02/05/17 – Proposals to protect consumers in the gas and electricity markets

Speaker: John Penrose MP

2 May 2017 – meeting notes

Proposals to protect consumers in the gas and electricity markets

Chair: Lord Whitty

Lord Whitty opened the meeting by welcoming everyone and introducing the speaker and the subject.

John Penrose, MP:

This meeting is probably the final meeting of this current parliament: at midnight the shutters come down for the next five weeks until the General Election takes place on 8th June.

I am pleased to have been invited because, rather unexpectedly, this topic looks likely to be an election issue, but even if it wasn’t, it has been a political, economic, commercial and consumer toothache for quite a few years, and it does need to be fixed one way or another. I am glad of the opportunity to outline what I’ve been suggesting, but also to get the views of people from the industry who are here in this room.

I have thought long and hard as a Conservative free-marketeer before even daring to consider proposing any kind of a market intervention along the lines of a price cap for this market. It is almost in desperation that I have ended up where I find myself. The reason why is fairly straightforward: I think that there is a canker at the heart of the industry – not a deliberate one and no one knows how to get out of it so maybe political action is needed to change things and allow good people in good companies the space to move the industry forward.

The consumer energy sector (and SME/micro business energy too) is one of the few sectors where the price can go up without your immediate consent at the moment of change, and for many people (the man/woman in the street) this feels wrong. It feels unfair and similar to inertia selling, which is not allowed in other sectors of the economy. This is why we are in a pickle and this keeps hitting the headlines: no one planned for it to get to this stage, but we are here and we need to solve it.

The recent Competition and Markets Authority (CMA) report has quite a few proposals that are good and sensible, and OFGEM is now picking them up, but even if they are all adopted tomorrow (which they won’t be), it will take years to bring about changes in consumer and supplier behaviour to make the market fairer, e.g. not permitting the rate to be raised at the end of a contract without permission at or around the time that it happens, and for customers not to be squeezed and used to subsidise other rates, such as acquisition rates.

They won’t happen fast so I have reluctantly reached the conclusion that we probably need something sooner in order to protect the two-thirds of people on standard variable contracts who are being milked. The pro-consumer, pro-choice, pro-competitiveness changes will take place over time but we need something to stop customers being taken advantage of in the meantime.

If we end up with a cap, it should be time-limited. It has to be something that has a sunset clause on it.  Ronald Reagan famously said that there is nothing so permanent as a temporary government programme, and we would have to make sure that whatever we do would have to be explicitly extended every so often, so that it doesn’t become a permanent part of the landscape. And it shouldn’t need to be permanent because of the other measures that will come in, provided they are done in the right way.

There are different types of price cap and some of them are less distortive and less damaging to competitiveness than others, some will help us to get to a more competitive place, and others will not. We could consider an ‘absolute’ price cap, such as the pre-payment meter cap, where the number is set by the regulator. The problem with that is that although OFGEM is full of clever people who understand the market very well, unfortunately no one is clever enough to set a price that is guaranteed to be correct, up-to-date and future-proofed against the twists and turns of the wholesale energy market and the behaviour of different groups of consumers.

For these reasons I suggest we avoid an absolute cap and go instead for an alternative ‘relative’ cap, which would be based on each supplier’s best deal.  Each supplier would have an acquisition price for fixed term deals and the relative cap would say that the default tariff, the SVT, could be no higher than X% more than the best acquisition tariff. What that means is that there would still be lots of differentials in the market – many different types of tariff and different price points – and they could move. Suppliers could change the price every day, even twice a day if necessary, so that the price and SVT could fluctuate according to wholesale price and changes to hedging strategy.

