Clive Moffatt is an energy analyst and former chairman of the UK Energy Security Group.
Since its introduction the cap has probably resulted in consumers having to pay on average more than is justified. One reason perhaps why gas is more expensive in the UK than in almost every other European country.
It has also contributed to a massive increase in public sector borrowing, following the introduction of the Energy Price Guarantee last year.
The main takeaway from this debacle is you cannot control retail prices if you have no influence on the wholesale market (in this case the global gas market) and despite attempts to decarbonise the energy system the UK will remain heavily dependent on imported gas for heat and power in the foreseeable future.
Furthermore, the use of blanket price subsidies to hold down consumer bills is a blunt and blanket mechanism for solving welfare problems. It delays the normal market adjustment to higher prices and benefits those who need it least (in this case energy suppliers and those families not in fuel poverty).
A targeted grant support policy aimed at those genuinely in need would have avoided the pitfalls of the energy price cap. If the cap were removed now, it would give suppliers the freedom to compete more aggressively on price and service.
The idea of a price cap had its origins in the aftermath of the last Labour Government’s decision to encourage the vertical integration of the energy market following its abolition of the wholesale market Electricity Pool.
Generators needed the higher supply margins to compensate for falling wholesale prices – with the result that we ended up with a market dominated by the “Big Six”.
The Government and Ofgem’s reaction was to try and compensate for this reduction in wholesale market competition and liquidity by attracting a large expansion in the number of retail suppliers.
This was despite repeated warnings that the policy would backfire by creating a pool of small under-resourced companies highly exposed to the vagaries of the international gas market.
When gas prices did start rising this financial risk was aggravated when the Government responded with the price cap. Ofgem then had no option but to try and manage the collapse of scores of companies unable to hedge their costs – at huge cost to the consumer.
To avoid further embarrassing and costly failures Ofgem have since focused on using the cap to sustain the liquidity of existing suppliers.
The cap was put in place to shield customers from excessive gas bills. But what started life as an upper limit on price has fallen victim to ‘mission creep’ and it may now be being used for energy policy implementation purposes.
By establishing a headline limit, the cap is also ‘muffling’ what little retail competition there is left in the market and is possibly keeping prices higher than they would be otherwise without it.
Furthermore, it should not be dismissed as ‘far-fetched’ to worry that any periodic re-setting of the cap could be influenced by balance sheet concerns of energy utilities, notably those to whom Government assurances may have been made before signing future American LNG contracts, in the wake of ESAP (Energy Stability and Affordability Partnership) discussions.
The details of this “political” deal agreed in December last year to guarantee shipments of US shale gas when we need it are not known but there is some evidence to suggest that contracts might already have been agreed at a premium price significantly above the market price – as an incentive for US exporters.
Such was the fall in gas prices since the ESAP that there can be little doubt that any participating utilities will be nursing significant mark-to-market losses. Consequently, the cap could now be being used as a price support mechanism which, some in the industry were hoping would eventually happen when it was first introduced.
On 11 October this year, Ofgem announced plans to increase the cap, despite the significant reduction in forward gas prices over the last 18 months. At the moment, it is intended that a new cap will be applied from 1 April, 2024 for which Ofgem has announced an interim consultation.
Ofgem explained that the price cap may need to rise “to reduce the risk of energy firms going bust or leaving the market as a result of unrecoverable debt”. So ostensibly this increase is to cover utilities for losses over unpaid bills. However, the subject of arrears is not new in the industry and a normal business risk in retailing.
And whatever the average increased arrears’ loss is, that amount could be dwarfed by mark-to-market losses on LNG contracts. Notwithstanding this, Ofgem either way appears to be admitting for the first time that it is using the cap to support prices.
So my conclusion is that the cap is no longer fit for purpose – but should the same conclusion also be applied to Ofgem?
I have serious concerns about the lack of coherence and consistency in UK energy market governance and regulation and the adverse impact this is having on both public and private investment.
In the last ten years,( especially since the launch of decarbonisation) it has become increasingly apparent that politicians, officials, Ofgem, the CCC (Climate Change Committee) and National Grid (ESO) are operating in separate silos and struggling and often in conflict over how best to balance affordability, security, sustainability and competition.
In my view, the time has come to remove this lack of cohesion and certainty and take the politics out of energy.
One option would be to create an independent Strategic Energy Authority to remove unrealistic targets for decarbonisation of the system, manage the wholesale gas to power market in real time and put in place a predictable regulatory and investment incentive regime which would stretch beyond 2050.
But that is another story…