Energy Price Caps: Help or Hinderance?

As the dust settles following OFGEM’s fanfare announcement on energy price caps last week, it is worth stepping back and reviewing some of the facts and fictions in arriving at this point:

1) The ‘need’ for a price cap has been driven by politics and journalists- as is made very clear in the language contained in OFGEM’s consultation documents. Emotive language used by politicians and the media around ‘broken markets’, ‘rip off tariffs’ and ‘massive savings’ is largely wrapped up in the ability to achieve political mileage by doing something about it. The fact that, when finally announced, the headline impact of the average saving for those 11 million households on Standard Variable Tariffs is likely to be around £75 per year, or 20p per day, perhaps did not achieve the wow factor that was originally anticipated by the politicians. This is particularly true, when OFGEM and any journalist worth their salt, continue to highlight that significantly higher amounts can be saved if those same households switched to a fixed price tariff with one of the 70 or so suppliers offering customers contracts in the market today. It is no real surprise that the weekend papers had very little in them about price caps at all.

2) Underlying all the noise is historical reality: The Big 6 were an oligopoly and through their position were able to make a disproportionate amount of their retail profits from their disengaged customers who never had any interest in switching away from the supplier. By setting default tariffs at a price significantly above cost, ‘superprofits’ were achieved from the dormant customer base. It is these legacy customers that are the subject of all the ‘noise’ that has resulted in the creation of price caps. However, the reality now is that active switching is higher than it ever has been and continues to grow month on month. The Big 6 have already lost 20% of their market share and continue to lose more. Their size coupled with legacy system and data issues make them less efficient, higher cost and more cumbersome than the well run new entrants that are already in place and continue to come to market. Arguably, any of the Big 6 who had not yet got the message that they need to replace their ‘superprofits’ from SVTs with something different, would be looking down the barrel of failure, regardless of this price cap or not. It is therefore not surprising that all of them are looking to transform themselves, whilst having profits squeezed and trying to keep shareholders happy- not an enviable task.

3) The days of ‘superprofits’ are over. Without a doubt the reality that is driving the energy retail market now is fierce competition. Whether Big 6 (soon to be 5) or challenger businesses, the value in ‘supply only’ businesses has been significantly eroded from the days when there were only a handful of players. To succeed in the energy retail market today, businesses need to have more than just supply tariffs in their tool kit. Whether leading with technology propositions, developing energy as a service offerings or combining energy supply with some other related service, to succeed, suppliers now have to find alternative value streams if they are to grow their profits. Relying on being the cheapest, to gain market share is a fool’s game, as Iresa found out to its cost.

4) It’s a tough market. Whilst needing to be focused on developing innovative offers, businesses need to also keep abreast and in sync with all that is coming down the line from policy and regulatory change. The importance of robust risk management and governance has never been stronger as there is no financial leeway if a ball is dropped. The increasing rate of supplier failure is no real surprise- in addition to strong risk management, if businesses do not have experienced management teams, sufficient working capital funding and agility to respond to market change it will be hard to survive. For those who have all these ingredients in place, it is exciting times. The Big 6 have an enormous challenge to transform themselves before they completely lose their natural dominant position, particularly when they are the ones who are really impacted by the price caps. Challenger brands have the opportunity to exploit the waning oligopoly and continue to grow in power as they bring new and exciting propositions to the market at speed.

5) Price caps are largely an irrelevance. In the context of market reality, those who are going to win, will win with or without price caps. Whilst there can be no complacency, well run and tightly controlled businesses have nothing to fear. By the time price caps are removed, whether 2020 or 2023, the market will look very different from today. No doubt there will be fewer suppliers in total, but the well known and successful ones will likely be drawn from a different list than we know today.

If you read the documents carefully, all that is written above is included in OFGEM’s consultation. The media messages may be positioned differently and are largely to support the political drive for price caps. However, OFGEM should be congratulated on the fact that the price cap as proposed, whilst meeting the requirements of government, and sadly predicted to drive switching down by up to 30% in the short term, has been carefully set at a level that should not materially impede the direction of travel in a rapidly transforming and developing supplier landscape- which can only be a good thing for customers and businesses alike.