3The case for an absolute price cap
Relative or absolute price cap?
42.The Government’s primary goal, which we support, is to reduce quickly and significantly the overcharging of the millions of customers on standard variable and default tariffs identified by the Competition and Markets Authority. To this end, the Government decided that the price cap should be an absolute one and the draft Bill is framed accordingly.88
43.Some of the evidence we heard was strongly in favour of achieving this outcome with a relative cap. We heard evidence from several stakeholders that a relative price cap would be less disruptive for the market and would allow efficient suppliers to thrive.89 For instance, John Penrose MP told us that a relative cap
restores the link between the prices which companies advertise in the marketplace and those which they charge the majority of their customers [ … ]; allows more price competition [ … ]; doesn’t limit the number & type of tariffs [ … ]; encourages innovation & fresh thinking and will reward efficient business models–those that maintain high SVTs will rapidly lose market share90
44.Some suppliers, such as Octopus Energy and Ecotricity, argued that an absolute cap would not solve the issue of “tease and squeeze”91 (or “price gouging”92) by which suppliers allegedly
offer far cheaper energy prices to new customers than they do to existing ones. [ … ] The incumbent customer base is used to subsidise the energy price of new customers.93
45.Data from Octopus Energy suggests that some challenger firms would fare well under a relative price cap.94 However, we were concerned by the evidence from Ofgem, the Government, Citizens Advice and others about the risks associated with relative price caps.95 They convincingly argued it would bear the following risks:
(i) It may have a limited impact on the SVT prices of the Big-6; (ii) It poses a greater risk of distorting competition in the Fixed Term Tariff market; and (iii) The choice of what price differential to allow is essentially arbitrary. We want to make clear that the notion that a basic relative cap represents “less intervention” is false; the extent of intervention should be based on the impact of the intervention rather than the number of pages of text required to explain the intervention.96
46.Even more worryingly, the same submissions argued a relative cap risked substantially increasing prices for many consumers and more so than an absolute cap. This is because, as explained by the Centre for Competition Policy
Different firms have different proportions of their consumers on FTTs97 and SVTs. The Big-6, being the former incumbents, have a much greater proportion of their customers on SVTs, which are the more profitable product. To protect their profits, and knowing that their SVT customers are unlikely to switch, the Big-6 are likely to comply with a basic relative cap by increasing their FTT prices by significantly more than they reduce their SVT prices. While increasing their FTT prices means they will lose some of these customers, the profits lost through this would be lower than from an equivalent reduction in SVT prices.98
47.We agree with this argument and think it likely predicts what would happen under a relative cap.
48.We acknowledge and accept the warnings we received that some prices may increase under an absolute price cap as early evidence from the prepayment cap suggests it leads to some cheap deals exiting the market.99 However, we concluded that the greater risks of a price increase on both the highest and the lowest tariffs under a relative cap could not be reconciled with the aim of this Bill which is to reduce overcharging. Moreover, we believe that on balance the risks associated with an absolute cap are outweighed by the greater risks associated with a relative cap and the immediate benefit to consumers on poor-value tariffs.
49.We believe an absolute cap is the best price control to achieve the specific goal of removing overcharging for 12 million customers immediately and achieving greater fairness. It is right that the Bill does not allow for a relative cap to be implemented.
Lessons from Northern Ireland
50.The electricity price cap in Northern Ireland has allowed for switching rates to be as high as those in Great Britain and for competition to flourish with four suppliers currently competing in the market to beat the incumbent’s capped price. It has also allowed for a price differential to remain, meaning that customers still have some incentives to switch and that “regulation and competition can usefully co-exist.”100 We acknowledge that only careful conclusions can be drawn from international examples as, in the words of a supplier:
The truth is that a mass-market GB price cap will be unique. Most countries with price caps have small, undeveloped and uncompetitive markets, introducing price caps as a staging post on the way to a more full market liberalisation.101
51.Nevertheless, we believe the Northern Irish case is the most directly applicable to the GB energy market amongst the many international comparisons cited in the evidence. We conclude from the Northern Ireland experience that “regulation and competition can usefully co-exist” under an absolute price cap and maintain incentives to compete on prices.
Alternative measures
52.There was some evidence that alternatives to price controls (e.g. collective switching, engagement measures, standing charge cap) would be as effective as an absolute cap in swiftly reducing overcharging.102 We agree with advocates of engagement measures that these are key to increasing switching and though they are slow to make a difference, they will be beneficial for the market in the long term.103
53.However, switching is not an end in itself; nor is it the panacea for effective competition.104 It is only one of several indicators of a competitive market.105 There is confusing evidence on the link between price differentials — which are a normal feature of a competitive market — and switching rates. Although “saving money” is the biggest motivation for switching,106 switching rates and average price difference do not appear to be positively correlated.107 Switching rates are increasing108 but they are still too low to have a lasting influence on driving prices down for consumers on standard variable and default tariffs.
