Government’s energy tariff plans will exacerbate fuel poverty

The Energy and Climate Change Select Committee poses the following question: Will the government’s proposals to ensure that consumers are on the cheapest tariff have any impact on fuel poverty?

The answer is yes – the proposals will exacerbate fuel poverty rather than alleviate it.

The reason is that the proposals will increase energy prices and hence fuel bills, rather than reduce them. This is for several reasons:

– The proposals will either prohibit, or lead to the withdrawal of, some of the best (lowest price) offers in the market. See the example below.

– The proposed limit on the number of tariffs that each supplier can offer would prevent innovation, because it would be too risky for a supplier to give up an existing profitable tariff in order to introduce a new one whose appeal would be uncertain.

– Because the lowest price offers would no longer be available, and there would be less innovation, there would be less competitive pressure on all other prices.

– The rules on tariff simplification proposed by Ofgem and DECC would encourage coordinated effects by suppliers and lead to narrower price differentials and again less competitive pressure.

– The reduced availability of significant price reductions would lead to less customer interest in switching between suppliers. (Ofgem claims that simpler tariffs would increase customer engagement, but Ofgem’s own research shows that the availability of savings opportunities outweighs simplicity of information as a determinant of customer switching.)

– All these factors leading to a reduction in competitive pressure would lead to further increases in prices and retail profits.

– There is evidence that Ofgem’s retail energy policies have already had this effect. Its restrictions on tariff pricing, and its pressure on suppliers to cease doorstep selling and to simplify tariffs, seem cumulatively to have led to an increase in retail profits margins totalling some £10bn over the last four years.

– In sum, the Government’s tariff proposals, including the endorsement and extension of Ofgem’s proposals, would increase energy prices and make all customers worse off. This would have a particularly adverse impact on vulnerable customers in or near fuel poverty.

I have set out these arguments in more detail in my response to Ofgem’s updated Retail Market Review proposals for the domestic market. I now set out a real, current and important example to illustrate how the proposals will either prohibit, or lead to the withdrawal of, the best (lowest price) offer in the market today.

The supplier SSE has recently introduced a tariff called Discounted Energy 2015. It guarantees 11% off the company’s standard energy tariff for the first year, then 2% off for the second year. It also has a £50 exit penalty if the customer switches away from it before April 2014. This new tariff is currently listed by an independent switching site as the ‘best energy deal’ available in the market today. (The Sunday Times, 17 February 2013)[1]

Ofgem’s proposals, endorsed by the government, would prohibit SSE from offering this tariff. Why? Because the discount is expressed as a percentage rather than as a fixed amount. And because the discount is different in the second year and the first. Yes, it is that petty. It is difficult to see why customers used to labels saying ‘10% off’ thousands of products in any supermarket would find the use of percentage discounts a barrier to spotting a good energy deal.

Perhaps Ofgem and the government think that SSE could simply reformulate its offer as a fixed rather than percentage discount. If so, they have not considered the implications. Suppose that, for an average consumption customer, an 11% discount represented an annual saving of £127.  But for a larger customer, with double the annual consumption, £127 would be only half what the percentage discount would have given, and therefore only half as attractive. For small customers with half the annual consumption a fixed discount of £127 would be twice what the 2% discount would have been – but it might well not be economic for SSE to offer such a double discount to smaller customers. Furthermore, a discount expressed as a percentage is designed to give protection to both customer and supplier against the risk that wholesale prices go substantially up or down over the next two years. A fixed discount runs the risk of becoming unattractive or uneconomic.

Suppose the proposed restriction on absolute rather than percentage discounts were abandoned. Would this solve the problem? No, because the government’s proposals would then presumably require SSE to put all its customers on this tariff because it is cheaper than its standard tariff. But the Discounted Energy 2015 tariff has a £50 exit penalty if the customer switches away from it before April 2014. That is acceptable if the customer voluntarily chooses that option. But should an energy supplier have the ability, indeed the obligation, to impose an exit penalty on an existing customer? And even if customers had the right to choose otherwise, is it really in their interest to be forced to object, and made subject to an exit penalty if they fail to realise what is happening?

Would it solve the problem if SSE were required to put all customers on the new tariff but not allowed to charge an exit penalty? No, because without the guarantee that the customer would stay for a year, why would SSE find it sensible to offer such a discount? SSE would simply withdraw this new offer, or in future not make it in the first place.

There is yet another problem. If SSE already had four successful products, that customers liked, it would have no room for another. The Ofgem/government proposals would simply prohibit SSE from offering this Discount tariff as a fifth product.

SSE’s Discounted Energy 2015 tariff is an excellent example of the innovative and competitive nature of the retail energy market in Britain. SSE has designed an offer that reduces its customer handling costs and its power purchasing risks, and gives it the opportunity to demonstrate its standards of customer service that have been rated among the best in the market. In return, SSE passes these cost reductions to customers in the form of a discount. This currently makes this tariff the ‘best energy deal’ in the market.

But the government’s proposals would prohibit the best energy deal in the market. How can that help customers get the best possible energy tariff? And how can it not have an adverse effect on the problem of fuel poverty?

Stephen Littlechild, Fellow, Judge Business School, Emeritus Professor, University of Birmingham, and former GB electricity regulator

[1] Annual bill of £1146 per year for those paying by direct debit for dual fuel, average across all regions, for average annual use of 16,500 kWh gas, 3300 kWh electricity, attributed source

Member of the Advisory Council

Prof Stephen Littlechild is a Fellow in Privatisation, Regulation and Competition, at Cambridge Judge Business School, and Emeritus Professor at the University of Birmingham. He is a member of the  Academic Advisory Council at the Institute of Economic Affairs.

1 thought on “Government’s energy tariff plans will exacerbate fuel poverty”

  1. Posted 07/04/2014 at 12:09 | Permalink

    One dark sleety night in November 2007 a British Gas engineer rolled up to do a routine check on my meter. In spite of my mother having been taken into a hospital 70 miles away critically ill, I had made the time to be there.

    He decided that because my gas pipes had been laid from the front to the back of the house below a concrete floor he would have to seal the meter and cut off the supply. I was told that it was a safety issue and the I needed to find an alternative way to connect the boiler and kitchen to the meter and then drove off into the night.

    Having other priorities at that moment I bought several portable electric radiators and an electric hotplate. In the intervening years the time has never seemed right to have a gas supply run around the external circumference of the house so I got on with my electrically fueled life until Spring 2014.

    OK a few years ago British Gas sent me a bill for 10p of used gas which over the year got rounded from zero usage to 70p.

    Hey presto in 2014 the Government decides to relieve fuel poverty and British Gas decide to charge me (in advance) 26p per day standing charge for the gas meter. I now either have to get the gas meter removed or find a supplier (EBICO – part of SSE) who will alow me to open an account for zero usage of product.

    Complaints to British Gas gets you bounced back to the automatic switch board and from department to department until the response was that “the Government now requires them to apply a standing charge on all customers”. When asked on what basis they had changed my tarrif they told me that I had been notified in November 2013. I’ll admit that is a possibility but I did not conceive that a company that I had bought no gas from in 5 years would suddenly decide to charge me £24 a quarter for not supplying me with their product.

    The fact that EBICO offers a no standing charge account and the detail of the government requirements indicate that British Gas staff are either instructed to lie to customers or at best not properly trained.

    OK so my situation is not typical but this ludicrous license to fleece customers for even more money must apply equally to other low users or folks with property that is not occupied all year round.

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