So that is, in a nutshell, where I’ve got to, and now I want everyone’s views. There is a great deal that the sector can do to help get this right, because whatever the Government or Civil Service proposes will not be as good as anything the industry can come up with itself. If the industry could say, “We are going to drive consumer engagement; we are going to change what we do; we are going to come up with proposals to get rid of standard variable tariffs completely and come up with something different” then the very strong pressure for intervention would start to decrease.  For example, Scottish Power has had an idea of giving targets to suppliers with SVTs, to reduce the number of customers on variable tariffs over a period of time. I’m not saying that this is a good or a bad idea, but using it as an example of the industry coming up with something. Do people here think that is a good idea?  I am pleading with you collectively in this room to say that you should be the people who lead the debate on whether it is a good or bad idea. You know better than us so, if you think it is a bad idea, say so and propose alternatives. You can do better than politicians, but if you don’t come up with solutions, we will have to. Speaking as someone who wrote the Conservative Party’s policy on better regulation and getting rid of red tape, I would far rather have an industry-defined set of proposals and have politicians to fill in gaps or provide a sharp stick to prod the progress along, rather than being the authors of this. As time goes by and behaviour changes, I think you will be much more up-to-date and you won’t have to persuade people like me of what needs to happen as you will be able to do it for yourselves, and much more quickly.

So my plea is to make the politicians redundant in this matter. We are probably past the point of no intervention, but you can minimise the effect, the distortion and the time in which the intervention happens, if you own this. It’s not too late to do that, and I don’t think anyone deliberately got this sector into this situation where it is so disliked, but I am sure you have solutions at your fingertips and I’m ready to hear about them.

Comments, Suggestions and Questions

Eddie Hyams, Rockfield Energy Investments: I was involved at the start of retail competition, and some decisions we made then, that were for a process which we thought was temporary, still endure. We began tweaking them but we have ended up with a process that has become more and more web-based and more and more difficult for customers who are stuck on a standard variable tariff. I have some suggestions. First of all, we should have a switching process that doesn’t need you to go through a price comparison process on the internet. This can be done.  Now, all the energy companies are forced to publish what OFGEM calls a tariff label. This is on most energy companies’ websites but it is usually buried and you have to find it. So actually a price list of all the prices of gas and electricity is much easier to deal with and you don’t need a price comparison website if you can just choose gas only, electricity only, green tariff, etc. You don’t need a price comparison site.

If you move house you have to sign up with the previous owner’s company, and that’s all because of the process of switching. The Competition and Markets Authority seem to think that smart meters will solve all this, and they may solve some of it in time but I don’t think we can afford to wait. Having been very wary of anything resembling a price cap because of unintended consequences, I would concur with the idea of having – for a fixed term – some quick and dirty fixes and then see how quickly we can move SVT customers onto fixed contracts. OFGEM needs to facilitate a lot of this because there is a lot of inertia in energy companies, but I think it can be done. We’ve been starting in the wrong place because we keep modifying what we did in 1996 which we thought would last until 2000 and not much more beyond.

Tony Thornton, Gemserv Ltd: Customers in this bracket are a mixed bunch with a range of different reasons and we probably need to understand them better. They range from the ‘not bothered’ to the very vulnerable. A price cap is a blunt tool and blunt tools can have unintended consequences and market effects that may not be felt straight away, so it is right to encourage the industry to step up with some creative solutions.

The sunset clause approach means you are looking for a market change to take place: for something to change for the clause to take effect. A price cap might not stimulate the market in the way you expect it, unless it is purely to protect consumers. We need to be very clear about the purpose: is it to protect customers or to stimulate competition?  If it is the former then I understand the motivation but if it is the latter I think we need to be careful to understand the outcome. I agree that we have got beyond the point of no action, and maybe the threat of action will stimulate the industry to do something different: the mere threat can have quite a galvanising effect.

Philip Davies, Green Star Energy: I agree that the market is in an awkward place and that something needs to be done. However, there is no getting away from the fact that if you introduce more regulation of this sort, then competition will be less intense. You may wish to go ahead anyway, but you need to be aware of that. The sunset clause is a great idea and I like it, but I’m not convinced you will be able to lift it because I’m not at all sure that the circumstances will prevail that enable you to lift it.  Quite the contrary, in fact, as (for example) third party charges on the bill are estimated, by independent forecasters, to go up by 18% in the next five years. This is nothing to do with suppliers’ costs – it’s just that stuff that they’ve got to recover will increase by that amount, so even if wholesale costs stay level, bills are going up, so lifting an absolute price cap when bills are going up would be politically difficult. From that point of view a relative price cap has some advantages, but both measures would mean less competition.  The PPM price cap is serving a purpose, which is fair enough, but there is no doubt that the PPM market is being dulled as a result: for instance as a supplier we direct less sales activity towards the PPM sector because the price we are competing at gives us less room to beat it.

