Submission to Ofgem’s Call for Input on Standing Charges

Summary

When Ofgem introduced the price cap on default tariffs in 2019 it inexplicably lowered only the unit rate. The standing charge was left at the prevailing market rate even though the level of these tariffs was known to be excessive. (That had been the central finding of the CMA’s Energy Market Investigation, which led to the price cap.)

Thus the dual fuel standing charge was initially set at £169 p.a. (excl. VAT) for direct debit customers and £200 p.a. for those paying by standard credit. Using Ofgem’s analysis of suppliers’ costs the costs that should be recovered through the standing charge (those that relate to serving customers rather than supplying energy) are estimated to be lower than this: about £55 p.a. per (non-prepayment) customer.

Since then the standing charge permitted under the cap has risen sharply and excessive standing charges have:-

  1. Harmed low income households. These consume less energy than high income households so the standing charge forms a larger proportion of what they pay and means that overall they pay the highest price per unit of energy.
  2. Increased carbon emissions and reduced the U.K.’s energy security. Higher standing charges entail lower unit rates in the price cap which lead to increased energy consumption.
  3. Contributed to the collapse of suppliers. Standing charges in excess of costs are likely to have encouraged the entry and expansion of suppliers that were more intent on capturing these payments than on managing their energy costs effectively. Many of the failed suppliers were caught out when wholesale energy costs increased because they had amassed customers very quickly by offering deals that didn’t cover their costs and hadn’t bought enough energy in advance.
  4. Made it more difficult for consumers to compare tariffs and identify those offering good value. This was identified by the CMA as a key issue adversely affecting competition and leading to high tariffs although it has not recently been an issue for domestic consumers protected by the price cap. However, it remains a very significant issue for non-domestic consumers whose standing charges are less transparent and more variable.

2. and 3. are leading to yet higher standing charges (a vicious circle) because:-

  • Approx. £5bn p.a. of the costs of installing and maintaining the electricity network are now recouped from suppliers through fixed rather than volumetric charges following Ofgem’s Targeted Charging Review (TCR).
  • The costs of the Supplier of Last Resort (SoLR) process are also added to the standing charge for electricity.

NB These decisions weren’t made (as they should have been) on the basis of the economically efficient recovery of costs, which would have led to them being added to the unit rate instead. Rather, they were seemingly at the behest of the Energy Minister who wanted there to be no “free riders” (apparently referring to people with solar panels who consume less so would contribute less to these costs if this was done through the unit rate).

The costs incurred by suppliers that are appropriately recovered through the standing charge are now likely to be of the order of £74 p.a. and the TCR and SoLR add another £76 p.a. to the cost of serving a customer. However, the current level of (non-PPM) standing charges is vastly more still, around £300 p.a. (excl. VAT) (£288 p.a. for direct debit and £330 p.a. for standard credit customers). Thus suppliers are currently making about £150 p.a. profit from every customer before they even supply any energy (effectively ‘free money’).

Standing charges should be capped at about £74 p.a. (with TCR and SoLR costs switched to the unit rate). This would address a number of issues simultaneously. As well as enabling low income households to heat their homes etc it would reduce carbon emissions; improve energy security (reducing the amount of investment needed in the network and generation); reduce the risk of future supplier failures; and simplify bills, thereby helping consumers to compare (and constrain) suppliers’ tariffs.

Capping the standing charge for non-domestic customers, too, would produce similar benefits.

In addition:-

  1. There have been calls for the government to withdraw VAT from energy bills on the basis that energy is a necessity. In fact not all energy consumption is necessary but access to a supply of it undoubtedly is. If the standing charge was capped tightly this would significantly reduce the cost to the government of eliminating VAT on the standing charge so it would be more likely to happen.
  2. Ofgem is proposing to lower prepayment meter (PPM) standing charges (currently £350 p.a. excl. VAT) to nearer the direct debit level (although not apparently equal to it). In fact the price cap for PPM customers with smart meters was previously set at the direct debit level (for both the standing charge and the unit rate) but for some reason this protection was removed in 2020. There is a strong case for the price cap for PPM customers with smart meters to be reduced to below the direct debit level on the basis that they cost less to serve as they can’t incur debt. This would help vulnerable consumers to control their debt and eliminate much of the resistance to both PPMs and smart meters.

In its recent consultation paper Ofgem finally acknowledged that low income households would benefit from lower standing charges but it seemed still to be focused mainly on the exceptions to this rule. These should be addressed by specific measures targeted at those individuals who are unable to avoid high energy consumption (for example because they need to use medical equipment) rather than forcing all low income households to pay more.

Submission-of-Ideal-Economics-to-Ofgems-Call-for-Input-on-Standing-Charges-January-2024Download

Reforming energy standing charges for prepayment customers

Forced installations of prepayment meters have been widely condemned but the fact that prepayment customers pay significantly more than other energy consumers has attracted far less attention.

