Pandemic halts progress towards lifting price cap

Ofgem has said the impact of the coronavirus pandemic on the smart meter rollout contributed to its decision not to recommend the price cap be lifted at the end of this year.

The energy regulator set out the rationale behind its decision in a report published this morning (7 August), alongside the announcement it was lowering the cap in October.

Writing in a foreword to the report, Ofgem’s interim chief economic adviser Maureen Paul said, while the pandemic has not ultimately changed or driven its decision, it has “decelerated and in some cases halted progress” towards meeting the conditions it set out last year.

“Overall, our review recognises that the market is working well in many ways, for example, through increases in switching rates and overall engagement driving stronger competition between suppliers to win and retain engaged consumers,” he added. “However, more than half of energy consumers are still on default tariffs and the evidence does not show that they would, in the absence of the price cap, continue to be treated fairly.”

There are three conditions set out by Ofgem which must be met in order for it to recommend the cap be lifted:

• Structural changes from the government, Ofgem and the wider market are facilitating competition
• The competitive process should be expected to work well in the absence of the price cap
• The competitive process should deliver fair outcomes for consumers

For the first condition Ofgem says while important progress has been made, such as the modification of licensing requirements, smart meter installations have been slower than expected and further limited by the pandemic. It added that additional changes expected in the coming years, such as Ofgem’s faster and more reliable switching programme, will help with progress in meeting the condition.

Speaking in a conference call with journalists this morning, Paul said Ofgem was assessing the conditions “in the round” and the regulator did not have a threshold by which it would deem there were enough meters to recommend lifting the cap.

In assessing condition two, Ofgem recognised the retail market has become more competitive and that consumer engagement has overall increased, with record high rates of switching pre-Covid. It is, however, concerned about the number of disengaged customers, who are more likely to be on a lower income.

“In particular, it is not clear that engagement levels across default tariff customers would be sufficient to constrain the price setting of default tariffs, in the absence of the cap. While the proportion of households on default tariffs for electricity has fallen by 5 percentage points since 2016, it remains the case that the majority of households are on these tariffs”, the report said.

While larger suppliers are pursuing efficiency programmes to bring costs closer in line with the cap, the programmes will take time to bear fruit and deliver lasting productivity gains. Furthermore, Ofgem is monitoring how the financial impact of coronavirus will affect market structure and competition.

For the third condition, Ofgem said it expected the default cap would narrow price differentials between default tariffs and fixed tariffs. It added that price differentials have not fallen but may still be lower than if the cap were not in place. There is therefore significant uncertainty on how prices and differentials will evolve post-cap, with little evidence to suggest that households on default tariffs would continue to pay a fair price if the cap were lifted.

Ofgem said this, combined with increased pressure on household budgets due to Covid-19, increases the risk of lifting the cap.

The regulator found that overall, it is not clear that customer service is improving. Customer satisfaction is highest among medium sized suppliers, with smaller retailers seeing a rise in complaints. This suggests that some of the smaller suppliers may not be adequately prepared and resourced to meet their commitments, and as this is addressed there may be changes to market structure.