Another point overlooked is the customer psychology – we could have a situation where half the people feel it’s really important to go out and switch and get the best deal, and the other half don’t worry because they believe the Government is looking after them. In reality of course people don’t fit neatly into these categories so it’s difficult to direct marketing activity appropriately to them and we risk having a rather confused message that we send to customers. If you look at related products, e.g. broadband and telecoms, I would imagine that particularly a Conservative government would take the view that while there are backstop protections in place, customers are expected to be active buyers of services looking out for their own best interests.

So those reasons can it please be acknowledged that competition will be less, and when we look at the costs and benefits of whatever measures are taken can that please be taken into account.

An alternative proposal that I would like to put into the mix: our position would be that a relative price cap has advantages over an absolute price cap, but why would it be applied to companies beyond the Big 6? If the background to this is the CMA investigation, none of the criticisms apply to small suppliers. I know there are commentators who say that there are rampant “tease and squeeze” practices going on in the market, which personally I don’t believe, but let’s have a look at that then. If some suppliers are doing that then there are other ways to control it without resorting to something as draconian as a price cap.

JP: Do you have some examples of how to stop the squeeze and tease practices?

Philip Davies, Green Star Energy: You start with information transparency in communications, to make customers more empowered, and if you decide that that’s not working maybe then look at measures, but I suggest that not enough is being done on the information front.   But coming back to this point about the Big 6 only, there are precedents, for example a couple of years ago we had a big debate about market liquidity and we have measures now that just require the Big 6 to make buy and sell offers in the wholesale market because of their position. We have 50 small suppliers in the market, some very tiny and to have a relative price cap apply to those really would fail the better regulation test.  If you look at the power they have in the market – practically zero – to have fairly draconian pricing restrictions would have effects, e.g. when companies are trying to set competitive prices because they see a dip in wholesale prices they would have to reconfigure all their prices to stay in line with the X% rule, and that seems out of proportion to the problem.

The underlying political frustration is that some suppliers have legacy customers who have never switched and who have no interest in their energy bill (and who possibly need to be protected from themselves) but most customers of small suppliers will have come to the market at least once (to be customers in the first place) and so they have shown interest in the market at some stage. Do they need the same level of protection as those who have never shown an interest?

JP: All 3 contributors have acknowledged the background which is a huge step forward. We need to be really careful not to limit competition. I completely agree with that. It only makes sense to have a temporary intervention if you have at the same time introduced as a permanent measure the other pro-competitive, pro-choice, pro-consumer measures, many of which have been proposed by the CMA or which may be proposed in the future by the industry. If not, you’re just limiting competition.

Why am I proposing this? (Answering Tony Thornton) If a cap is introduced, it must by definition be reducing competition in some way, but my proposal will I hope be the least competition-reducing solution. It is to protect consumers but we have to take these other steps at the same time in order to stimulate the competition, otherwise we’re all missing the point. The reason I was asking for examples was because we could take the line of greater transparency and greater data availability (e.g. I as a consumer give my consent to a potential supplier to get hold of my usage data and give me a tailored quote, with it all happening in real time without permission being sought from my current supplier), or we could have better consumer information about unit pricing, etc. as was suggested earlier – very good measures but, in the end, they won’t be enough to move the dial on their own. We need some price comparison sites and suppliers to agree to back it all up with a large advertising campaign, similar to the ones we see for car insurance or broadband, to persuade people that they can have trust in the market and can get involved with confidence.

That what we need to get to, and to go back to my initial remarks, we can’t afford to lose sight of the moral question which underlies all the current dislike and distrust – e.g. raising prices without customer’s say-so, on products that they have to have, fails most people’s ‘sniff test’. We must fix that regardless of what else we do. If we do, there is a great prize in that this won’t be a politically sensitive market any more.

