Is the current UK Electricity and Gas pricing structure fair to consumers ?

 

In a word, no.....

Why ?

First, some background. 

In less straitened times, much more competition existed in the energy supply marketplace, and some quite competitive offers were available, particularly from new suppliers. Amongst these deals were some involving tariffs which were ‘no standing charge’ i.e. you paid a higher unit rate for your gas and electricity, and only paid for the units you used, which were all priced at this higher rate. 

This benefited low users of gas and electricity, and at the time these tariffs started to appear they were hailed by environmentalists as a much fairer and greener way of charging customers, given the urgent need for us all to consume less of the fossil fuels we use to power our boilers and generate our electricity.

The recent upsurge in ‘raw’ gas and electricity prices has changed all that....

We should all recognise, of course, that the UK energy suppliers are not entirely responsible for the current state of affairs themselves. 

World 'post'-pandemic events, and the efforts of a certain Russian autocrat, have been largely responsible for initiating the change, and more recently Putin has exacerbated the problem further by weaponising Russian energy supply in an attempt to 'fuel-starve' Europe into agreeing to stop support for Ukraine. 

When we will actually be able to rid the world of Putin's malign influence is likely to depend on the will of the Russian people, and the timing of this happy event is unpredictable. The current conflict in Ukraine could even drag on for years or even decades, and could spill into other areas. In the meantime we must ensure energy supplies are maintained, and to achieve this we will probably all need to live with higher energy prices for some years to come. We must also all do our best to economise on our energy use, particularly that derived directly from valuable fossil fuels. My recent blog on the energy crisis discusses how we might help do this in detail.

How do we encourage UK consumers to help us do this ?

Certainly not by front-loading much of the increase in gas and electricity tariffs on the standing charge element, as the 'big six' suppliers have recently done across the board…..

Why have they done this, and how have they been able to get away with it ? 

Since the start of 2021, not only have virtually all the new start-up supplier companies in the industry been eliminated from the market place (to the evident delight of the big six), but zero standing charge tariffs have completely disappeared from the market place. The remaining suppliers (the original big six, and a couple of larger new ‘survivors’ of the supplier meltdown) are all that is left of the marketplace, and they now form a virtual cartel who are effectively allowed by OFGEM to set their own pricing structures. Regulation of the industry by OFGEM can only be described as 'light touch' and is primarily in the form of regularly reviewed (and invariably increasing) price caps.

Why were the suppliers all so quick to eliminate zero standing charge tariffs and front load most of the increases on Standing Charges ? 

It doesn’t take a genius to work this out – as a supplier, by making sure your standing charges form a large part of the total bill, you ensure that everybody has to pay extra, not just those who use large amounts of either fuel. This ensures greater profits, which can then be passed on to shareholders in the form of increased dividends, which in turn will attract more investors, etc.…..capitalism in action, in fact.

The other factor, which is perhaps less obvious, is that the current rapid upward price pressure on bills will inevitably force many consumers to use less of both fuels. Suppliers will no doubt have looked into their 'crystal balls' and decided that the only sure way to maintain profits in the face of this expected reduction is to increase standing charges. None of us consumers can avoid these as long as we maintain a domestic supply.

But why is this policy particularly unfair to low users, especially those who may have very limited means on which to survive ?

Many older people living on their own are naturally prone to being economical with their fuel use, having been brought up at a time when thrift was still fashionable (it will be again shortly, I suspect). They may also be forced to ‘watch the pennies' even more carefully nowadays, particularly if they are solely dependent on the meagre state pension we offer them in UK. 

Since early 2021, their fuel costs have increased in far greater proportion than the average user’s, to the extent that many are already defined officially as being in fuel poverty. They may well have to make the choice between heating and eating during the winter months to come, and as a society we should be ashamed that as a relatively prosperous western economy, we have allowed this to happen. 

I can illustrate this effect nicely by providing real data taken from a low user account over the period since March 2021 - click the table below for a clearer view (projected figures are italicised, and are based on the £2500 price cap announced in early September):

 

You can see from this busy, but rather revealing table (and the even more striking bar chart below it) exactly why there is an issue with fairness here. 

