One year of the energy price cap

The price cap has certainly caused a stir in the market and has been blamed for denting supplier profits. Yet despite industry expectations, it is yet to dampen energy switching. One year in, Adam John looks at the effect of the cap and what a new government means for its future.

1 January 2020 marks one year since the default price cap was introduced to the energy retail market.

A legacy of Theresa May’s turbulent tenure in Downing Street, the cap is designed to protect around 11 million vulnerable energy customers. Already we have seen the cap revised to keep in line with wholesale gas and electricity costs and the next adjustment is expected in early February.

One year on what, if any, changes have we seen to the market?

One industry expert argues that the cap was introduced as a way of taking money away from suppliers. It would seem the larger players concur as many have blamed it on denting their profits.

Martin Price, a retail energy director at Baringa Partners, says the government’s positioning to Ofgem was that some companies were profiting from a lack of engagement.

“The government instruction and positioning to Ofgem was that some companies are not sufficiently efficient and that they were making money off the back of customers who haven’t engaged in the market and therefore haven’t switched.

“Ofgem’s methodology was to fund on the basis of an efficient operation, such that non-switching (default tariff) customers wouldn’t be overpaying for their fuel.

“This has effectively taken a chunk of money out of the market as many companies weren’t able to become sufficiently more efficient that rapidly, therefore making either less profit or making a loss. So to an extent, you can understand why companies would blame the price cap in making less money because in part that is what it was designed to do.

“I guess there’s a challenge certainly for the big six companies to rapidly become more efficient and therefore catch up with the allowance in the price cap. That’s a tough ask of any organisation and you can arguably say they would have probably been trying to do that anyway.”

A reduction in the number of customers switching supplier was widely expected following the cap’s introduction, but this never materialised. Switching in fact has been increasing and 2019 looks set to be another record year, with 2018’s total of 5.8 million switches already being achieved in November.

Lakis Athanasiou, utilities analyst at Agency Partners LLP, says “in theory” a price cap should massively dampen down switching as it forces narrower differentials in tariff offerings.

“In 2019 this dampening did not come about, as wholesale prices moved below those set by the tariff cap, allowing significant undercutting.

“Over this past summer, the wholesale price for an annual contract was around 25 per cent below the tariff cap equivalent, due to the collapse in global gas prices, with excess LNG. This allowed around 10 per cent margin discounting.

“In practice, discounting relating to wholesale prices could have been even higher, with some of the discounters just focussing on near term prices (ie summer only,  rather than a one year lookahead) leading to even greater discounting.

“This led to intense competition and high switching over the past summer.”

Despite the increased switching numbers, one industry voice takes the opposite view and instead believes switching was hampered by the cap.

Peter Earl, head of energy at Comparethemarket.com, says the increase in switching this year is largely down to the period between the announcement of the price cap increase and its implementation in April.

“Although the published data from Energy UK suggests this will be a record year for switching volumes, it seems like there is an increase but probably that has been supressed in our view by things like the cap.

“Many customers who are aware the cap is in place on SVTs have sat and done nothing when arguably this year they could have shopped around and found something better.

“The message here is a bit mixed because depending on whether the price cap level goes up or down, of course depends on how the market treats and communicates that. In October, the cap level was reduced and there wasn’t the same hive of activity around in the months prior to the cap being in place.

“I think the balance of the year will show there has been a slight increase year on year in switching activity, that was driven primarily in the months February to March. And that’s driven almost the entire growth volume for the year.”

Energy UK’s figures do show a high amount of switching around the time Ofgem announced the increase in the cap level.

For example, in February 453,000 switched, increasing to 615,500 in March and peaking at more than 668,000 in April this year – up by 34 per cent on the previous April and the highest number ever recorded.

In May, the figures fell to 487,000 – a decrease of almost 30 per cent on the previous month.

Following the decline in May, Energy UK’s graph shows that switching rates never reached the same peak as earlier in the year.

While Earl argues that the cap hindered switching, Ofgem’s own data highlights how consumers had a low awareness of the price cap during the first quarter of this year, suggesting it may not have been the case.

According to the regulator’s quarterly consumer perception survey, only a quarter of consumers said they were aware of the cap, while 19 per cent said they had an informed awareness of the cap.

Furthermore, switching has grown year on year which may even be an indication of a developing habit among energy consumers. In 2015 3.8 million customers switched electricity supplier, compared to 5.8 million in 2018, a figure which will be surpassed in 2019.

So as we enter a new decade, what next for the price cap?

As the law stands the price cap will end in 2023. The government can opt to remove the cap before this date if market conditions are sufficient to recommend to the energy secretary to remove it before the end of that year.

Specifically the framework will assess whether the conditions are in place for “effective competition” in domestic supply contracts.

Ofgem says it expects effective competition to deliver fair outcomes for consumers including not being overcharged, receiving a good quality of service, and having access to a range of energy products and services.

Yet this poses a dilemma as Alan Whitehead, who served as Labour’s shadow minister for energy and climate change, has previously pointed out to Utility Week. What Ofgem may think is a resumption of a fair market may be influenced by how it perceives its own work.

Several amendments providing detail on how Ofgem can assess the market were proposed at committee level during the passage of the bill through parliament. All but one were rejected.

One factor that should not be underestimated is Boris Johnson’s emphatic general election victory, which ends several years of political uncertainty.

The Conservatives have promised to keep the existing price cap and even introduce new measures to lower bills. Certainly the key question for the new government is whether or not they will make the cap permanent, or at the least extend it beyond 2023.

As Martin Price points out, the removal of the cap is a very politically weighted decision.

“Aside from the cap itself, structurally there hasn’t yet been significant changes to how the market operates, or in engaging the customers who are still not yet participating the market”, he adds.

It’s clear the cap is not the silver bullet many thought it would be. That said, it is here to stay for now but as for what happens next, both the government and industry have much work to do to engage inert customers.

While it is not exactly clear what needs to be done to tackle the issue of protecting the vulnerable, it is important that we try our best to understand the price cap’s effect on the market. Doing so will enable both the government and regulator to make better informed choices.