Gary Keane, Pöyry Management Consulting: I’m interested in how you would determine the differential? Customers on fixed price tariffs have given up the right to switch without paying an exit fee, and that reflects some value to suppliers as they have a more stable customer base in terms of procuring wholesale supplies.

If you get a more competitive market or more volatile wholesale prices, the value to suppliers of these customers will increase, so the very conditions where you say you want to remove the differential will actually lead to the differential widening, which will make it harder to remove. That’s the problem I have with an effective sunset clause: how are you going to invoke it in a more contestable market?

JP: That’s a really good point. I nominated 6% but that was just a way of throwing out a number for discussion. The detail of my proposal says it should be X% set by OFGEM, and that it shouldn’t change very often. At the time of my submission 6% was the narrowest that the differential had been in the previous three years – I think it has come in a bit narrower than that since then but at one point it had been as wide as 57%.

You are also quite right to point out that flexibility comes with a value and locking yourself in comes with a cost and a value to suppliers, and that is part of the reason why the wholesale market curve tends to be positively sloped most of the time.

To answer the point that somebody made about whether the sunset clause will be based on time or conditions, my instinct is that it should be based on time rather than conditions because there will be too much scope for lobbyists if we base it on conditions being met. It’s better to say that it stops unless somebody makes a really cogent case for it to continue. And at that point it might also be an opportunity for OFGEM to say that it can continue but at a different level of markup.

Time is better but anything regulatory is always going to be an imprecise science and we need to have a number that will allow competition without restricting the financial incentives to switch in the first place.

Tony Thornton, Gemserv Ltd: You made a very good point about a big marketing campaign to drive consumer engagement.  While I’m not advocating this, if we turn the clock back to the time of doorstep sales agents, despite their very bad reputation they did nonetheless tap into people who didn’t engage otherwise. There was certainly a lot of switching activity around that time – I believe something like 70% of customers were engaged with the market. Since the demise of the doorstep sales agent we’ve got inertia. We need a greater range of channels to engage with customers, together with ways for supplies to encourage engagement through those channels. I’m inclined to steer away from price control although I understand the logic for wanting to do that, but I think that even with a sunset clause the dilemma is when the time is right to remove it: I understand what you’re saying about it being time-limited but that suggests that we should only protect consumers for a limited amount of time and after that, all bets are off.

So moving back to the idea of how to stimulate the market, which seems a more attractive idea to me.  The proposed “disengaged database”, although not related to price control, is a route to that, potentially.

JP: An interesting point about different channels – some will be effective and others less so, and some have behavioural and cultural issues around them. On the subject of the disengaged database, the consensus that I’ve got very strongly from the challenger brands that I’ve been talking to is that no one thinks it will make any difference to the number of disengaged people becoming engaged. The idea has the right goal, but the feedback I’ve been getting suggests that there are other ways to go about it.

Interestingly, what I’ve also been hearing is that it is not just marketing and sales channels and promotional channels, although I would far rather the challenger brands were making the decisions about the channels they want to use because you know better than regulators or politicians what works for you and where you want to put your marketing budgets and where you don’t.  We would be in a very anti-competitive world if we tried to dictate that to you. But what I’m hearing is that a lot of initial benefit comes from just reducing the factors that results in stickiness in the first place, which goes back to Eddie Hyams’ point about reforming some of these processes, such as the requirement when moving house to stay with the supplier of the previous owner, which although extraordinary is an accident of history rather than anything else.

There’s a whole series of things we can do to remove some of the things that make people stick. This will lead to steady changes and at some point that will pay off.

Tony Thornton, Gemserv Ltd: The dilemma of moving in and out: there are undoubtedly advantages to retaining the same supplier as it ensures continuity of supply. The opportunity to switch later, at their own convenience, is of course available to the new householder. It is true that some people aren’t aware of who their supplier is and that makes it hard to switch.

JP: This is where comparisons with other utilities, e.g. broadband, etc., become interesting. Why do we do it differently for energy?  I hope these questions will spark suggestions.