This particular user was forced out of their original zero standing charge tariff (EBICO Green Zero SC) in 2020 when EBICO (which itself emerged from the corpse of the failed Robin Hood Energy enterprise) went bust in Autumn 2020, and transferred onto a short term legacy tariff with British Gas, which expired in August 2021. Thereafter, they were migrated to a Standard Variable Quarterly tariff....and the grim reality dawned.  

Note particularly the vast increase in the size of the electricity standing charge, increasing from zero to £45 per quarter in the space of just 15 months. The standing charge element of all our collective bills is likely to increase again substantially in the planned October price rises, and I have provided estimates of this in the December '22 values. Total charges for both fuels have already doubled; the new price cap should ensure they stay at ca 20% above the current level until 2024. However, thereafter it's anybody's guess as to whether market prices will have stabilised and unit rates will remain steady - they could skyrocket to make up for the loss of the cap restraint if free market prices have continued to rise. We could be looking at domestic energy prices 5-fold what they are now by 2025. 

Since the increases in standing charges we've seen recently are considerably higher than those in the unit rates, medium and high users will be proportionally less affected, with much more moderate percentage increases in their total bills. To illustrate this, British Gas quote 'average' quarterly consumption levels at 3000 KwH for Gas and 726 KwH for Electricity. If you calculate the figures for such an average user, the position is very different:

Looking at the effective cost per unit (i.e. total bill/number of units used) in particular, we can see that for Gas, the value has only increased ca 3-fold, with electricity increasing by only ca 1.6 fold. This is because the standing charge element forms a much smaller proportion of the total bill than for our low user.

Unfortunately this tendency to penalise low users has been a feature of suppliers' marketing strategy for many years. It is obviously in their interests to sell the consumer as much gas and electricity as possible, and low users are seen as a burden rather than an asset. Originally the penalties were applied by tiered pricing based on the number of units used, with the first 200 units being priced at a much higher per unit charge than the remainder. This practice eventually proved a bit too controversial for comfort, and was discontinued some years back, but once the supplier competition had gone bust, the differential was reintroduced by manipulation of standing charges, with low users now paying a whopping 3-fold more per unit for their electricity than the 'average' user, with more increases to come. 

At a time when we are all being actively encouraged to reduce consumption for the sake of the planet, and to ensure we can ‘keep the lights on’, how can we possibly justify this gross abuse of pricing structures by the suppliers in order to maximise their profits ? This example reveals one of the worst aspects of unrestrained capitalism, and is clearly morally and environmentally unacceptable.

It would be much fairer, and hopefully encourage more consumers to reduce their consumption, if every supplier were required by by OFGEM to offer at least one zero standing charge option. The unit rates applying to this tariff should also be capped at an agreed level (no  more than ca 50% higher than the SVT unit rates) to stop energy companies setting it so high that it deters anyone from subscribing. 

An option such as this would allow consumers who so wished to pay only for the units they used (albeit at a higher rate). Those on moderate and low consumption regimes could opt for a zero SC tariff, thereby reducing their bills significantly, and allowing them to cope better with the swingeing general increases in the cost of living, possibly even reducing their need for future additional government hardship grants as a result. (These handouts are likely to be phased out in any case now that the new PMs views are established).

Those bill payers who were either unwilling or unable to moderate their consumption could opt to stay on their existing tariffs, but would have an added incentive to think again about reducing their usage, thereby also benefiting society as a whole.

Consumer champions please take note - we really need your help on this....

Viv

Update 3.8.22: There is another important aspect to energy pricing which all parties need to look at urgently – the price cap itself….

This measure was introduced relatively recently to help regulate the tariff structures in a rapidly evolving marketplace, and more importantly, ensure that no power supplier could charge more than a set amount for either fuel. The cap was introduced at a time when gas & electricity prices were much lower than they are now. As we have already seen from the abuses that have been allowed to occur on low usage pricing, an overall cap is a very blunt instrument, and can cover a multitude of pricing sins.

