Temporary measures proposed to combat market volatility

Ofgem is considering requiring energy suppliers to make all new tariffs available to their existing customers as one of several possible short-term interventions to help them better manage the risks of buying energy.

On Wednesday morning (15 December), the regulator published a series of documents, including a call for input on potential changes to the price cap, as part of plans to strengthen retail market resilience.

Any changes to the price cap are unlikely to be in place in the short term and as a result Ofgem is consulting on three potential temporary measures to help suppliers manage the risks of buying energy for their customers in the face of “severe price volatility”.

“When prices rise sharply, millions of domestic consumers who would normally take a fixed-term contract instead choose a standard variable tariff at the (cheaper) price cap level, which suppliers may not have anticipated or hedged for,” the regulator explained.

“When prices fall sharply, those consumers move off the standard variable tariff to now cheaper fixed-term contracts, leaving suppliers potentially facing losses on the energy they had purchased for those consumers.”

“When wholesale prices fall, we want consumers to benefit from lower bills in a timely manner. We also want to avoid the risk that consumers could end up paying more in the longer run due to the costs involved if more suppliers fail due to being unable to recover costs that they have incurred in serving customers protected by the price cap.”

The first option being mooted is requiring suppliers to make all new tariffs available to existing customers. This would be time limited until the end of September 2022.

Under this option, Ofgem argued, the incentives for suppliers to price tariffs significantly lower to acquire new customers would be reduced to some degree, lowering the intensity of price competition and therefore potential losses for suppliers in the event of significant falls in wholesale prices.

Along with its plans to improve the financial resilience of suppliers, Ofgem said this would discourage suppliers from offering unsustainably low prices.

The second option being considered is to allow suppliers to charge exit fees on certain standard variable tariffs (SVTs) as is already commonplace for fixed-term contracts.

In its rationale, Ofgem noted suppliers will usually have hedged to supply the expected demand from SVT customers. If market prices fall, the regulator said millions of these customers may move to fixed deals, leaving suppliers unable to cover the costs of their hedges.

“Exit fees would enable the supplier to recover the legitimate hedging costs they have incurred on behalf of their SVT customers,” it said. Furthermore, supplier losses would also be reduced as some consumers who may otherwise have switched, would choose not to do so – or not be able to do so – because of the existence of an exit fee.”

The third option is to require retailers to pay a “market stabilisation charge” to the losing supplier when acquiring new customers. This charge would represent a proportion of the economic loss to the losing supplier when the switch occurs and would be based on customers’ estimated annual consumption.

The regulator would set the charge so that it would only come into effect if wholesale prices were to fall significantly below the level assumed in the summer 2022 price cap – somewhere between 30% and 50% based on its current modelling and market outlook.

It would calculate and publish the level of the charge on a regular basis in line with a transparent methodology, such that suppliers can factor this in when setting their tariffs.

Ofgem stressed the actions it has announced to improve financial resilience among new and growing suppliers will go some way to mitigating risks posed by market volatility and it is not yet convinced that further action is warranted.

“Nevertheless, it is prudent for Ofgem to work up contingency options in case significant risks to consumers look likely to materialise,” it remarked.

Ofgem acknowledged that all three options would “dampen competition and reduce savings available to consumers” in the short term.

Given the potential downsides, the regulator said it is not attracted to the more “interventionist” options of exit fees or customer acquisition charges. It said it continues to believe strongly in the benefits of competition and so there would be a “high bar” to any measures that put even modest and temporary constraints on switching

The consultation is open until 17 January and Ofgem will make a decision by the start of February on whether and how to proceed.