How effective is the new Supplier Cost Index?

Ofgem aimed to increase market transparency with its new Supplier Cost Index (SCI). Jane Gray considers how the new index has been received by industry and the press.

Like sharks sensing blood in the water, energy journalists in the national media used to swarm on the quarterly publication of the Supply Market Indicator (SMI) with voracious glee.

The metric, in use until May 2015, used to forecast the profitability of energy companies and was a regular source of ammunition for those keen to wave evidence that energy companies are unfairly profiteering at the expense of customers. Of course, the SMI did not provide any robust view of the actual profits of energy companies, but that was an irrelevant detail to many commentators.

In the midst of the Competition and Markets Authority (CMA) investigation into the energy market, and after relentless criticism of the SMI from suppliers and trade body Energy UK, it was eventually withdrawn while Ofgem awaited the outcomes of the CMA’s work.

Now though, in the wake of those findings and following consultation with industry, the energy regulator has revealed its new look SMI – the Supplier Cost Index (SCI). Will it avoid the pitfalls of its predecessor and provide a useful measure of fair energy pricing?

At a press briefing for the new index, Ofgem chief executive Dermot Nolan was hopeful. He was clear about what the metric is intended to be used for, and about what it cannot show.

Much to the chagrin of national reporters, he emphasized that the SCI does not provide any information about energy company profitability (information available in the Consolidated Segmental Statements) or provide a “pounds and pence” figure for what suppliers ought to be charging.

What the SCI does show, is a 12 month ahead view of the expected cost of supplying the average UK energy customer, compared to historical cost levels. As quarterly updates are issued, Nolan said the index should track the underlying costs of energy supply and make it clear whether prices are following costs.

Supply costs considered in the index include wholesale energy prices, network charges and the cost of government programmes, such as the Energy Company Obligation. Companies’ operational costs, including metering and billing and any expenses associated with the smart meter rollout are not within scope – though Citizens Advice, who broadly welcomed the SCI’s contribution towards greater transparency in the market, urged Ofgem to consider how operational costs might be included in the future.

The first index figures that the projected cost of an average dual fuel energy bill in 2017 is 15 per cent higher than it was at the same point in 2016.

However, when taken in a longer term context, this increased cost base is still around 10 per cent lower than the annual cost of supply recorded in January 2014. On this basis, considering the long term hedging strategies most large suppliers employ to provide for the large bulk of customers on standard variable tariffs, Nolan said he does not see “any obvious reason” why suppliers would raise the price of these tariffs today.

He added that the annual cost base increase recorded in the first SCI is “far from unprecedented” and that companies, especially larger ones, ought to be able to offset the additional expense via efficiency measures.

For most of the big six, Nolan’s statements will not cause consternation. Many announced price freezes for their SVT customers before Christmas.

EDF Energy is one of the few to have scheduled a price hike. In March, its electricity prices for SVT customers will increase by 8.4 per cent – though when offset by a reduction in gas prices, customers with dual fuel accounts will only feel a 1.2 per cent increase.

Responding to Nolan’s suggestion that price increases are unjustified when considered in the light of longer term reductions in the cost of energy, EDF Energy told Utility Week that “Our policy of buying electricity ahead of time has protected customers from the more recent volatility in wholesale price”. However, “non-wholesale energy costs have risen and we have been honest with customers about the future impact on prices”.

These non-wholesale costs are explained as costs to “ensure reliable supply though investment including in networks, renewables and metering” – though according to the SCI, non-wholesale contributions to the energy supply cost base have been minimal over the past 12 months (see graph).

Individual cases aside, the response to the SCI in the national press shows that suppliers can still expect the release of market data by the regulator to lead to lashing. Headlines following the release of the SCI focussed on Ofgem’s “warning” to suppliers.

However, despite this unsurprisingly critical reaction to the SCI data, the market has grudgingly welcomed the metric as a boost to transparency at a time when it sorely needs customer trust.

Suppliers were no doubt relieved that this quest for openness did not once again seek to measure profitability, though any joy on this front may be short lived. At Utility Week’s Energy Customer Conference (19 January) CMA energy investigation chair Roger Witcomb reopened the issue of energy company profitability saying that “incredibly opaque” and inconsistent reporting is a source of mistrust in the market.

Ofgem has invited feedback on how it can improve the effectiveness of its many market metrics. It may well yet be required to revisit its methodology for measuring whether suppliers are charging more than is fair.