When letters land on 15 million doormats this autumn alerting households to a rise in their energy bills, many families may wonder whether the government’s much-vaunted price cap is working.
The controversial policy was introduced in 2019 for 11 million households on default or standard variable tariffs, extending a cap for four million with prepayment meters. By setting a regulated maximum price, updated twice a year by Ofgem, ministers promised consumers fair pricing and an end to “rip-off” tariffs. Yet when it updates the cap this week the regulator has said it could increase the level by as much as £150 or 13 per cent — authorising what would rank as the biggest price rise in a decade.
Ofgem insists that the increase will be justified. Jonathan Brearley, chief executive, has said the expected rise will primarily reflect surging global gas prices, which have pushed wholesale gas and electricity costs in the UK to highs not seen since the Noughties. “When legitimate costs of supplying energy increase, this needs to be reflected in the price cap,” he said.
In fact, supporters of the cap say that tariffs would be even higher were it not in place. “Next week’s expected rise isn’t evidence the cap’s not working,” Gillian Cooper, head of energy policy for Citizens Advice, said. “People on default tariffs are still saving an estimated £75 to £100 per year. Suppliers are making less money than prior to the cap, as well as improving their efficiency.”
The government introduced the cap after the Competition and Markets Authority found loyal customers who didn’t shop around for cheap fixed-price deals were overpaying by £1.4 billion a year on default tariffs, as weak competition allowed for excess profits and inefficiency. The cap is set so that only an “efficient” supplier can make a modest profit.
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Sure enough, the cap “has decimated supplier margins”, Deepa Venkateswaran, analyst at Bernstein Research, said; average margins for large suppliers were negative in 2019. Suppliers such as British Gas and Eon have together cut thousands of jobs in efficiency drives in response. “Companies are trying to address their cost base to get to a more respectable margin, and that involves layoffs and moving to more agile IT platforms,” she said.
The cap was originally due to be a temporary solution removed by 2023 at the latest, but little progress has been made on alternative means of tackling the “loyalty penalty”. Although switching rates have held up, hitting a record high after the cap came in, more than 60 per cent of default tariff customers have still never switched.
The government plans to trial “auto-switching” such customers to cheaper deals or suppliers but said last month it would legislate so it could extend the cap beyond 2023, as it did not believe the cap could be removed “without risk of returning to excessive loyalty penalties”.
Indeed, the biggest critics of the cap remain those who complain it is set too low and that suppliers should be free to charge more for their default tariffs.
“Prices bunch around the cap level because of zero margin, nullifying competition” said Utilita, which focuses on the prepayment market. Stephen Littlechild, the economist and former regulator, claims that the original CMA calculation was “a mistake”, requiring an “unrealistic” low level of costs.
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According to Keith Anderson, chief executive of Scottish Power, “the price cap is falsely depressing the market right now”. He blames an “anomaly” in how Ofgem calculates the cap using historical wholesale cost data: the level from October will be based on actual prices between February and July. This means “the cap lags what’s going on in the marketplace”.
Suppliers buy wholesale energy for default variable tariff customers to match the way the cap is set, but typically buy energy for fixed-price deals closer to current market prices.
When wholesale costs were falling, that boosted competition: companies could easily buy cheaper energy to offer discount fixed-price deals to customers who shopped around, undercutting capped default tariffs pegged to historical higher prices. But in today’s steeply rising price environment the reverse is true: Anderson says fixed-price tariffs should be priced above the level of the default tariff cap if suppliers are to cover their costs of buying energy.
Some suppliers are indeed doing this; the price of fixed deals has risen sharply in recent months, reducing the discounts on offer from switching, and some are offering fixed deals at or above the level of the default tariff cap.
Proponents of the policy see this as evidence that loyal customers are no longer being ripped off. Anderson however regards the situation as “a bit bonkers” since it would encourage switching back to default tariffs. “The whole purpose of the cap was they wanted people switching off them.”
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He argues the cap has set a “false ceiling” in the market, with many suppliers still offering fixed deals at or below the level of default tariffs despite facing higher wholesale costs. He claims this will “cause a bunch of companies to go bankrupt”.
Though others share concerns about the time lag in the way the cap is calculated, opposition to the policy seems less fierce than it once did. British Gas and Eon were two of the most vocal opponents of a cap at the outset yet neither directly criticised the cap when approached for comment in recent days.
Some believe Eon’s opposition may be softening as it succeeds in cutting costs: it is forecast to return to profit this year. Eon boss Michael Lewis instead chose to criticise the government’s proposed “auto-switching” plan — the policy ministers have suggested could offer an alternative means of tackling the loyalty penalty and ultimately enable the removal of the cap. The industry appears almost united in opposition to auto-switching; some may regard the cap as the lesser of two evils.
Meanwhile, suppliers that supported the cap at the outset are in the ascendant. Ovo has swallowed larger former cap-opponent SSE, while Octopus Energy and Bulb have continued to show breakneck growth. All remain supportive of the policy — although Hayden Wood, boss of Bulb, believes the government should go further and “ban the loyalty tax outright”.
Greg Jackson, chief executive of Octopus, believes the cap offers a lasting solution. “The minimum wage has been a permanent feature of the UK economy since it was introduced and helped make sure we have a decent employment market,” he said. “In the same way, the energy price cap has made sure we have a decent energy market; I can’t see any reason to get rid of it.”
