UK Government acts to introduce retail energy price caps

Following earlier announcements about an intention to introduce energy price caps, on 12 October 2017 the UK Government took the first step to implement this promise, by publishing in draft the Domestic Gas and Electricity (Tariff Cap) Bill (the Tariff Cap Bill).

What you need to know

• The Tariff Cap Bill will require Ofgem to modify the supply licence conditions of suppliers, to impose a cap on the gas and electricity tariffs charged to domestic customers on all standard variable and default rates.
• It is intended that the tariff cap will be in place from winter 2018/19 or sooner until the end of 2020, but the Bill also provides for this period to be extended.
• Pending the implementation of the tariff cap, Ofgem has announced that it intends to extend the existing prepayment meter tariff cap to other vulnerable domestic customers, with effect from February 2018.

Background

Calls for energy price caps, as a means to address rising energy prices, have been championed by various stakeholders for the last few years. Notably, the Labour party promised that it would "freeze" gas and electricity prices for consumers if it won the 2015 general election. More recently, the Conservative party included a "price cap" pledge in its 2017 election manifesto. The Labour party manifesto also proposed an "emergency" price cap. Nonetheless, it was unclear whether this would be going ahead until the Prime Minister, Theresa May, announced in early October 2017 that the Government intended to proceed with a tariff cap.

The Government is pressing ahead with its proposed tariff cap notwithstanding that the Competition and Markets Authority (CMA), as part of its two-year inquiry into the energy market which concluded in 2016, expressly considered and rejected the idea of a cap that would apply to all domestic customers. The CMA, which did order the introduction of a temporary "safeguard" tariff cap for prepayment meter customers, as part of its suite of remedies to address features of the energy market which have an adverse effect on competition, said that "attempting to control outcomes for the substantial majority of customers [by introducing a price cap] would – even during a transitional period – run excessive risks of undermining the competitive process, likely resulting in worse outcomes for customers in the long run".

Meanwhile, the gas and electricity markets regulator, Ofgem, has been taking forward various initiatives designed to make it easier for domestic customers to benefit from competition in the retail market, and reforms designed to remove barriers (actual and perceived) to customer "switching". In addition, on 11 October 2017 Ofgem announced that it would be extending the prepayment meter customer price cap to customers receiving the Warm Home Discount from a supplier who is required to participate in this scheme. It is intended that this "vulnerable customer" tariff cap, which is expected to be in place from February 2018, will fall away once the new universal cap is introduced. Ofgem has also announced that suppliers will be allowed to transfer customers at the end of a fixed-term contract onto another fixed-term tariff, in the absence of an election to the contrary by the customer, provided the customer is no worse off, and can exit the new deal without penalty at any time.

Who will the cap apply to?

In its current form, the Tariff Cap Bill requires Ofgem, "as soon as practicable" after the Bill becomes law, to modify the standard supply licence conditions to impose a cap on all standard variable and default rates that may be charged by suppliers to domestic customers. The cap will not apply to prepayment meter customers, because such customers already benefit from the existing prepayment meter cap imposed pursuant to an order made by the CMA. Importantly, the cap will also not apply to the supply of "green energy" – i.e. where, typically, 100 per cent of the electricity being supplied is from renewable energy sources.

How will the cap work?

The Tariff Cap Bill stipulates that the supply licence conditions will need to set out how the cap is to be calculated, and may also make provision for specifying how a standard variable or default rate is to be identified.

The Tariff Cap Bill contemplates that Ofgem will consult on how the cap is to be calculated. This is consistent with the approach to the price cap on High Cost Short Term Credit introduced by Government legislation in 2015, where the task of setting the cap was also left to the regulator.

The Bill itself does not provide detailed guidance as to how Ofgem should determine the cap, other than stating the matters that Ofgem must have regard to in exercising its powers, such as:

• the need to protect existing and future domestic customers who pay standard and variable and default rates;
• the need to set the cap at a level that enables effective competition;
• the need to maintain incentives for domestic customers to switch to different domestic supply contracts; and
• the need to ensure that holders of supply licences who operate efficiently are able to finance activities authorised by the licence.

When will the cap come into force?

The Government has said that the tariff cap will be in place within months, but there is speculation that it may not be until winter 2018/19. This is to allow time for the Bill to go through the parliamentary process and for Ofgem to carry out its consultation. That said, there is an unusual consultation provision in the Bill, which states that consultation occurring before the Act is passed is as effective as consultation after the Act is passed. This appears to be intended to speed up the process of bringing the price cap into effect.

Initially the cap will be in place until the end of 2020. However, the Bill also requires Ofgem to carry out a review in 2020 into "whether conditions are in place for effective competition for domestic supply contracts". If, following the review, the Secretary of State considers that such conditions are not in place, then the cap can be extended for another year. This annual review and extension process can be repeated until 2023.

Analysis

While not unprecedented in the UK context, the setting of an energy tariff cap that applies to all domestic customers is a very significant development, as it marks a further return to retail price regulation in the British energy market, and another signal that the current UK Government intends to step in if markets, or their regulators, are not seen to be achieving a "fair" outcome for consumers. However, the move comes at a time when there are more suppliers in the market than ever before: as at March 2017, there were 54 active suppliers in the domestic gas and electricity retail markets. Moreover, in the 12 months to March 2016 alone, the combined market shares of small and medium-sized suppliers in the domestic market grew by nearly four percentage points to 14 per cent, while the six large suppliers have continued to lose market share. On that basis, and given the various regulatory remedies being implemented following the CMA's energy market investigation, the question needs to be asked whether the introduction of a universal tariff cap is unnecessary or at least premature.

What is clear is that in asking Ofgem to determine appropriate tariff caps for gas and electricity, that protect customers without damaging competition, the Government has set Ofgem a challenging task.