Ofgem: domestic proposals aim for engagement

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14 November 2012, Gas, Electricity

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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 whistleblower 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.

Source: MarketLine

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