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Stuart Jackson is Chief Financial Officer of Octopus Energy.

Of all the responses to the Government’s announcement that it will fix the country’s broken energy market, the least credible has been the howls from the Big Six and their apologists that this represents interference in a free market.

Unfortunately, retail energy has never been a free market in the UK. The market structure is a synthetic one, designed over two decades by bureaucrats and the very companies it regulates. The Big Six were born of a former nationalised industry and, after 20 years, still carry statist inefficiency and the gift of a large population of disengaged customers.

It is therefore unsurprising that the incumbents are fighting to defend the status quo: their business model is systematically to create and exploit confusion and disengagement, and then benefit from the high prices this enables them to get away with.

Centrica and E.On’s latest calls to ‘end the Standard Variable Tariff’ (SVT) should be seen in this light. They are proposing to replace the SVT with unspecified fixed term contracts. Replacing the SVT with such a roll-on fixed tariff would not end the concept of default tariffs – after all, you’ve got to charge customers something when they are beyond a contracted period.  However, such a move would enable them to obscure their default price, with a bespoke (expensive) tariff for every customer.  Instead of all loyal customers being on the same SVT there’d be myriad different levels, so that no one would know their suppliers’ “real” price.

One function of the SVT has been to provide a benchmark price – and the ensuing outcry each time the Big Six raise SVTs rightly puts them under extreme political scrutiny. It’s also one of the very rare occasions when reasonable numbers of customers become aware of the amount they’re overpaying and switch away (the media are rather better at letting customers know they’re paying too much than their suppliers are). It’s no wonder the large suppliers want rid of the SVT.

By contrast, challenger energy suppliers like Octopus Energy – and the eleven others who have supported John Penrose’s call for a relative price cap – have had to build up their customer base from scratch, fighting for every customer. If any supplier is credible in saying they actually want competition, it is surely the challengers.

Rather than adding yet more layers of complication by tinkering with special tariffs for vulnerable customers (as proposed by Ofgem) or dictating pricing in the market (as proposed by Labour), the Conservatives now have a real opportunity to harness free market principles to fix structural problems. A short, sharp shock to introduce competition, transparency and efficiency is urgently needed, and I agree with John Penrose that the best means to achieve this would be through a ‘relative’ price cap.

A ‘relative’ price cap is simply a maximum mark-up between each energy firm’s best deal and their default tariff, forcing energy companies to link their ‘teaser’ rates to their underlying default tariff.

This simple measure would achieve real competition (because firms are free to set prices but cannot offer artificially cheap deals that are only economically viable by quietly jacking prices up later), incentivise efficiency (only efficient firms can consistently offer low prices) and bring prices down for the majority (companies would be forced to compete for new customers or wither fast).

Despite the phrase “price cap”, this is not government meddling. It’s the same sort of simple rule as weights and measures in physical products, or advertising standards rules. It makes sure that customers know what they’re buying, and are not systematically duped by companies. A relative price cap still allows companies to set their own prices, but stops them being able to pretend they’re offering great value by declaring one set of prices in their advertising whilst charging most of their customers vastly more.

Energy needs this rule. It’s impossible for most people to really understand their energy prices: there are four components to the price (standing and unit charge for each of gas and electricity), purchasing units no one understands (seriously, how many people know what a kWh is, or how many they use?), contracts based on estimated future consumption (this won’t go away with smart meters), and direct debits, which are the same every month despite varying consumption (so not even your bank statements allow you to see what you’re really paying). The only clue you have is impenetrable infrequent statements from the energy supplier or the laborious and error-prone job of using a comparison site (which are hardly neutral in this game).

Let’s be clear: truly competitive and properly functioning consumer markets force companies to keep their prices low for everyone in order to compete for the small percentage of people who shop around. A good example of this is the grocery market, in which there is ongoing price competition between supermarkets, even though there is relatively little “switching”. By contrast, in energy the Big Six’s ‘legacy’ customers are milked to subsidise low prices for new customers, so that they look competitive in headline prices. In this way, the retail market is actually structured to protect incumbents from real competition that is based on efficiency and transparency.

The respected free-marketeer John Penrose MP has fought to keep focus on the great SVT rip-off. The answer is not to abolish SVTs, but to subject them to competitive pressure by tying them to prices offered to new customers.

Government should now stay firm and ensure policy makers and regulators implement a relative price cap to force transparency and expose the inefficiency of the formerly nationalised energy companies. Only then will they start to offer clear prices and enable this market to behave like other consumer markets, forcing poor performers to reform or die.

46 comments for: Stuart Jackson: Why it’s time for a relative energy price cap

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