The energy price cap is a relic of another era

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What’s the point in a consumer energy price cap that does very little to cap consumer energy prices?

When it was introduced, the UK energy price cap aimed to solve the problem of the “loyalty penalty” — higher prices for people who didn’t regularly shop around for a new supplier. The problem is, that’s now a non-issue. What it wasn’t designed for is the conundrum we face: unaffordable energy prices. As a result it is failing to serve any function well.

To recap, the default price cap in 2019 was introduced against a backdrop of concerns that suppliers were overcharging disengaged consumers.

That wasn’t a trivial problem. The competition watchdog found in 2016 that 70 per cent of the Big Six energy companies’ domestic customers were on “expensive ‘default’ standard variable tariffs”, now known as the only show in town. At the time, it was the case that if consumers switched, they could save perhaps £300 a year. Across the market the loyalty penalty added up to £1.4bn a year on the Competition and Markets Authority’s estimates.

The cap on the default tariff was designed as a fallback to stop companies from using loyal customers to subsidise switchers, beyond a price determined by the energy regulator Ofgem. It also aimed to solve a fairness problem: that no one should have to pay more than the watchdog-determined fair price for energy.

What it didn’t set out to do was set the domestic market price or address broader affordability questions.

That is unfortunate because the energy price cap is misunderstood by some consumers as a mechanism that should be controlling prices. Meanwhile the issue of disengaged consumers it was designed to tackle is no longer relevant. There is no point in shopping around because there are no tariffs lower than the current price cap of £1,971 for the typical home. Even the fixes below October’s estimated cap of £3,500 have their drawbacks.

It’s true that the cap has held down costs for consumers over the past year, as wholesale prices have climbed above the level set six months earlier. Suppliers have undoubtedly ended up subsidising customers.

But it has also served to delay rather than eliminate the pain. Wholesale rises are still passed on to households. And as the central debate around household energy prices has shifted from how to protect one group of consumers — non-switchers — to how to insulate almost everyone in the domestic market from exorbitant prices, policy solutions need to shift too.

The cap has brought on all sorts of unintended consequences, too.

It distorted competition in the market by capping the top price that companies could charge, which created unsustainable business models. Its interaction with surging wholesale prices exacerbated the rate of supplier failures. And when suppliers did fail, everyone else ended up bearing the burden through their bills via the supplier of last resort system. That was where fairness fell apart.

The issue of affordability will have to be solved by other means. This is clearly the aim of proposals from opposition politicians to temporarily freeze energy bills. But those also rely on assuming the present problems are transitory, suspending the cap for a period of time rather than doing away with it entirely.

Removing the cap would be politically difficult even if politicians introduce more widespread reforms to tackle affordability. If it were to be axed, suppliers would probably resume some form of gouging certain customers.

But the price cap as it stands isn’t a sustainable solution to problems in the energy market that are likely to endure for some years to come.

Some households will have to adapt to higher prices. Extra efficiency measures will need to be introduced. It is hard to argue against introducing some form of social tariff for the poorest consumers akin to that which exists in the broadband market. In the short-term, some kind of assistance with bridging the affordability gap will be required given the price shock consumers already face.

In the longer term, the price cap needs to go back to being a market backstop, not its primary feature.

cat.rutterpooley@ft.com
@catrutterpooley