Report suggests energy price cap will ‘reduce competition’

The incoming energy price cap on standard variable tariffs (SVTs) will reduce competition in the market, a report compiled by the Adam Smith Institute suggests.

Sam Dumitriu, the institute’s head of research, said price differences between “rip off” SVTs and cheaper fixed tariffs are not evidence of low levels of competition as has been suggested. Instead, he says, “large price differences” between similar products are frequently observed in highly competitive markets.

Dumitriu argues increased competition leads to wider price differentials.

He said: “Economic theory and international evidence predicts that imposing a price cap on the retail energy market will lead to less customer engagement, the withdrawal of the biggest discounts and higher average prices.

“Reduced rates of customer engagement will lessen the uptake of cost-saving innovations, such as smart metering and decentralised energy distribution, harming consumers and increasing carbon emissions.

“Relative price caps will also likely lead to reduced customer engagement, lesser competition in the fixed rate market and higher mark-ups on SVTs. Access to information will likely increase customer engagement and the CMA’s [Competition and Markets Authority] recommendation of the creation of disengaged customer database should be implemented alongside further trials of other information interventions.”

The report also discusses proposals by former industry regulator, professor Stephen Littlechild, which call for the big six to transfer 10 per cent of their customer bases to a subsidiary before selling off the subsidiary (at market prices) to a new entrant.

To promote competition, Littlechild says, customers sold off should “have been with the company for at least three years, preferably since the market opened”.

Dumitriu added: “Customers would still be given an opt-out and Ofgem would monitor the situation closely. Littlechild calculates this would make four million new customers available for new suppliers.

“Unlike price caps, this measure would stimulate competition and allow new suppliers to prove their ability to offer lower prices and better service.”

In response to the report, an Ofgem spokesperson said: “With more than one in five customers now with small and medium sized suppliers as more people switch to get a better deal, competition in the energy market is already helping people to save money on their energy bills.

“We are introducing the price cap as a temporary measure that protects consumers from being overcharged by energy suppliers. The price cap is being designed to allow for continued competition and enable efficient suppliers to offer deals below the level of the cap.

“Our reforms, including making switching easier, faster and more reliable, will make the market even more competitive.”

The price cap was proposed by Ofgem to be set at £1,136 per year for a typical dual fuel customer paying by direct debit. When it is introduced in December suppliers will have to cut their prices to at or below the level of the cap.

Ofgem says 11 million households on poor value default tariffs are set to save around £75 on average, while a typical consumer on the most expensive tariffs would save more than £120.

But some suppliers have warned against the proposals, with SSE issuing a warning that the cap will hit profits next year and potentially impact its full-year results.

Fellow big six company Npower meanwhile said the level of the cap is a cause for concern for energy companies.

A spokesperson for Npower said: “The potential level of the price cap is concerning for the whole industry.”