It is also arguable as to whether the cap is a responsive enough control mechanism at times when commodity prices are changing rapidly. For one thing, it is still only reviewed 6-monthly. As we have already seen, a lot can happen in 6 months – it already has in the previous six. 

The main worry I have as a hard-pressed consumer, is that the cap is likely to remain high for up to 6 months at least after any sustained downturn in ‘raw’ energy prices. Given OFGEM’s light touch approach (also supported by government), the cap is likely to remain high beyond the six-month mark following a price downturn in response to lobbying by the powerful energy supplier associations. They will no doubt argue that they need the cap to remain high to make good their losses incurred during and immediately after the pandemic, provide for future investment and allow for increased costs. While none of us want to see yet more of them go out of business, we must ensure that energy remains affordable for all consumers, and avoid the build-up of even more consumer debt.

Can a continual increase in the cap really be justified ? Oil prices are already significantly lower than their peak earlier in the summer, and gas prices (which are naturally more volatile due to the greater Russian influence on world supplies) have not reached the peaks seen in January and March of 2022, despite Putin's continued threats. It is also quite interesting to compare this profile with the electricity and gas bills discussed above....and perhaps speculate as to how the rise of the predicted price cap from ca £1200 p.a. a year or so ago to £3600 p.a. for the average consumer is really justifiable....

If the cap is allowed to go on rising in the way that it has, there will be severe consequences for our UK population. 

Many pundits have already predicted that a large swathe of less well-off consumers will not be able to afford to pay their energy bills from this winter onwards. Quite apart from the moral considerations regarding a first-world economy (still ranked 6^th largest in the world) being prepared to allow some of its senior citizens to die of exposure in their own homes for lack of heating, there is a real risk of mass-default on payments this winter, and this may even lead to civil disobedience of a more active variety. Government (however transitional) needs to step up to the plate on this if it is to fulfill its duty to protect the public and avoid financial collapse in the energy industry. How ?

Periodic ‘lifelines’ in the form of one-off grants are all very well, and welcome to many, but will do little to reduce the risk of defaults, given the size of the recent and projected increases. Many will go even further into debt in an attempt to pay their bills, thereby worsening UK's domestic debt burden. 

The only effective way to ensure the consumer is being charged a realistic and affordable price for their energy is to control pricing at source via a price cap based on affordability. Any short-term shortfall in the funding of energy companies due to commodity price spikes of the type illustrated should be agreed and the necessary (rather than desirable !) level of extra funding provided by the taxpayer. This will prevent mass consumer default, and ensure that company profits reflect the true costs of supply, and are kept in reasonable bounds via tight government control.

Update 5.8.22: OFGEM have just announced they will be reviewing the price cap every three months from October, rather than every six as at present. Some progress at least, then. Perhaps they will now look more closely at the criteria for setting the cap, and ensure that affordability is given appropriate weight.

Update 13.9.22: As expected, the arrival of a new PM has shaken things up favourably for consumers, although at vast additional cost to the exchequer. In addition to retaining all the additional benefits promised this winter as C.O.L. relief for domestic consumers, a price cap of £2500 is being imposed for 2 years, with funding from new borrowing covering the deficit for fuel suppliers. Business is also getting comparable relief, but only for 6 months initially.

It's difficult to see what else HMG could have done in the circumstances, given that handouts themselves wouldn't have been enough to prevent widespread hardship amongst voters, and many SMEs would have gone to the wall this winter without help. Great to see a prompt and appropriate response at long last, though, and a commitment to 2 years worth of capping relief. Although we will still see a 20% in bills from October 1st, it's a lot better than the original 80% + 50% 'combo' we were faced with under the old regime.  

Given the huge cost of all this, there's nothing else for it now but to 'go for growth' as recommended in my June blog on taxation. The PM and chancellor have obviously taken up this cause bigtime, with the civil service now being indoctrinated into the 'new way', and the message being spread far and wide. The 'mini-budget' in a couple of week's time should provide the full details, including any stimulatory tax cuts.

Let's hope it all bears fruit...the alternative outcome is just too horrible to contemplate...

Version Date 19.9.22