Prepay customers pay more simply because their standing charges are so high, now £350 p.a. for gas and electricity combined, which is £50 p.a. more than those who pay by direct debit.

Most prepayment customers are on low incomes so spend less on energy. Their higher standing charges further reduce the amount of energy they can afford, with many self-disconnecting from their energy supply.

The government has announced that it will spend £200 million of tax-payers’ money to take the edge off this for nine months from July but the higher standing charges are the explicit result of a series of policy decisions by the energy regulator Ofgem. Ofgem has consistently favoured the energy companies over the most vulnerable consumers.

Standing charges should be much lower for all consumers, and particularly prepayment customers, because they substantially exceed the costs that should be recovered through them, as Ofgem’s own analysis shows.

High standing charges contributed to the energy crisis by encouraging the entry of firms that were more intent on capturing these payments than on managing their energy costs effectively.

Ofgem’s policy of reducing the unit rate rather than the standing charge has also increased overall demand for energy, exacerbating carbon emissions and reducing the U.K.’s energy security.

Download the report commissioned from Ideal Economics by National Energy Action:

Reforming energy standing charges for prepayment customersDownload

The high level of the standing charge in energy bills

The new energy price cap came into effect on 1 April and this was accompanied by some media attention about the shockingly high level of the standing charge in it. The news coverage was sparked by an open letter from Fuel Poverty Action which drew on work by David Osmon, a former senior economist at Ofgem, at Ideal Economics. The letter can be read at: https://docs.google.com/document/d/1R6zGe4K2PTUCnAO6Z6w8lY-4eiJV0YKjg7PsUHbnQJI/edit

The main points are:-

  • In the new price cap the fixed (‘standing’) charge is around £300 p.a.. For the poorest 10% of households this amounts to a third of their total energy spending.
  • Ofgem’s policy of raising the standing charge instead of the price per unit of energy is perverse. The higher standing charge disproportionately affects poor households (who use least energy) while the lower unit rate increases total energy consumption, thereby raising carbon emissions and reducing energy security.
  • The standing charge should be about £60 p.a. according to Ofgem’s own analysis of the costs incurred by suppliers.

The standing charge is already set to rise further absent a change in policy. Not only is Ofgem planning to load further costs onto it but any increases in it will be cumulative: they will cause more households to be in fuel poverty and thereby eligible for the Warm Home Discount, the costs of which are passed back to consumers in… the standing charge! This approach is unsustainable.

Ofgem should instead reduce the standing charge by £200 p.a., which would directly help the lowest paid to heat their homes without the government having to spend any money to achieve this.

In addition, the government should remove VAT on (just) the standing charge and if Ofgem lowered the standing charge the cost to the government of doing this would be greatly reduced.

Some further points relating to the standing charge:-

  • High standing charges contributed to the energy crisis because some suppliers entered the market more focused on acquiring customers in order to obtain these payments than on managing their energy costs.
  • The price cap was introduced because many consumers were unable to identify good value tariffs, which was made more difficult by tariffs having standing charges as well as unit rates. Ofgem had previously planned to fix the level of the standing charge to simplify tariffs but gave in to pressure from suppliers not to do this.
  • Replacing the current price cap with a much simpler cap on just the standing charge would not only protect vulnerable consumers, reduce emissions and improve energy security but also boost competition because consumers would only need to consider unit rates to find the cheapest option. This would lower prices generally.

There is more on these points in the attached article by David Osmon:-

The high level of the standing charge in energy billsDownload

The extortionate level of the standing charge in the energy price cap

Amid the furore surrounding the increase in the energy price cap it has gone unnoticed that the fixed element of energy bills (the standing charge) has increased by £75. From April households will typically have to pay £265 p.a. but in some cases as much as £328 p.a. before they can consume any energy.

Low income households are worst affected by this because they spend less on energy so the standing charge forms a larger proportion of their bills. The poorest ten per cent spend £931 on gas and electricity every year and the standing charge will now take up around 30% of that. Those who will pay the highest standing charge (people in the south west who don’t pay by direct debit) will be left with just £603 worth of energy.

Ofgem has been loading up the standing charge since it introduced the price cap, when for some reason it lowered the price per unit of energy but not the standing charge. Not only did this confer the biggest savings on the high income consumers who use most energy but it also increased overall energy consumption, leading to higher carbon emissions and reduced security of supply.

Standing charges greatly exceed the costs suppliers incur in taking on customers and by perpetuating this Ofgem’s price cap contributed to the energy crisis. Energy firms’ incentive to acquire customers in order to gain their standing charge payments may have taken precedence over managing their energy costs effectively. Many failed suppliers amassed customers very quickly by offering deals that didn’t cover the costs of supplying them with energy and hadn’t bought enough energy in advance.

Almost all of the latest increase in the standing charge is to reimburse suppliers for taking on the customers of failed companies. It’s unfortunate to say the least that the low income households who most needed protection by the energy price cap are now picking up the tab for its poor design.

