Is the energy price cap a good fit for companies and customers?

Ofgem has revealed proposals to set a cap at £1,136 per year, but research by Moody’s shows this will mean credit negativity for some suppliers.

The idea of a cap on energy prices is one that has been bandied about for several years. Now it’s looking increasingly likely to be in place by the end of 2018.

A few important milestones have already been marked this year, including the notion moving from a topic of conversation to something more formal in the sense of draft legislation to finally passing into law.

It’s been a top priority on Ofgem’s to-do list and the main item on its Christmas wish-list for quite some time as the regulator has outlined on more than one occasion that it hopes to implement the price cap by the end of December.

Since the Domestic Gas and Electricity (Tariff Cap) Act became law on 19 July it has been full steam ahead for Ofgem.

But the level at which to set the cap had remained a moot point until last week when the regulator decided to show its hand. On 6 September it revealed proposals to set the cap at £1,136 per year for a typical dual fuel customer paying by direct debit. Suppliers will have to cut their prices to at or below the level of the price cap when it is introduced.

A fairer deal

The regulator’s chief executive Dermot Nolan says Ofgem has made “full use of the powers” it has been given by parliament to “propose a tough price cap which will give a fairer deal to consumers on poor-value default tariffs”.

Ofgem claims 11 million households on poor-value default tariffs are set to save around £75 on average, while a typical consumer on the most expensive tariffs would save more than £120. Prime minister ­Theresa May has previously indicated the move would save customers £100 on average.

The exact savings for each individual household will depend on the price of their current deal, how much energy they use, whether they have both gas and electricity, and how they pay for their energy.

Energy companies have been cautiously waiting to see exactly how low Ofgem will go and now say they plan to study and “scrutinise” the detail of the regulator’s proposals.

Some of the big players in the market have wasted no time in suggesting the proposed level is a cause for “concern” for the industry. Trade body Energy UK also highlights it will pose a “challenge” for companies.

Lawrence Slade, chief executive of Energy UK, says: “There are over 70 suppliers in the energy market who will now be assessing how this impacts their individual business, however for many suppliers this will pose a significant challenge.
“It is crucial that the cap ensures we have an investible energy sector where efficient and financially robust companies can trade, and innovation and engagement can continue to flourish and deliver benefits for consumers.”

But Citizens Advice describe the cap as an “important step in the right direction”.

The organisation’s chief executive Gillian Guy says: “While the price cap should save people on standard variable tariffs money, people should still be able to find a better deal on their energy bills by shopping around. A cap on default tariffs is a good start in ­tackling the cost of being a loyal consumer.”

Nolan insists that once the price cap is in place, all households in Great Britain ­covered by the cap “will be protected from being overcharged for their energy”.

“Consumers can have confidence that falls in energy costs will be passed on to them and if costs increase, Ofgem will ensure that any rise will be due to genuine increases in energy costs rather than supplier profiteering.

“Households protected by the cap will be able to save even more money by shopping around for a better deal. Meanwhile, Ofgem will continue with reforms which aim to deliver a more competitive retail energy market which, combined with protection for those who need it, works for all consumers,” he says.

Competition, not caps

Big six energy supplier SSE argues it is competition and “not caps” that will be best for customers in the long term.
The company’s retail arm is a step closer to merging with Npower after gaining provisional clearance from the Competition and Markets Authority on 30 August.

SSE chief executive Alistair Phillips-Davies says: “SSE will assess the potential impact on its customers, operations and the wider GB energy market and will respond fully to Ofgem’s consultation. The key question to be answered is whether the proposed cap is ­cost-reflective, fair and sustainable.

“An absolute price cap is a significant market intervention, requiring a complex set of judgements around the multiple and ­variable costs involved in supplying energy.

“Setting the cap at a level that protects the needs of current and future standard tariff consumers, preserves effective competition in the market and enables efficient suppliers to finance their licensed activities is a challenging task but also an essential objective, and it is against that objective that the proposed cap and associated methodology needs to be tested.”

He adds: “SSE supports the ­development of a healthy, well-functioning ­competitive energy supply market and continues to believe that competition, not caps, best serves the long-term interests of customers.

“Nevertheless, we will continue to engage fully with Ofgem to ensure that the default tariff cap is as fair and robust as possible.”

A spokesperson from Npower suggests: “The potential level of the price cap is ­concerning for the whole industry.”

Credit negativity

Meanwhile, financial services company Moody’s says the “partial re-regulation” of energy prices and resulting reduction in cash flow are credit negative for energy ­suppliers, including Centrica. The company’s research highlights the regulator’s calculation is based on its view that suppliers should earn a “normal” Ebit (earnings before interest and taxes) margin of 1.9 per cent, but also includes a “headroom allowance” of 1.45 per cent of costs, intended to provide opportunity for companies to compete for customers by offering ­tariffs below the cap.

“Taking the normal margin and headroom together, we estimate that Ofgem expects an efficient company to earn an Ebit margin of around 2.8 per cent, or £32 per customer per year. This compares with the average margin of 4.2 per cent or £50 per customer earned by large suppliers in 2017 and the £70-85 earned by the most profitable,” Moody’s says.

It estimates that the default tariffs of the six large energy retailers will fall by an average of £105 per year, slightly greater than the reduction of “as much as £100” promised by the prime minister in May 2017.

All the large energy suppliers have increased their prices between April and July 2018, and all except SSE and Npower announced a further increase to take effect between August and October.

Moody’s points out companies are likely to respond to the default tariff cap by “increasing unregulated tariffs and accepting the associated loss of customers to independent suppliers, and by reducing costs”.

EDF says it plans to “work constructively with Ofgem” to identify any adjustments that might be needed to ensure the “cap is set appropriately”.

“The cap needs to reflect all the costs that companies face while preserving service and competition,” the company says.

Poisoned chalice

Consumer champion Martin Lewis’s main reservation is that a “fair” tariff is not the same as a “good” tariff. The founder of Money Saving Expert says: “Ofgem has been brave, setting the price cap lower than expected. It will mean millions see a noticeable reduction in bills. Yet the regulator was given a poisoned chalice. It is calling this new tariff a ‘fair’ ­tariff, but that isn’t the same as a good tariff.

“The savings are still pitiful compared with the amount people would get if they switched and went to the market’s cheapest providers – but there is a real concern the imposition of a cap will give people a false sense of security that doing nothing is fine.”

Mid-tier supplier Ovo is looking forward to the industry being able to focus on other matters once the price cap is in place. A spokesperson for the company says: “A price cap is the only solution that will protect customers and still allow innovative suppliers to compete. All energy companies should accept the need to reassure customers and restore trust in the energy market.

“The sooner the cap is in place, the sooner the industry can move on and focus on utilising intelligent technology like home batteries and electric vehicles to transform the customer experience and cut emissions.”

Hayden Wood, co-founder of green energy company Bulb, adds: “It’s good news the government is taking action and that prices will go down for millions of people. But even after the cap comes into force, energy bills will still be too high.”

Temporary measure

The level of the cap will be updated by Ofgem every April and October, to reflect the estimated costs of supplying energy.
It is designed to be a temporary measure until 2023 at the latest. Ofgem says this will allow it to put further reforms in place to make the energy market “more competitive and work better for all consumers”.

Ofgem is aiming to confirm the cap level in November in time for the price cap to come in at the end of the year, subject to the statutory consultation process.

The first update of the level of the price cap will be announced in February 2019 and come into effect in April 2019. It will then be updated every six months.

The price cap is coming whether the industry likes it or not. The time for simply talking about it is almost over.