Ofgem releases first working paper on energy price cap

Energy stakeholders have two weeks to respond to Ofgem’s early “evolving” thoughts on how it will set the price cap.

The regulator has released the first in a series of working papers about the design and implementation of a cap to protect all domestic gas and electricity consumers on standard variable tariffs (SVTs) or other default tariffs.

Existing safeguard tariffs cover only those vulnerable customers with prepayment meters and recipients of the Warm Home Discount (WHD).

Ofgem was tasked with creating the default tariff cap following the government’s introduction in February of the Domestic Gas and Electricity (Tariff Cap) Bill, currently going through Parliament. The legislation will give the regulator powers to place an absolute limit on how much energy firms can charge customers on such tariffs.

“Working Paper #1” addresses high level design questions about the cap which it says needs to be brought in “as soon as practicable”.

It aims to create a cap mechanism which reflects an “efficient level of costs” and enables “suppliers to compete and maintain incentives for domestic customers to switch”.

Ofgem confirmed any mechanism would also need to allow for regular price reviews, at least every six months. It also said, in line with the progressing bill for price regulation, that the cap will be time limited and could be removed from the market in 2020 if a review finds it is no longer required as a precaution against overcharging. If the 2020 review finds the cap is still needed, it could be extended on an annual basis out to 2023.

Later papers from Ofgem will focus on specific issues relating to the default tariff cap, while this first paper raises three main “overarching” considerations:

• the legislative framework determining which factors will be taken into account when choosing the methodology for setting the cap
•  the design of the cap, and particularly whether different levels would apply to different consumer groups
•  finding the most reliable guide to estimating an efficient level of costs to help set the level of the cap, including by reference to an existing benchmark, an updated “competitive” price benchmark, linking it to trends in a basket of market tariffs, or by using a “bottom-up” approach

Ofgem points out that many of the questions around the design of the default tariff cap are closely related to issues raised in its previous consultations on the vulnerable safeguard tariff. Given the overlap, evidence received from stakeholders in that context will be noted.

”The main feature of the default tariff cap which distinguishes it from the existing safeguard tariffs is the wider scope…

”A key area of our focus will therefore be what implications this broader scope has for how the cap should be designed.”

The regulator added: “We have not included questions in this paper but are inviting comments on any or all of the issues raised.”

The proposed licence changes are due out in August, assuming the government achieves Royal Assent for its price-cap legislation before the summer recess.

A second working paper in April is expected to cover how market pricing data can be used to set the level of the cap and update it over time.

Ofgem is also planning to publish further working papers by May 2018, covering issues such as the principles underpinning the level of headroom suppliers will have in order to compete, and the regulator’s approach to estimating companies’ own operating costs, including smart metering.

It is calling for feedback within two weeks of publication of each paper. The series will be followed by a formal policy consultation.

Around 11 million homes across the UK are said to be on default tariffs, with a 2016 report by the Competition and Markets Authority (CMA) finding consumers were paying around £1.4 billion a year in excessive fees.