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Price Caps are Coming | Five Reasons Why


27th April 2017

By Peter Atherton

Over the weekend the Conservative Party confirmed that it would propose a ‘price cap’ on Standard Variable Tariffs (SVT) in domestic energy bills in its forthcoming manifesto. Conservative politician’s were quoted as saying that this could save households up to £100 per annum. Understandably the share prices of the listed energy suppliers reacted negatively with Centrica falling 3% and SSE 2%.

The share price reaction was actually very modest. When Mr Ed Miliband, then Labour leader, first proposed a price freeze in September 2013, share prices in SSE and Centrica fell 10-15% in the following days. Part of the reason for the relatively modest reaction so far is that intervention has already been priced in to some degree.

Prime Minster Mrs May has made four major domestic policy speeches since becoming PM and has advocated intervention in the retail energy market in three of these. It was well known that the government was preparing a policy paper for this spring the would have set out its preferred form of intervention. That policy paper will now effectively be rolled into the election manifesto.

But why has a Conservative government apparently decided that price controls on SVT’s are an appropriate response? I believe there are five core reasons:

  • Significant pricing differentials are not politically acceptable.  Most politicians across all parties view gas and electricity as homogenous goods that are also an essential service. Therefore many find it hard to accept that prices should vary significantly between consumers. But pricing differentials are precisely what competition has consistently delivered. It was partly to tackle this issue that Ofgem introduced its notorious Retail Market Reforms.
  • The poor and loyal tend to pay the most. Pricing differentials might be more palatable for politicians if it wasn't for the fact that the highest prices have consistently been paid by poorer households and those that don't regularly switch. Whilst there are clear cost and market reasons why this is the case, most politicians (and media and public) view this as un-equitable. Despite various initiatives (most recently Centrica’s loyalty scheme) the industry has never been able to shake off the question “why do your most loyal customers pay the highest prices?”
  • Prices are rising: a combination of higher commodity prices and environmental costs are pushing up domestic bills once again. Conservative politicians are acutely aware that Mr Miliband’s intervention in September 2013 was one of the few occasions that the Labour Party managed to set the political agenda in the last Parliament. Therefore they hope by taking their own action they can neutralise the issue.
  • The CMA has given cover for intervention. In its initial proposals following its mammoth review into the retail energy sector, the CMA proposed a price cap on SVTs. Whilst they backed away from this in their final report, their initial analysis and proposal provides the intellectual cover for government intervention. In particular the CMA’s (hotly contested) analysis that consumers are being systematically over charged by c.£1.5bn per annum is often quoted government sources as the key justification for intervention.
  • The Government is interventionist. Little was known of Mrs May’s economic philosophy ahead of her taking over as PM. But since she became PM it is clear that Mrs May believes in intervention and is the first Conservative PM for quite a while to place an ‘Industrial Strategy’ at the heart of her domestic program.

For good or ill it has been clear for some time that this government was heading towards some form of intervention in the retail market. Politicians generally and Mrs May in particular do not believe that the current market arrangements can deliver acceptable outcomes for households. Of course history (and basic economics) tells us that price caps tend not to work for consumers in the long term and in themselves become politically toxic as politicians eventually get to own price rises. 

In terms of the impact on the suppliers themselves much will depend upon what form of price cap is implemented. Cornwall and myself will be writing much more on this in the coming weeks.

Cornwall associate Peter Atherton is a well-known equity analyst having headed utility research at several eminent City institutions, most recently Jefferies, and is a respected energy commentator.

 

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The Post-Election Energy Markets: New Consensus or Continuing Paradox? | A Cornwall Conference

Session 1 – The impact of intervention in the retail energy markets

  • Introduction and Welcome
  • Keynote address – Balancing Intervention and Competition
  • The impact of non-wholesale costs on future energy bills
  • Can the market still innovate?
  • The debate: Regulation, engagement and the new political agenda

Session 2 – Striking the balance in low carbon, capacity and flexibility

  • Keynote address—unravelling the paradox

  • Why capacity, low carbon and flexibility policies work against each other, and why a policy reckoning is inevitableCharting the least cost pathway to 2030
  • Assessing the capacity market’s contribution
  • Balancing services fit for the future
  • What is a credible policy framework for long term investors in the sector?
  • The debate: Where next for the low carbon agenda

 

 

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