Ofwat raises non-household price cap

Small business customers who have not engaged with the water retail market will face increased prices from April, with Ofwat increasing the price cap by an average of 6.4% for consumers using less than 0.5 megalitres (Ml) per annum.

The regulator said it retained the protection for some business customers because competition was not working at the smaller end of the market, which 85% of customers falls into.

Ofwat raised the cap from the proposed £34.07 in the September consultation to £43.91 following feedback from retailers including new evidence supporting a higher cap.

The rate will only apply to commercial customer who have not engaged with the retail market either by switching or renegotiating prices with their supplier. For these customers, Ofwat identified competition was not effective. All commercial billpayers are eligible to change water supplier or renegotiate prices with their retailer since the market opened in 2017 however the regulator identified that only 8% of smaller customers had ever engaged. For these customers the Retail Exit Code (REC) provides regulatory protections including specifying the maximum prices for small- and medium-sized commercial customers.

“It is not yet clear whether or when effective competition will develop amongst smaller business customers,” Ofwat said. “At present we continue to see low levels of market awareness and engagement by smaller business customers. They currently have less incentive to engage in the market. They can expect to make smaller financial savings from switching and face limited differentiation in supplier offerings and possibly also a lack of awareness about how service offerings differ between retailers.”

This is the first time Ofwat has thoroughly assessed the cost to serve across retailers and concluded that competition was not fully effective for all users. To calculate the cap, the regulator benchmarked costs against costs to serve of a reasonably efficient retailer.

Ofwat explained the approach reflected “reasonably, and not the most, efficient costs to serve” that should allow a “reasonably efficient” retailer to make a return and offer “generous headroom” for the most efficient.

Following the September consultation, the cap is higher than previously proposed. Retailers had raised concerns that it was not high enough and would result in customers being served at a loss in some instances.

Ofwat accepted some of the arguments presented in consultation responses, together with additional data from the market including suppliers covering bad debt.

Customers using more than 0.5 Ml in a year or those that have engaged with the market are not affected by the cap, because Ofwat felt the competitive market was working for them.

The existing price protection was retained for users of 0.5Ml to 50Ml in a year. This is calculated as the gross margin +8% for water, and +10% for wastewater services.

Retailers hit back at Ofwat’s proposed rise in September arguing that the cap would be insufficient to serve small customers and could result in supplier failure as margins were too narrow.