Ofwat warned price cap proposals risk supplier failures

Water retailers have warned Ofwat that its proposals for a national price cap for small, disengaged business customers would not enhance competition and could instead lead to supplier failures.

The Strategic Panel, a group formed of non-household market participants including retailers, wholesalers independent members as well as representatives from Defra, Ofwat and CCW, said the proposals laid out in Ofwat’s consultation on adjusting the REC Retail Exit Code (REC) could have the opposite to the intended effect and would “likely reduce levels of rivalry between retailers and the benefits that could bring to customers”.

The panel said faced with the prospect of insufficient margins until the next review in five years, retailers would be unlikely to invest in growth or expansion and predicted a dampening effect on new entries to the market.

Ofwat’s consultation launched in September reviewed the price and non-price protections in the REC and proposed a single national price cap for disengaged customers with consumption under 500,000 litres a year.

Bills could fall by 13% for some customers or rise by up to 18% for others, depending on current regional price variations. The group said adjustments posed by Ofwat would deliver only short-term benefits, but improving margins to boost competition has the potential to drive more advantages in the longer term.

The panel told Ofwat its proposals would hamper the competitive market and proposed working with the regulator to develop a strategy to overcome barriers to competition. It also expressed concern that insufficient consideration has been given to why the market is not working for small business customers.

The group’s response argued against Ofwat’s assertion that inefficiency is the key reason for overall market losses and suggested, where known inefficiencies exist, they are primarily outside of retailers’ control. Cost incentives already exist, the group said, but most retailers remain loss making meanwhile no new entrants have emerged to undercut current suppliers.

“We do not believe Ofwat’s proposals will allow for competition to develop or allow retailers to earn sustainable returns,” the panel argued. “We believe this increases the risk of retailer failure and stranded customers should a large incumbent retailer fail.”

Business customers whose consumption is equivalent to a household, or below, have little incentive to change supplier and, according to Ofwat’s State of the Market reports, low awareness of the option to switch. They therefore tend to remain with incumbent retailers that are unable to recover the costs of supplying and are therefore unlikely to invest to improve service to those customers.

The panel suggested it is likely that retailers with a higher cost to serve than Ofwat’s allowances would need to make efficiency savings of around 40% or face default.

While the failure of inefficient suppliers was acknowledged as a necessary part of a functioning market, the panel raised concerns that the proposed REC price caps would not allow efficient retailers to make a fair return either.

Ofwat will publish its decision in December ahead of any changes coming into effect from April next year.