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:-
- 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.
- 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.
- The cap has reduced competition and tariffs that were below it have been increased.
- 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:-
- Low income households would save most.
- 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.
- 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.
- 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: