Price protection in a flexible world

As Ofgem sets out its intention to replace the existing price cap, leading energy analyst Martin Young writes for Utility Week on what the future might hold. With a solution more befitting of a smarter and flexible energy system the end goal, Young calls for protections for those keen to embrace change while ensuring we have a just transition.

Our relationship with electricity will change hugely over the course of the next few years and into the 2030s.

Smart meter penetration will increase, EV take-up will accelerate, there will more domestic solar, some will install batteries, and the number of heat pumps installed will grow (albeit from a low base).

In turn this will see larger amounts of electricity consumed and at times of the day that are different to historic norms.

In order to shift demand and better utilise the electricity system for the benefit of all, consumer behaviour will need to change. I expect to see a broader range of time-of-use (ToU) tariffs come to market, and the engaged are likely to adopt these with enthusiasm, keeping an eye on prices, and managing consumption.

But what about the mass market?

Around 90% of consumers are on default tariffs and although many will have been previous switchers, it is likely that there is a sizeable cohort who value the assurance that the price cap provides.

As we seek to encourage demand to shift, it is right to ask the question as to whether there should be price protection for such tariffs, and if so, what form could it take? This week’s discussion paper from Ofgem on the future of domestic price protection is therefore very timely.

Now, I’m a big fan of innovative tariff options, and as wholesale prices have come off their highs, the Octopus Agile tariff (one of the most innovative ToU tariffs) has proven to be extremely attractive over the past year when compared to default tariffs, and even more so for those able to shift demand away from the 4-7pm peak pricing period.

I expect that we will see more tariffs of this ilk come to market over the next few years, particularly when Market-wide Half-Hourly Settlement (MHHS) is introduced in 2025.

But such tariffs will not be for all, and there is always likely to be a cohort who want simpler options, but who also want the comfort of price protection. Against this backdrop, Ofgem’s discussion paper seeks to stimulate debate and explore options as to how price protection might evolve.

There is recognition that cap has worked well in driving down supplier costs, that price protection will need to play a part in an equitable transition to a flexible net zero energy system, but maintaining a flat, universal and stringent price cap will be challenging. Ofgem will explore the role of price protection in a more dynamic retail market.

The paper includes analysis of where the cap is today, including challenges, risks and costs, and how the one-size-fits-all approach works favourably for some suppliers, but to the detriment of others.

MHHS could exacerbate this risk, with consumers with low-cost consumption patterns potentially moving to ToU tariffs, leaving higher cost consumers on the cap, in turn potentially leading to a higher cost cap. Given the impending introduction of MHHS, Ofgem has indicated that it intends to conduct a review of the wholesale allowance methodology.

What might the future hold?

The focus of the discussion is very much on electricity, with options to move away from a flat cap being a static ToU or dynamic ToU cap, options to move away from a universal cap being a targeted cap based on vulnerability, and a bottom-up cap that excludes customers with certain ToU or use products, and options to move away from a stringent cap being a market basket cap, a within supplier relative cap, a Ban on Acquistion-only Tariffs, or a margins cap.

The deadline for responses is 6 May, and it is highly likely we will see many more suggestions, but in my view, we need a greater proliferation of flexible pricing options, but to support this with pricing protection for those who desire it, as if products are considered too risky, it is likely to be a deterrent to their uptake.

Equally it is imperative that the vulnerable are protected and that we have a just transition.

Martin Young will be the guest speaker for our next interactive virtual briefing in the Utility Week Horizons series. In this Chatham House event, Martin will give his frank view of the opportunities and challenges facing utilities over the coming years, including the attractiveness of the UK to investment, the evolution of the regulatory regime and policy blockers. Utility Week members can join for free by emailing editor James Wallin.