In stark contrast to Ofgem’s approach, capping only the standing charge is likely to be the only way to make the market work well. This would ensure the poorest consumers save most and it would reduce overall consumption of energy, thereby reducing emissions and improving security of supply. It would also boost competition as consumers would only need to consider unit rates to find the cheapest option and suppliers would have no incentive other than to provide sustainable energy deals.

“It is perverse that Ofgem has chosen to rack up the part of energy bills that hits the poorest households hardest and in doing so has increased carbon emissions and reduced security of supply. This is the very opposite of what people expect them to be doing”, says the author of a report on this published by the Ideal Economics think tank, David Osmon.  

“No-one, least of all people on low incomes, should have to pay £328 before they get to access a supply of energy, especially as the costs suppliers incur in providing this are so much less than that.”

Download the report here:

The high level of standing charges in the energy price capDownload

The case for a cap on the standing charge in energy bills

In January Ofgem introduced a price cap on energy suppliers’ default or standard variable tariffs (SVTs). This ‘default tariff cap’ effectively limits just the unit rate – the standing charge is unchanged. As such the cap has four fundamental flaws, as Ofgem has acknowledged:-

  1. Low income households save less than those on higher incomes. Yet these are the most vulnerable consumers − the least able to avoid paying high prices for energy and the most likely to suffer hardship as a result. In particular, they consume the least energy so the standing charge forms a large proportion of their total bill, which means they pay the highest overall rate for the energy they use.
  2. Uncertainty about the efficient level of suppliers’ costs to be recovered through the unit rate has led Ofgem to set the cap above the estimated cost level, reducing the savings to consumers.
  3. The cap has reduced competition and tariffs that were below it have been increased.
  4. By lowering the unit rate the cap has increased energy consumption. This has raised greenhouse gas emissions and reduced security of supply, which may cause energy bills to rise in future to pay for additional investment in generation and network capacity.

The cap has the same structure as a cap introduced for consumers with pre-payment meters in 2017, which has the same drawbacks.

According to Ofgem’s estimates the increase in price of better value tariffs may have negated up to 84% of the savings to consumers from the default tariff cap. Energy suppliers have also reduced the number of customers eligible for it, moving many of them from SVTs to fixed deals, which may be more expensive. These factors together mean the cap may not actually have saved consumers any money. Most of any savings will have gone to higher income households.

Ofgem is required to remove the default tariff cap between 2020 and 2023 and the PPM cap is also scheduled to be replaced from 2020. This paper proposes replacing both of these with a cap on just the standing charge.

Households on default tariffs pay an average of over £160 p.a. (including VAT) in dual fuel (i.e. gas and electricity) standing charges. However, the vast majority of costs suppliers incur depend on the amount of energy rather than the number of customers supplied so should be recovered through the unit rate rather than the standing charge. The true, cost-reflective level of the dual fuel standing charge is over £100 lower, at approx. £60 p.a..

A standing charge cap would have four powerful beneficial effects:-

  1. Low income households would save most.
  2. It could be set at the efficient level of costs so would maximise the savings to consumers. The few costs that should be recouped through the standing charge can be estimated much more accurately and transparently than suppliers’ other costs.
  3. It would dramatically boost competition. Consumers would find it much easier to compare tariffs as they would only need to consider unit rates. This would lead to lower prices for consumers generally.
  4. While those in fuel poverty would be able to afford more energy, the resulting higher unit rates would lead consumers to reduce energy consumption overall. This would lower carbon emissions and improve security of supply.

A standing charge cap would guarantee savings for low income consumers of at least £150 million p.a., with 80% going to the very poorest households. In fact the boost to competition means benefits are likely to be much higher. By combining more effective competition with protection for those who are unable to benefit from it, a standing charge cap could eliminate the entire £1.4 billion p.a. detriment suffered by consumers on SVTs. Enhanced competition would also lead to better deals for consumers who are not on SVTs.

In addition, lower demand would reduce both carbon emissions and the costs of maintaining security of supply.

However, Ofgem’s scope to introduce an effective standing charge cap is threatened by its proposal to introduce a substantial fixed charge for consumers to pay for network costs. As with the default tariff cap, this is ill-conceived: it fails to consider economic efficiency or take into account the adverse effect on low income households, carbon emissions and security of supply.

Capping the standing charge in energy bills to businesses as well could eliminate the £220 million p.a. detriment to SMEs in the same way.

Ofgem could further reduce standing charges by approx. £250 million p.a. if it took action to address competition problems in metering markets and thereby reduce the costs suppliers incur in providing meters. In addition, the Government could eliminate VAT on the standing charge, which would save consumers a further £70 million p.a..

A standing charge cap provides a general model for regulation of retail markets for essential services where competition is not effective, such as water and telephone landlines.

About the author:

David Osmon is a former Senior Economist at Ofgem.

You can download the paper that describes this proposal more fully here:

The case for a cap on the standing charge in energy bills REVISED JUNE 2019Download