the buck.

“It’s not our fault…it’s all down to higher costs, but don’t worry, we are protecting you blah…blah … it’s a fair price, honestly… blah…blah … you are still better off….blah, blah”

Let’s take some examples.

Example 1

When?

7 Feb 2019

Ofgem’s Headline

Higher wholesale costs push up default and pre-payment price caps from April

(which one might reasonably interpret as….”not us guv, not our fault”)

Followed by…

  • Customers on default deals are still better off…
  • The caps will continue to ensure that the 15 million households protected pay a fair price for their energy
  • Under the caps, households on default tariffs are protected and will always pay a fair price for their energy
  • We can assure these customers that they remain protected from being overcharged for their energy

Times words used

Fair / fairer – 4

Protect / protected – 5

What actually happened?

Energy price cap increased by a thumping £113.

The reality

At the time Ofgem was “protecting” consumers with “fair” prices, consumers could have saved themselves over £315 by switching. There was no mention of this in the release. Instead, Dermot Nolan, the then Ofgem CEO said “We can assure these customers that they remain protected from being overcharged for their energy”. Thanks Dermot, good to know.

The Full Release is right here…

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Example 2

When?

7 Feb 2020

Ofgem’s Headline

Savings on energy bills for millions as price caps fall

Times words used

Fair / fairer – 1

Protect / protected – 8

What actually happened?

Energy price cap cut by a miserly £17.

The reality

Customers could have saved themselves an additional £347 by switching energy provider. That’s 20 times more than the reduction in the price cap. To be fair, Ofgem did mention in the press release that “Currently, switching away from a default tariff to a cheaper deal could save a typical household up to £305”. Which is helpful, if you read past the headline, which very few do. For the majority a miserly cut of £17 was hailed as a monumental triumph – Savings on energy bills for millions.

The Full Release is right here…

So what is it with Ofgem and its deceptive messaging?

Do they lack the backbone to face up to the reality that their energy price cap is a disastrous failure?

Are they more concerned about covering their own backs than protecting the genuine interests of consumers?

Did they just let the intern loose on their press releases?

Who knows?

The Pro

The energy price cap has accelerated Industry consolidation

If there is a positive side effect to the energy price cap, it is that it has played a role in speeding up consolidation in any industry which had too many weak, underfunded, poorly managed and unsustainable players. Several companies, including extra energy, have directly blamed the price cap for pulling out of the market, even although extra energy was neither weak nor underfunded. Consolidation of the industry around a smaller number of stronger players will ultimately lead to more sustainable competition with better service to consumers. Provided of course that the number of players doesn’t fall too far. However, with some 60 energy suppliers still active in the UK domestic energy market we are a very long way away from that.

WRAP UP

We are going to wrap with this simple observation. If you have stuck with the “fair” prices that Ofgem is “protecting” you with, you will, to 1 April 2021 already have overpaid by £738 for your energy. Across 11 million households still on standard or default tariffs, a number provided by Ofgem which seems stubbornly stuck at that level, that comes to a thundering £8 billion.

Nobody wants to be one of those suckers, right?

Why pay more for the same energy?

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Read more … 

  Energy Price Cap Guide

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