Gary Keane, Pöyry Management Consulting: In the last 20-25 years we’ve seen the introduction of choice, for example with schools. It is true that there are some people are better than others at making choices, and that’s for something that is fundamental to the life chances of children in the future. Is this the start of removal of choice? Are we going to say that we have given up on choice?

JP: If I’ve given that impression that is not what I intended because it’s quite the opposite. There’s a whole series of pro-competitive, pro-choice, pro-consumer empowerment alterations and changes that need to happen. This proposal is temporary consumer protection while the other changes take effect. These days there is a lot less tolerance to being dictated to than there was in the past. There is a lot of resistance to intervention and whether you think that is a good or a bad thing, that is the trend nowadays and it has been for some time.

Ian Campbell, BJIC Consulting: Two-thirds on STC are not going to be reached by price comparison websites so I completely agree that we lost the doorstep sales agents for very good reasons, but how can we restore some of that engagement? Education is part of the answer but the current Gaz and Leccy campaign is only talking about smart metering. There’s an opportunity off the back of that, particularly with everyone’s home being gone into, to educate people about switching. There are much bigger savings to be made by switching from a Big 6 supplier to a challenger brand, and a lot of people just don’t know that.

JP: Absolutely right and some of the earlier comments about greater transparency and ease of comparison would really, really help that, because none of us make a fuss about changing toothpaste and we need to make this as straightforward and easy.

Bob Middleton, Trade Link Solutions: There are a few things missing here. One thing that’s different about energy is that suppliers are obliged to supply. Some people on variable rate tariffs don’t pay, but they have to have energy. There’s a percentage of people that suppliers would cut off, given the choice. This is the only market I know where the supplier cannot reduce the supply: for example if you don’t pay your phone bill the phone stops working. This is because as a society we have taken the decision that energy must be supplied. Just to counterbalance some of the things that have been said round the table, when it comes to pricing it isn’t all one-sided: this is the only product I know where the supplier is obliged to supply regardless.

JP: Maybe water is similar although they can reduce it down to a trickle.

Bob Middleton: It is remarkable that people don’t switch, but I ran a small supply company and we even had members of our own staff who wouldn’t switch, sometimes on the grounds of their current supplier having done nothing wrong for 20 years. The psychology of it is very strange.

With regards to the proposal about the cap on variable tariffs, what is the X% a percentage of?

JP: If your best fixed rate tariff is costing, for example, £500, you wouldn’t be able to have a variable tariff that is greater than X% of that.

Anna Ross, Cornwall Energy: I know we’re talking about vulnerable customers here but we work with lots of suppliers and after the prepayment cap was brought in there was a lot less interest in the prepayment side from new entrants. A lot of suppliers we talk to are talking about a lot more innovation in tariffs, about bringing in battery storage and DSR and long-term tariffs and tracker tariffs. How would that play out with a relative cap?

JP: Those other options wouldn’t be prevented at all, as the cap would only affect the gap between your best tariff and your default, so you could have loads and loads of other tariffs as you mentioned and they would be untouched by the relative cap. It will just affect the gap between your best price and the one that people get put on without their explicit consent at the time. This is an important point because if you want to really stifle competition you would go for an absolute cap, which would result in people coalescing around the cap level.

Philip Davies, Green Star Energy: That’s an important point, because the market is not just about price comparison and I think what you’ve just said opens the door to other areas of price not being affected, but then you get into the question of what is the “best” price, because maybe the best deal is not just about price, but includes something else as well.

JP: Indeed, there are many innovations in tariffs and bundles and who knows which way the market will go? I strongly believe that politicians shouldn’t stand in the way of that.

Lord Whitty: Big 6 should be thinking of new ways as well as the new entrants.

JP: Exactly right. There’s nothing stopping the incumbents from being creative, although culturally they might find it a bit harder and they may have legacy issues that get in the way, but I believe that they too should have the opportunity to delight their customers.

