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The pros and cons of an energy price cap

The government has published draft legislation designed to bring down the cost of the most expensive domestic energy tariffs. Following Theresa May’s speech at the Conservative Party Conference, the Draft Domestic Gas and Electricity (Tariffs Cap) Bill will give Ofgem the ability to cap standard variable tariffs. About 12 million households pay for one of these tariffs, which customers are often moved to when cheaper temporary deals expire. Standard tariffs are often hundreds of pounds per year more expensive than suppliers’ cheapest deals. There has been much debate about the relative merits and demerits of such a policy. Below, we summarise the arguments made for and against the energy price cap.

Pro: It protects vulnerable consumers

Theresa May’s primary justification for the energy price cap was that it would help protect vulnerable consumers. Her idea was originally promised in the Conservative’s 2017 election manifesto, but mention of it was missing from the Queen’s Speech in June. Reviving the idea at the party Conference, she said: “The energy market punishes loyalty with higher prices, and the most loyal customers are often those with lower incomes, the elderly, people with lower qualifications and people who rent their homes”. For a long time, consumers have been told that they need to switch suppliers regularly to make sure they are on the best deal. For many people, switching energy suppliers has never been simpler. Online tools and switching services make switching a doddle for those who are web-savvy and financially informed. But some consumer groups still find switching difficult. The Prime Minister identified several groups who have barriers to switching. The decision to regulate prices will ultimately benefit these groups.

Con: It may dampen competition

The downside to regulating prices is that it stifles competition. Business and Energy Secretary Greg Clark: “We have published draft legislation today, sending a clear message to the industry that we will protect the interests of their customers if they do act now to tackle the detriment found by the Competition and Markets Authority.” But according to some insiders, the cap went against the advice of the Competition and Markets Authority (CMA). Competition and switching have, for a long time, been the only solution to get a cheaper energy deal. But for switching to work, you need significant differences in price to motivate people to change suppliers. If you start moderating the most expensive tariffs then it reduces the incentive to find different prices. If customers switch off from the energy market then many could see prices increase.

Con: Prices could rise

Counterintuitively, an energy price cap on standard variable tariffs could cause prices to increase for some customers. A price cap on standard variable tariffs could cause many of the cheapest deals to start disappearing as smaller energy companies lose their grip on the market. It depends on where the tariff cap is set, but many tariffs will start to group around the cap putting smaller suppliers with less name recognition at a disadvantage. If Ofgem sets the price cap too low it could start knocking small energy suppliers out of business, causing disruption and potentially leading to higher prices for households and businesses that use these companies.

Pro: It is only temporary

Many experts and editorials have made clear that they don’t believe that the price cap is a full solution. Money Saving Expert’s Martin Lewis called a price cap a ‘halfway house’. Because of this, perhaps, the legislation has been billed as a temporary solution. Ofgem has said that the cap is unlikely to take effect before this winter and will last until 2020, with the possibility of being extended to 2023 if deemed necessary. The briefing that accompanied Theresa May’s speech said that the measure was intended to be temporary, until “innovations such as smart meters arrive and enable the market to work properly for everyone”. In the future, the widespread availability of smart meters will enable more flexible ‘time of use’ tariffs should usher in a new era of domestic energy. E.on has already withdrawn its ‘standard variable tariff’ and introduced a new tariff that is conditional on customers accepting a smart meter.

Con: It could hurt energy companies

Many people will find it hard to sympathise with large energy companies, but hurting them can have unintended consequences. Many of the smaller suppliers could be knocked out of business, causing disruption and potentially higher prices for domestic and business customers. If energy company profits fall then it can limit the amount of money that they put into important things like research. Britain has been on the forefront of developing offshore wind technology thanks in a large part to investment by large energy companies. Lots of ordinary British people have shares in large energy companies, particularly British Gas. These shares have varied significantly over the last week. Many of these shares are also tied into pension funds.

Con: Standard tariffs are already disappearing

There is evidence that large energy suppliers are already scrapping the standard variable tariff, withdrawing their most expensive price plans in favour of more reasonable contracts. As mentioned above, E.on has already stopped offering a standard variable tariff and Ian Conn of British Gas owner Centrica has hinted that Britain’s biggest energy supplier could soon follow. It could be the case that, by the time the price cap comes into force, that most standard variable tariffs could have disappeared. Although it is worth emphasising that the energy companies have probably been spurned into action by the threat of tariffs.

Published by Utility Helpline on