Fixing the SVT Problem

Despite a lengthy CMA investigation, which the industry, government and the regulator, all hoped would lay to rest the public’s concern over the energy supply market, the market finds itself back in the headlines and firmly on the political agenda.

For a government that is concerned about the Just About Managing (Jams), and have a stated intent to intervene in markets that aren’t working, this is an unacceptable place to be. Already with sterling’s fall and inflation feeding through to consumer prices, the last thing the government wanted as a set of energy price rises that were up to seven times the current rate of inflation.

So, what is the current state of the market. The current structure of the market means that some 65 per cent of the market is still on the standard variable tariff (SVT), despite being able to save over 200 per fuel and numerous campaigns to promote switching. The government believes in competitive markets and has relied on promoting people to switch and the emergence of new entrants (now 40+).

However, this has arguably resulted in those that do switch, simply moving between suppliers, whilst the inert customers remain on SVT. The total returns of the large suppliers are not excessive but the current structure of the market means that little profits is made on prepayment tariffs or fixed deals with the vast majority of profits coming from SVT customers who tend to be less active in the market.

New entrants come into the market are competing purely on price and are earning very small margins on introductory deals hoping to acquire enough market share in order to sell their company or move their customer base to a higher SVT over time. The problem is with more new entrants coming into the market the former new entrants aren’t making money and haven’t been able to sell. Combined with a more volatile commodity market and without adequate stress testing of new entrants from Ofgem, we are likely to see further exits from the market. It may be a sign of a heathy market were entrants are free to enter and exit however there is a cost to consumers when companies exit the market and it is estimated that GB Energy’s demise cost consumers in excess of £20 million.

The CMA has offered some protection from those on prepayment meters by placing them on a regulated tariff. The customer loses this protection once they have a smart meter installed. How much this saves customers depends on the price curve and the price movements of SVT. Given that prices are likely to rise early in 2017, then the prepayment, which was based upon a fixed price earlier in the year, is likely to be much cheaper than the SVT.

This however still leaves many SVT customers who have not switched for many years and therefore are unlikely to switch. The CMA have proposed a data base for those that have not switched, which would be open to new entrants, but there are questions how effective this will be in prompting switching, and the legal issues about data privacy etc.

What is worse is that no-one seems happy at the current state of the market. Consumers feel that they are being ripped off, with over inflation rises in prices. Suppliers are achieving low single digit returns in the supply market , are taking substantial political heat for the pricing structure and are failing to build trust with their loyal long term customers, the very customers that they need to sell more products to as they transition from energy companies to service companies. So the conclusion must be that the market is not working, either for companies, the consumer or the government.

So what are the possible solutions and what are their implications?

Possible Solutions

• Regulated Tariff

Extend the current regulated tariff for Prepayment meters to all customers who have not switched in the last three years and are on SVT. This would impact a significant number of customers but would reduce competition in the market, with those customers previously being on SVT now feeling that they were on protected regulated rate and hence not looking to switch. This would kill switching and lead to new entrants leaving the market and switching sites suffering. In addition the Labour party could well claim that the government was adopting their policy first put forward by Ed Milliband.

• Cap the differential between the SVT and cheapest tariff

If there was maximum differential between the SVT rate and the cheapest rate – say £100 or a set percentage then the following could happen.

The large suppliers would not be able to have price differential of greater than £100, so would either have to reduce the SVT or raise their fixed rate deals. Given their large SVT bases they are likely to keep SVT high and offer less attractive fixed deals. If this happens then new entrants will offer attractive rates and gain market share however it would mean that the market splits into two with a market for switchers, where prices are set by new entrants and the SVT rate set by the large suppliers. Under this scenario it does not seem to benefit the SVT customers, as they so no real price reduction unless the large suppliers are forced to compete due to losing customers. It should be noted that the rule would apply to all suppliers, so that some new entrants who are making money from a high SVT would also be impacted. However they would work out the economics of whether they would make more money on having a competitive fixed prices versus a higher SVT price.

• Make the SVT tariff renewable every year

The SVT tariff would have to be renewed ever, effectively moving to an annual renewal market. Every year the supplier would have to write to the customer detailing the following:

• Renewal Notice
• Their proposed tariff at time of renewal ( it is not fixed)
• Their cheapest other deal (including all fixed deals they have)
• A link to the Ofgem switching website and a list of sites can advise on energy.
• A statement in bold from Ofgem saying that customers can typically save money by switching to a non SVT tariff and this can be as much as £200.

If the customer does not positively opt into a new fixed deal within 30 days then they continue to receive the SVT rate but are placed on a database for other suppliers to access.

If they positively opt-in then they will remain on SVT for a further year. This would make the SVT customers much more aware of the options and prompt them to make a decision, compared to now where they simply stay on the SVT tariff and get an annual statement.

For a government who has stated that they will intervene in markets that aren’t working and who are keen to be seen to act on behalf of the Jams, the question is no longer will they act but what will they do. No solution is perfect or straight forward, but the current position is also unsustainable, the question therefore remains which has the least downside to consumers and politically in the medium term.