Eddie Hyams, Rockfield Energy Investments:  This is a plea for OFGEM to think differently from the way that OFFER did. When competition first stared in the domestic market we had the bright idea to create an internal challenger brand with a low cost, and offer this everywhere. OFFER didn’t like this because it was going to distort the smooth entry of competition. Other companies had the same idea but it didn’t happen and we all worked out quickly that defending your franchise was a much better bet than trying to be competitive and that has overhung the market all this time. OFFER made that decision then and we have really got to think about all the unintended consequences that could result.

Lord Whitty: The whole point of the proposal is that we have a temporary cap which allows time not only for companies to innovate but also for regulators to innovate or withdraw.

Gary Keane, Pöyry Management Consulting: One day we will have universal smart meters. How many people will be interested in engaging in dynamic pricing?

JP: I don’t know. Some might like it while others will find it intrusive. I don’t know, and I’m willing to admit that I don’t know, and I think that other politicians and – dare I say it – some regulators should also admit that they don’t know. The way to find out is to allow suppliers to find out what appeals to customers and what doesn’t. My guess is that people will change their minds once they see what can be done.

Anna Moss, Cornwall Energy: Are we talking about vulnerable customers or all disengaged customers? I heard about a proposal to extend the prepayment cap to the warm home discount group, which would protect the vulnerable people.

JP: There are people who argue strongly for that but I’m not one of them. I don’t believe that this should just apply to vulnerable customers for a couple of reasons. Firstly, most people don’t think it’s fair or right that the cost of something can go up without your consent, and that argument applies to all customers. It is wrong and even though it may be more wrong for vulnerable customers, it is still wrong for the others.

Secondly, the way the market is behaving needs to change. While suppliers assume that they can take people on at a very keen price for a year or eighteen months and then claw back some of their margin later when customers fail to switch, the danger is that until that habit of behaviour has been expunged you will still have customer detriment embedded, and the focus will shift the same amount of customer detriment to a narrower group of customers i.e. the non-vulnerable ones.

Philip Davies, Green Star Energy: There is a licence requirement for suppliers to notify price increases 30 days. Are you talking about that or something else?

JP: The notification is written in impenetrable legalise. It’s not designed to get the consumer to engage in a decision that will be detrimental to the supplier. The aim is to satisfy the regulator rather than to inform the consumer, and this is not right. It’s fundamentally the problem about the way we are treating consumers.

Lord Whitty: I have two personal anecdotes. My 94-year-old father-in-law will not allow me to pay his bills by any other way other than queueing up at the post office, even though he would save 10% if I paid it online. He will never change, and we need to protect people like that. So the non-switchers are not all vulnerable people. And as for me, although I’ve been Energy Efficiency Minister and Consumer Champion, I did not switch my energy supplier until my bank suggested that I should, since when I’ve been quite active.  But I should also point out that the bank that so advised me, I’ve had my account with since the age of 17. So we are irrational, and sometimes we need to be kicked into doing something.

There are two ways of dealing with this: increase competition on the one hand, and motivate consumers on the other.

In motivating consumers to be more active the big thing from successive governments has been smart meters, although nobody here is convinced that this is going to work. It is the biggest intervention in the market by the regulator in a sense, and it’s going to cost companies and eventually consumers millions of pounds. If we end up with continuing inertia by consumers then it will have failed. I fear we haven’t built enough on top of smart meters in terms of education, advice, training, etc. for it to work very effectively.

We’ve had six big players for a long time and although there are more competitors now, unless there is a solution that in the end breaks the power of those, then we won’t ever have a truly competitive market.

So there are issues here besides tariffs – tariffs can deliver a certain amount of motivation in the market and a certain amount of competition, but they can’t deliver the full solution on their own so we do need some regulation.

JP: I would strongly agree with that last point that we do need some regulation, but on a declining curve because we as consumers don’t need them as much anymore, but we have a long way to go before we don’t need them at all.

I also agree with your point about inertia, and there are all sorts of reasons why different people don’t switch. And even if we get to the point where we’ve got everyone engaged, there will still be a group who will need protection. e.g. Ofcom has recently introduced protection for  voice-only customers with landlines.

Wouldn’t it be wonderful if the market was more commercial and less political? And if we as consumers had control over energy like we do in other areas of life?

The meeting closed at 1910.