Although improvements have been made across the industry, new simplified energy tariffs are still too confusing, according to the consumer group Which? who would like to see a single flat rate for energy.
Dr Richard Westoby, SSE's Director of Retail Economics, blogged last June on the issues surrounding a single unit rate and you can read it below:
The idea is that if all energy suppliers simply charged a single unit price, customers could see, at a glance, which supplier offered the cheapest price – as they can on petrol station forecourts.
Sounds great, but could there be unintended consequences? And would customers be better off?
The attraction of single unit pricing is easy to see. Customers could look at a list of the prices on offer and see instantly which deal was the cheapest. The Which? argument is that this would lead to better competition as suppliers would have to compete more explicitly on price.
So if it is so straightforward, why is it that energy prices are not being set like this already? After all, there’s no rule preventing an individual supplier from pricing in this way if they choose.
How does energy pricing work at the moment?
The following, lifted from an EnergyUK briefing, provides a good overview:
In supplying energy to a customer, suppliers have some “fixed” costs that are incurred irrespective of how much energy that customer uses. Examples of this include: meter provision, maintenance and reading; billing, call centre staff and other customer services; social... levies; and provision and maintenance of a connection. Other costs, predominantly the energy itself (bought on the wholesale market), vary according to how much energy the customer uses.
Historically, energy suppliers have recovered their fixed costs in one of two main ways. One way is via a “standing charge”, a fixed cost charged to the customer irrespective of how much energy they use, typically levied on a pence per day or pounds per month basis. The other way is via “tiered” unit rates, where the customer is charged at a higher rate for the first number of units they use in a year, and a lower rate thereafter. The fixed costs are theoretically “bundled” into the higher first tier.
Clearly, there is an important balance to be struck between simplicity, fairness and innovation. In recent years, it has become clear that the ‘tiered’ unit rate model can be confusing for customers and most suppliers have now adopted the standing charge approach. In fact, Ofgem is in the process of implementing its Retail Market Reform (RMR), which will ban this kind of pricing.
SSE now charges a fixed £100 standing charge (per fuel, per customer), spread across the year, which we believe is simple enough to be easily understood and compared, while also enabling us to recoup fixed ‘per customer’ costs fairly. We estimate that around one seventh of a typical energy bill is made up of fixed costs.
Why not go for a Single Unit Rate?
I think the potential negative impacts for customers can be summarised as follows:
1) Fixed costs would not be spread fairly across customers
At the moment, the standing charge means that costs that are the same for all customers regardless of consumption are spread evenly among all customers. However, if the standing charge were built into the unit rate, those who consume more energy, which can include large families or vulnerable people who are at home during the day, would end up paying a greater proportion of those fixed costs than those who use less energy.
Not only is this an unfair distribution of costs, but it could also lead to suppliers having to sell energy to low users at a loss, cross-subsidised by higher users. Arguably, this would create a perverse incentive for suppliers to attract high users and not low users.
2) There is a risk of upward pressure on prices
Bundling both fixed costs (like metering) and energy costs into one unit rate would mean that suppliers would have to recover all of their fixed costs through the unit rate. This means that, although some costs will be the same regardless of how much energy a customer uses, the amount they pay towards them will be dependent on how much energy they use.
This creates a risk for suppliers – if consumption is lower than expected, for instance in a very mild winter, they will not recover enough to pay for fixed costs. Equally, in an extremely cold winter (such as the one we have just experienced), consumption will be much higher and customers would pay more than they should do. This risk needs to be factored into pricing and could lead to higher prices. More importantly, it could be a barrier to entry.
3) Tariffs could not be tailored to customers’ needs
While the vast array of tariffs on offer historically could be confusing, the innovation in energy tariffs this allowed has enabled many customers to get a far better deal than they would otherwise have done. For instance, customers on ‘time of use’ tariffs can benefit from cheaper prices outside of peak hours and can therefore save money by running their appliances or heating systems overnight. Higher users are able to benefit from a tariff with a higher standing charge and lower unit rate, while lower users can opt for a tariff which offers the reverse.
Through RMR, Ofgem is limiting the number of tariffs each supplier can provide to just four in order to simplify the market for customers. Even though the number and type of tariffs on offer will be restricted, there will still be some flexibility for suppliers to tailor their tariffs to the needs of individual customer groups. A single unit rate system would make this more difficult and any such benefits could be diluted in a one-size-fits-all approach.
Ofgem is in the process of radically reforming the energy supply market through RMR – a series of reforms that will make the energy market easier for consumers to navigate. The package even includes the introduction of a Tariff Comparison Rate, which is designed to give customers a single metric through which to compare tariffs between suppliers. Undermining this process now in order to pursue Which?’s proposal is likely to lead to lengthy delays and, for many reasons including those outlined above, could actually lead to consumers getting a worse deal.
With these reforms already well underway following a long consultation period and careful consideration by Ofgem, it will be important to gauge just how effective they are before embarking on a radical change in direction. Ultimately, customers are the ones who matter in this debate and the full implications need to be thought through.
For now, though, we should be focusing on making changes which achieve three key aims: simplifying things for customers to get them engaged, opening up more competition and helping customers to get the best possible deals for their needs.