A bureaucratic nightmare risks stifling innovation in Britain's energy market

Stephen Littlechild

OFGEM’s chickens are coming home to roost, and the energy market regulator now faces a choice. It must decide whether it really is sensible to enforce the restrictions on energy suppliers it has spent the last few years formulating, or whether it will change course, given the bureaucratic nightmare and damage to market innovation that its rules entail.

Consider these examples from the last two weeks. Should a wind energy supplier be allowed to offer a discount to its customers in the neighbourhood of a windfarm if the wind output is greater than expected? Should suppliers and comparison websites be allowed to make cashback offers to customers who switch supplier? Should suppliers be allowed to pay customers interest on bill overpayments? In these cases, common sense says yes. But Ofgem rules say no.

How did Ofgem get into this pickle? Worried by the decline in customer switching – which its own non-discrimination policy had probably caused – Ofgem decided that the number of discounts and tariffs was too confusing for customers, that it reduced competition, and had to be stopped. Ofgem therefore introduced its Simple Tariffs policy, whereby all suppliers were limited to a maximum of four tariffs per fuel. Percentage discounts and other alleged complexities were banned.

Predictably, this led to suppliers withdrawing tariffs and discounts that many customers liked, particularly older retired couples. A notable example was E.On’s Staywarm tariff, which fixed a constant price per month regardless of the amount of energy used. Prompt payment discounts disappeared. Tariffs without a monthly standing charge were effectively banned, as Ofgem prohibited a lower charge per kilowatt hour at higher rates of consumption, necessary to make such tariffs viable.

The examples cited earlier are three more consequences of Ofgem’s simple tariffs policy. Ofgem has created the problematic situation wherein it is constantly required to judge which interpretations, exceptions and innovations are in consumers’ interests. How has it dealt with them so far?

Good Energy, the wind energy supplier, has been granted a temporary (two year) derogation, enabling it to give a discount of up to £50 per year to local residents. This is a sensible decision, but with an odd justification: only a small number of customers are affected. So discounts that benefit a larger number of customers would be prohibited?

Suppliers SSE and First Utility and the website Topcashback are now offering cashback offers. Ofgem has reportedly said that it is gathering evidence and intends to consult, so that it would not be in consumers’ best interest to take formal action now. This deferral is again sensible, but can we hope that such discounts will henceforth be allowed?

New supplier Ovo offers customers a 3 per cent discount on over-payments made in advance. It has reportedly been ordered by Ofgem to stop this, but is appealing, and Ofgem is considering the matter. It would be wise to allow this practice too. Ovo is a vigorous new competitor in the market. It not only offers lower prices, but prides itself on good quality of service. This discount is an imaginative and lower-cost way of reassuring those customers who are wary of direct debit or paying in advance. This is precisely the kind of beneficial innovation that competition can provide. Ofgem should be encouraging it, not preventing it.

More generally, Ofgem has been trying to prescribe, monitor and enforce what it sees as acceptable differentials between different payment types. But these prescribed types date back to the nationalised industries of the 1940s to 1980s. Smartphones were then unknown. The world is changing rapidly. There would be advantage in letting the market discover and provide the payment methods customers want in future.

So how should Ofgem react not just to the examples mentioned, but to the hundreds of innovative exceptions and special cases that will challenge its detailed rules on simple tariffs? Is it viable to distinguish between the sheep and the goats, favouring one supplier here and rejecting another there? That way lies a bureaucratic and public relations nightmare, with a pathway littered with dissatisfied customers. There is also an increasingly apparent incompatibility between these tariff restrictions and the variety of innovative tariffs that smart meters are meant to unleash.

Instead, Ofgem should suspend its simple tariffs rules for the duration of the proposed CMA market investigation of the energy sector. If, at the end, the CMA concludes that there is a problem, and that rules on simple tariffs are the answer, Ofgem would be justified in implementing them. If not, they can be scrapped. Customers will have been spared the restrictions that prevent some innovative offers being put into the market.

Stephen Littlechild is fellow at Judge Business School, emeritus professor at the University of Birmingham, and was the UK electricity regulator between 1989 and 1998.