54.We conclude that relying on engagement measures to deliver more effective competition via switching is unlikely to be sufficient. It will not deliver enough fairness for those customers that are currently on poor-value tariffs because they do not engage and the cap by itself will not help disengaged customers switch any more than they already do.109 As a result, engagement measures have an important part to play alongside other policy interventions aimed at other issues in the market such as overcharging.110 We hope Ofgem will continue to implement the Competition and Markets Authority remedies alongside implementing the Government’s absolute price cap.
55.We support the Competition and Markets Authority’s Energy Market Investigation remedies and we acknowledge Ofgem’s role in referring the domestic energy market to the Authority for investigation. However, we conclude from the evidence that the market will only deliver fairer outcomes for all consumers once it combines both stronger engagement and reduced overcharging. Thus, in our view, alternatives to price controls and the Competition and Markets Authority remedies are positive for engagement but they do not go far enough to remove the customer detriment quickly and effectively, especially for non-prepayment vulnerable customers.
Timing for the Bill
56.Ofgem have told us that they would need at least five months to put a cap in place from the moment the Bill receives Royal Assent.111 We welcome the Minister’s intention to see the Bill receive Royal Assent in time for the cap to be in place by winter 2018 but recognise that there are other legislative priorities too.112 The Government should provide protection to customers in time for winter 2018 by seeking to ensure that the Bill receives Royal Assent before parliamentary summer recess 2018.
57.We heard suppliers’ and others’ concerns about the lack of appeal rights to the Competition and Markets Authority.113 However, we believe such rights would be used by suppliers to delay the implementation of a cap that is not the result of a discretionary Ofgem decision but stems directly from a government intervention.114 We agree with Ofgem’s view that judicial review is a common and satisfactory appeal route for energy decisions, even highly technical ones.115 We also note that if the court felt that additional technical expertise were necessary, it could sit with assessors. We contend the view that judicial review appeals would delay the implementation of a cap more than an appeal to the Competition and Markets Authority as appeals to the Authority can be subject to judicial review themselves. We conclude that suppliers do not need appeal rights to the Competition and Markets Authority for this Bill. This could unnecessarily delay further the successful implementation of the cap.
88 Department for Business, Energy & Industrial Strategy, Impact Assessment: Draft Domestic Gas and Electricity (Tariff Cap) Bill, 29 November 2017, 11 December 2017, para.33
89 Mr John Penrose PLS0019, Ecotricity PLS0015, Octopus Energy PLS0035, ScottishPower PLS0034, Cornwall Insight PLS0027, Utilita Energy Ltd PLS0001, Hudson Energy Supply UK Limited PLS0007
93 As above
95 Rt Hon Caroline Flint PLS0041, Centre for Competition Policy PLS0049, Ofgem PLS0045, Energy Policy Group PLS0036, First Utility PLS0004, OVO Energy PLS0008, Bristol Energy PLS0002, Citizens Advice PLS0021, Co-op Energy PLS0030, Martin Cave PLS0044, uSwitch.com PLS0033, Utility Warehouse Ltd PLS0020; Department for Business, Energy & Industrial Strategy, Impact Assessment: Draft Domestic Gas and Electricity (Tariff Cap) Bill, 29 November 2017, 11 December 2017, para.35
97 ‘Fixed term tariffs’
106 Ofgem, State of the energy market 2017, p24
108 Energy UK, Energy switching hits record high in 2017, 10 January 2018
113 ScottishPower PLS0034, uSwitch.com PLS0033, Co-op Energy PLS0030, Confederation of British Industries PLS0029, Energy UK PLS0028, Centrica plc PLS0022, E.ON PLS0014, EDF Energy PLS0012, Professor Stephen Littlechild PLS0003, Utilita Energy Ltd PLS0001; Business, Energy and Industrial Strategy Committee, Letter from Energy UK Chief Executive to the Chair relating to Tariff Cap Bill, 29 January 2018, published 31 January 2018
114 Octopus Energy PLS0035; ‘Energy challenger warns wider energy price cap appeal rights could delay implementation’, City AM, 31 January 2018
115 Business, Energy and Industrial Strategy Committee, Letter from Ofgem Chief Executive to the Chair relating to pre-legislative scrutiny of the Tariff Cap Bill, 22 January 2018, published 23 January 2018
9 February 2018