Ofgem has launched a consultation on the revised Retail Market Review proposals for the domestic market, updating those put forward 12 months ago. This is a timely move given the recent wave of price rises from UK suppliers, but Datamonitor believes Ofgem should educate consumers about market dynamics and set realistic expectations, rather than calling for simpler tariffs and so curbing innovation.
The
changes to the Retail Market Review (RMR) address outstanding concerns related
to consumer engagement with the energy market, with a focus on requiring suppliers to give customers:
"simpler choices; clearer information about products, prices and available
savings; and fairer treatment."
The
proposals are twofold: driving transparency and reducing suppliers' ability to
make excess profits from disengaged and so-called "sticky" customers.
Ofgem has also made the proposals more serious by reserving the option of
calling in the Competition Commission for a Market Investigation Reference.
The
review calls for simpler tariffs, which Datamonitor believes is unwise: simpler
tariffs will reduce consumer appetite for tariff innovation, an important
element in the success of a future large-scale smart meter roll out in the UK.
Indeed, the roll out will require nuanced tariffs designed to influence
customer behavior and ensure the benefits that smart meters promise.
The
measures also include limiting suppliers to four tariffs per fuel, meter, and
payment type; the end of multi-tier tariffs in favor of a standing charge and
unit rate; and personalized information on bills regarding potential savings if
the customer switched to a competitor's cheapest tariff. In addition, Ofgem is
putting forward Tariff Comparison Rates to allow market-wide comparison, an
improved Annual Statement complete with personalized information arming the
consumer for engagement in the market, and the requirement to treat customers
fairly.
One
of the most common observations when retail prices rise is the disconnect
between profits from retail accounts and group profits reported by suppliers.
Retail margins are modest - usually around 4% - whereas overall profits are
significant, often driven by profits from upstream business units. Suppliers'
wholesale businesses benefit from the difference between going market rates and
their cost of supply, achieved wherever a supplier has a portfolio of
well-managed and well-hedged power stations and gas fields.
But
profitable upstream supply is not always guaranteed (as anyone with a combined
cycle gas-fired generator facing negligible or negative spark spreads will
attest), and utilities are still obligated to deliver value to shareholders and
invest in power stations and gas fields to ensure ongoing security of supply.
Additionally,
any argument for a supplier offering a cheaper retail rate given its level of
supply-side profit is effectively an argument for cross-subsidy between
business units, which could be construed as loss-leading and anti-competitive,
as it would disadvantage smaller suppliers without their physical assets to act
as a hedging strategy.
Recent
allegations about improper NBP trades by whistle blower Seth Freedman will not
help suppliers, even though there is currently no evidence that UK retail
suppliers were involved in any way. Whatever the outcome of FSA and Ofgem investigations
into this issue, and whatever the size of the material impact on end consumers,
this will remain a consumer relations headache. Indeed, many consumers may form
the impression that wholesale costs themselves are unreliable, and therefore every
effort must be made to highlight the reliability and improve the perception of
suppliers' wholesale market operations.
While
there are no direct measures that can effectively address the issue of suppliers'
group-wide profits, communication and consumer education about market dynamics
and setting realistic expectations for consumers would be a much better
starting point than holding back tariff innovation. Datamonitor believes that
the biggest risk with Ofgem's proposals is creating unrealistic expectations that
the proposals will be able to apply any material downward pressure on prices.
Written by Rhys Kealley
Lead analyst in Datamonitor's Energy team
Follow Rhys on Twitter: @RhysKealley
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