Ofgem announces a cap on prepayment meters, saving users between £75 – £80 a year

15 Aug 2016 By Amandla Jarrett (Financial Health Exchange)

Significant changes in the energy sector are projected following the announcement by the energy regulator Ofgem that they will be implementing several of the Competition and Market Authority’s (CMA) proposed remedies to combat ineffectiveness of competition in the market and prevent consumers from overspending.

The CMA has found that most households are overspending on their energy bills. One major remedy the regulator will impose is a cap on prepayment meters which is expected to save users £75-£80 a year. Prepayment meters allow people to pay for gas and electricity on a pay-as-you-go basis, as opposed to monthly or quarterly arrears.  The price cap will limit how much suppliers can charge for standard variable prepayment tariffs, which will help make these tariffs more competitive and also help vulnerable customers, who tend to suffer the most detriment.

The CMA’s report which was released in July this year outlines the findings of their 2 year review of the energy sector. It was driven by the concern that domestic energy prices were too high and the six large energy companies which supply 90% of British customers, accumulated profits which were too excessive. The report documents the extent of overspending by households within the sector and attributes this trend to consumer disengagement and misinformation of energy services. More specifically, the investigation revealed that up to 2/3 of households are disengaged and are currently paying more for their energy than those who have switched tariff. In addition, 70% of customers were found to have been on the more expensive ‘default’ standard variable tariff which costs consumers £1.4 billion more than a competitive market.

Ofgem’s report, (released on August third) integrates the CMA’s proposals. The remedies they will impose are based on freeing up competition and innovation in the market in order to reduce bills and improve services for all, as opposed to just a minority.  The aim of this approach is to encourage consumers to shop around and save money. This is crucial as prepayment customers (who tend to comprise vulnerable households) typically miss out on the best energy deals on the market and pay an average of £220 a year more than those on the cheapest deals.

Prepayment users tend to be those in rented accommodation, people who have had trouble paying in the past or who have debts and those in rented accommodation where the landlord chooses a prepayment deal. The introduction of a cap is projected to knock an average of between £75 and £80 a year off prepayment bills, a benefit which will mostly effect vulnerable people who are least likely to switch, from next April. The cap will effect 16% of the UK market and is intended to be an interim measure until 2020 when smart meters are due to be rolled out throughout the UK. Ofgem expects that as the smart meters roll out increases, competition rather than a cap will determine the prices paid by most customers. Further, the cheaper technology involved will remove the need for energy suppliers to charge additional costs for pre-paid energy.

Meanwhile, from 2018 the CMA will force the Big Six and other suppliers to share information on those customers who have been on expensive ‘standard variable tariffs’ for three years or more, otherwise known as  the ‘Disengaged Domestic Customers’ database. Around 70% of the customers of the six large energy firms are on the standard variable default tariff, and 55% of these customers have been on the tariff for more than three years. Ofgem will retain, use and disclose this data to rival suppliers in order to prompt disengaged customers to engage in the energy market.

Critics question the focus on consumer switching

However, the likelihood the CMA will reach their targets for consumer switching is uncertain. Kevin Peachey (BBC personal finance reporter) warns that switching is not as easy as the CMA suggest. The CMA’s final report says that over 1/3 of the 7000 people it asked still did not realise that switching was an option, particularly those on low incomes, those with few qualifications, and those that are tenants or over 65 – in essence the ‘vulnerable’ demographic they are specifically targeting. Critics also highlight the impracticality of expecting that most people would check every few weeks whether they were getting the best possible deal.

In addition, commentators accuse Ofgem’s strategy of being insufficient and long overdue. Ed Kamm, the UK Managing Director for First Utility stressed that Ofgem’s proposals put too much onus on the consumer. Despite the energy regulators resolve to target vulnerable consumers disengaged in the market, the organisation has admitted that it will be those already engaged in the market who will see the first benefit. Likewise, Mark Todd (co-founder of the switching service energyhelpline.com) casts further doubt on the potential  success of their strategy, noting that the average household only switches once every 9 years, costing themselves roughly £300 a year or £5000 a decade.

To remedy the issue of inefficiency within the sector, Byron Orme, a research fellow at the Institute for Public Policy Research (IPPR) highlights the need for a paradigm shift in the approach taken. He suggests that to materially reduce people’s bills there must be investment in energy efficiency improvement to ensure that costs are brought down and kept down.

Be that as it may, further changes expected in the energy sector suggest conflicting objectives and ambiguity about the likelihood of Ofgem successfully increasing competition. For instance, the government’s proposal to reverse the changes to the Confidence Code on Price Comparison Websites (PCWs) -including the proposal that online PCWs should be allowed to omit deals where they do not gain early commission- would prevent PCWs from disclosing all the information they have on best deals, thereby limiting consumer choice which disadvantages smaller suppliers and harms competition.

Furthermore, the disbanding of the DECC (Department of Energy and Climate Change) by Theresa May and the incorporation of its functions into the new department for Business, Energy and Industrial Strategy (BEIS) suggests a deprioritised focus on energy sector matters, particularly those relating to climate change. Permanent secretary Alex Chisholm insists however, that the government are focused on improving services for consumers and the rationale is to allow “a united focus on markets, investors and consumers”.

Nonetheless, whether an effectively competitive energy sector requires a renewed focus on consumers or suppliers remain unclear. In spite of doubts over the effectiveness of the CMA’s remedies, Energy UK claims that over 360,000 energy consumers switched in June 2016 which was a slight increase on the figure for May. Moreover, over 2 million customers switched in the first half of 2016 which is almost 1 million more than in the first 6 months of 2014. According to the latest electricity switching data, 120,000 people switched to small and mid-tier suppliers in June, accounting for 33% of all switches for the month. If these trends continue, Energy UK estimates that the 2015 figure of around 3.8million people switching energy supplier could be exceeded.