Pre-legislative scrutiny of the draft Domestic Gas and Electricity (Tariff Cap) Bill Contents

4Recommended changes to the Bill - How the cap is set

Subsection 1(6): the criteria to set the cap

Box 1: Subsection 1(6)

Under subsection 1(6), when setting the cap Ofgem is required to have regard to the five following matters:

(a) the need to protect existing and future domestic customers who pay standard variable and default rates;

(b) the need to create incentives for holders of supply licences to improve their efficiency;

(c) the need to set the cap at a level that enables effective competition for domestic supply contracts;

(d) the need to maintain incentives for domestic customers to switch to different domestic supply contracts;

(e) the need to ensure that holders of supply licences who operate efficiently are able to finance activities authorised by the licence.

Source: Draft Domestic Gas and Electricity (Tariff Cap) Bill, Department for Business, Energy & Industrial Strategy, 12 October 2017

58.Some of the evidence we received argued that the five subsections in subsection 1(6) were ambitious and may be hard to achieve simultaneously: many stakeholders thought it unlikely that any price control or policy could achieve all five aims at once or that it could do so when the cap is first introduced. 116 Some stakeholders even argued that some of the subsections were incompatible with one another or inconsistent with an absolute price cap. For instance, one submission argued that the cap would fail to meet subsection 1(6)(a) if it led to engaged customers facing higher prices.117 These arguments rely on the expectation that an absolute price cap will leave no room for competition on tariffs below the cap. Others were more optimistic and argued that, if carefully weighed, all five conditions could be met in the short or long term.118

59.We previously concluded from the Northern Ireland experience that, if set at the right level and with sufficient headroom, an absolute price cap would allow regulation and competition to co-exist, though it may prove challenging for suppliers that are not currently operating efficiently.119 Ofgem may also be challenged with judicial review on the way it will define an “efficient” supplier to accommodate the various kinds of suppliers operating in the market when setting the cap. Some stakeholders have argued in the past that the Competition and Markets Authority and Ofgem had miscalculated the costs they faced and what an efficient supplier was.120

60.We believe the Northern Ireland experience and the evidence show that it will be possible, if challenging, for Ofgem to set a cap that meets subsections 1(6)(a), 1(6)(b) and 1(6)(e). Some suppliers may struggle to adapt or challenge with judicial review how Ofgem will measure the costs of an “efficient supplier”.

61.Subsection 1(6)(c) is not precisely defined in the Bill and “the conditions for effective competition” could be interpreted in different ways by various stakeholders.121 The Minister and Ofgem were both confident that the definition of “effective competition” should be left with the regulator to adjudicate and should not turn into a box-checking exercise.122 We support the Government’s view that the determination of “the conditions for effective competition” in subsection 1(6)(c) should be left with Ofgem.

62.The evidence suggested that subsection 1(6)(d) could prove challenging to achieve as switching rates may go down, at least at first, as a result of the cap being introduced.123 This could therefore make Ofgem vulnerable to legal challenges which could hinder the implementation of the cap if they were successful. The Government should work with Ofgem to amend the wording of the Bill to make it as resistant as possible to successful legal challenge to subsection 1(6)(d).

63.Suppliers of different sizes and operating with different business models face very different costs. All suppliers are also subject to the fluctuations of wholesale, network and policy costs. A price cap will not be able to insulate consumers against unpredictable global price fluctuations. An efficient supplier should be able to hedge for these fluctuations, but we think the price cap will need to be updated regularly to reflect these changes and keep up with the market.

64.We recommend that the Bill be amended to include a requirement that Ofgem review the level at which the cap is set at least every six months to keep up with changes in suppliers’ costs and consumer engagement.

65.We were unconvinced by the argument that the five goals in subsection 1(6) are incompatible. We acknowledge that they are challenging and may not all be achievable at once but we believe that the current wording of the Bill, with slight amendment, allows Ofgem to prioritise and weigh them carefully when setting the cap.

66.To deter legal challenges that would delay unnecessarily the implementation of the cap, we recommend that the Government clarify in the Bill that Ofgem will not be required to set a cap that will meet all five subsections simultaneously, though it may eventually do so. This would be consistent with the main aim of the Bill of reducing overcharging, not increasing switching.

116 PLS0024, Which? PLS0016, E.ON PLS0014, EDF Energy PLS0012, PLS0033, David Osmon PLS0006, First Utility PLS0004, Centrica plc PLS0022, Centre for Competition Policy PLS0049, ScottishPower PLS0034

117 Centre for Competition Policy PLS0049

118 Citizens Advice PLS0021, Utility Warehouse Ltd PLS0020, OVO Energy PLS0008, First Utility PLS0004

119 Professor Martin Cave OBE PLS0044

120 Centrica plc PLS0022, E.ON PLS0014, ScottishPower PLS0034, npower PLS0031; SSE PLS0052

121 PLS0033,

122 Qq424-427 [Claire Perry]; Qq345-350 [Dermot Nolan]

9 February 2018