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:-
- 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.
- 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.
- 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.
- 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:-
- 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.
- 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.