Simpler energy tariffs will worsen fuel poverty and harm innovation

Stephen Littlechild
DAVID CAMERON has backed proposals by the regulator Ofgem to simplify energy tariffs. Under the new scheme, suppliers will be restricted to offering no more than four tariffs for each type of fuel, and customers will be put on their supplier’s lowest variable rate unless they choose otherwise. But will these proposals help customers with their energy bills, as claimed? No, they will increase energy prices and exacerbate fuel poverty rather than alleviate it.

The proposals will prohibit, or lead to the withdrawal of, some of the lowest price offers in the market. Consider what the Sunday Times currently rates as the best energy deal available – SSE’s Discounted Energy 2015 tariff. This guarantees 11 per cent off the company’s standard energy tariff for the first year, then 2 per cent off for the second. It also has a £50 exit penalty if the customer switches before April 2014.

Ofgem’s proposals, endorsed by the government, would prohibit SSE from offering this tariff. Why? Because the discount is expressed as a percentage, not a fixed amount, and because the discount is different in the second year compared to the first. Yes, it really is that petty. It is difficult to see why customers used to 10 per cent off labels in supermarkets would find the use of percentage discounts a barrier to spotting a good deal.

Perhaps Ofgem and the government think that SSE could reformulate its offer as a fixed discount. If so, they have not considered the implications. Suppose that, for an average dual fuel customer, an 11 per cent discount represented an annual saving of £127. For a larger customer, with double the consumption, £127 would be only half the percentage discount, and therefore less attractive. For small customers with half the annual consumption, a fixed discount of £127 would be double the percentage discount – but it might not be economic for SSE to offer it.

There would be another problem. The government’s proposals would require SSE to put all its customers on the Discounted Energy 2015 tariff because it is cheaper than its standard tariff. But it has a £50 exit penalty. Admittedly customers would have a right to stay on their original tariff, but should they really be forced to object to the transfer, or be subject to an exit penalty if they fail to realise what is happening?

There would be yet a third problem. Unless SSE could argue that this was just a variant of an existing tariff, it would have no room for another. The proposed limit on the number of tariffs that each supplier can offer would thereby prevent innovation. It would be too risky for a supplier to give up an existing profitable tariff to introduce a new one with uncertain appeal. Is this the end of green tariffs and tariffs with no standing charge, at least from the major suppliers?

Because the lowest price offers would no longer be available, and there would be less innovation, there would be less competitive pressure on other prices. The reduced availability of significant price reductions would lead to less customer interest in switching between suppliers. Ofgem claims that simpler tariffs would increase customer engagement. But its own research shows that the availability of good savings opportunities outweighs simplicity of information as a determinant of customer switching.

All these factors leading to a reduction in competitive pressure would result in further increases in prices and retail profits. There is evidence that Ofgem’s retail policies have already had this effect. Its restrictions on tariff pricing, and its pressure on suppliers to cease doorstep selling and to simplify tariffs, seem cumulatively to have led to an increase in retail profit margins of some £10bn over the last five years, presumably at the expense of customers.

SSE’s tariff is an excellent example of the innovative and competitive nature of the retail energy market in Britain. The company has designed an offer that reduces its customer handling costs and its power purchasing risks, and gives it the chance to demonstrate customer service standards rated among the best in the market. In return, SSE passes its cost reductions to customers in the form of a discount. This currently makes this tariff the “best energy deal” in the market.

But the government’s tariff proposals would prohibit this deal. How can this help customers with energy bills? Or help pensioners better heat their homes in winter?

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