ACTION: Ofgem Consult on Changing How Energy Bills Are Charged

Hi everyone,

Ofgem have a call for input titled “Energy system cost allocation and recovery review“. In this article, I’ll give a brief description on what this means and some of their ideas in the consultation, then I’ll tell you how to get involved and finally I’ll share my response.

The only difference between normal consultations and this one is that I really recommend you DON’T copy my response and send it to Ofgem, instead think of the simple options and email Ofgem your preference.

Why are Ofgem Looking to Change our Bills?

Our energy system is in a transition phase at the moment. We’re full-steam-ahead toward net zero, which means our reliance on gas will drop and our reliance on electricity will massively increase.

To meet these targets, we need huge investment in our electricity grid and in renewable energy sources. This investment is estimated to be £80billion between now and 2031. And most of this has to be paid for through our energy bills. The bright-side is that hitting net-zero should reduce our unit rates significantly.

Now, typically, these types of investment costs are put onto our standing charges, but this creates a problem for Ofgem. It will result in a system where we are all paying extortionate rates for standing charges, even though our usage costs should fall.

Imagine living in a 1-bedroom apartment paying £1,500 a year in energy bills whilst a 4-bedroom house only pays £1,700 a year, it would be considered by most to be unfair and unequal. Well, that’s what is going to happen if Ofgem don’t change HOW we are charged for energy.

What Options are Ofgem Considering?

At this stage in the process, Ofgem haven’t suggested that they are leaning in any particular suggestion, instead they are asking the energy industry and the public “what do you like, and why?”. In the Call For Input(CFI) document, Ofgem have given some examples of how other bills are paid and how other countries manage their bills, if this interests you then I recommend skimming through the actual CFI document, it’s not a terrible read!

Some of the thoughts they’re interested in include:

• Charges that vary with the amount of energy used
  • This could be done by removing the standing charge altogether and putting all fixed costs on unit rates
  • We could have a rising block tariff (energy gets more expensive after a certain amount of usage each month) or a falling block tariff (energy gets cheaper after a certain amount of usage each month)
  • We could just have the standing charge linked to usage, i.e. you pay more standing charges if you’re a higher usage household
• Charges that vary with time of use
  • Standing charges could be linked to usage at peak times
  • We could have lower standing charges offset by higher unit rates linked to peak times
• Charges vary with location
  • Ofgem are considering whether charges should vary with location or not, which they currently do. Think about it like this, water companies charge different amounts in different regions because it costs different amounts to service each region, but a stamp is the same price across the country regardless of how far a letter or package has to travel… which of these is a fairer/better system to emulate?
• Charges that vary with the ability to pay
  • Is it a good idea to link energy bills to income or wealth? Ofgem could use government data for salaries or potentially use council tax bands as a measurement of wealth.

There are a lot of intereting ideas in here. The idea of charging based entirely on consumption comes from things like petrol and groceries, where all the fixed costs that the business incurs are wrapped up in the prices of the items you’re buying. You can see that charges based on time of use are similar to train tickets, where you get off-peak and peak priced tickets for the same journeys. Locational charges are similar to the way water is charged, and charges based on a user’s ability to pay are similar to council taxes.

Ofgem have laid out a variety on options for us to consider, and this CFI states that we’re all welcome to offer suggestions that are mix-and-match of the above list, if we think it will provide a fair and efficient energy system.

The only thing we have to remember is that all costs must be covered. We cannot just ask for unit rates to stay the same but for standing charges to vanish, that is not something Ofgem are looking to do, they are simply trying to see if there is a fairer way to charge energy bills across the country.

Why are Ofgem looking at other countries?

Ofgem have thought that it makes sense to have a look at how some other countries manage their energy bills, just to see if there are any lessons to be learnt. They’ve given us a brief description of how Sweden, Australia and California manage their bills, just to give us an idea of other options we might consider before replying to this CFI.

Sweden: The key similarity is that most of their home-grown energy is produced in the north and is distributed to the south. The big difference is that they have 160-170 network companies who act as suppliers as well. Their regulatory system is based on principles and it is up to each network company to interpret the principles and operate in good faith.

There are new rules in Sweden that will be implemented by 2027, whereby their electricity tariffs are composed of four parts:

1. An Energy Fee – cost of electricity transport, based on costs that vary with usage. This fee can also be time-differentiated over the day
2. A (time-differentiated) Capacity Fee – prices are different at different times to reflect how the load on the electricity grid varies (means consumers can save money by avoiding electricity at peak times)
3. A Customer-Specific Fee – based on costs of metering, billing and broader customer services to a specific customer or group of customers. It is a fixed amount per customer.
4. A Fixed Fee – covers ‘residual costs’, which essentially represents the difference between the amount a supply earns from the amount they are allowed to earn. Charged based on the size of the main fuse, and capacity, at their home.

California: Unlike in the UK where the market is fully liberalised, California’s market is partially liberalised with companies either Investor-Owned Utilities which are privately owned by shareholders and regulated by the California Public Utilities Commission (CPUC), or Publicly Owned Utilities which are owned by local governments and public agencies.

California provides discounts on electricity and natural gas bills to income-qualified households through its CARE and FERA programmes. The discount received by domestic consumers is dependent on their total household income and linked to the Federal Poverty Guidelines.

Australia: Whilst the UK market is highly centralised and fully liberalised, Australia’s federated market varies by state. Although the National Electricity Market (NEM) covers most regions, there is a mixture of public and privately owned companies that vary by state.

Deployment of new technology such as solar and batteries creates opportunities and risks. They may help consumers reduce their contribution to network bills. However, this may result in transferring their share of fixed network costs onto other consumers. This scenario creates related but different cost allocation and recovery considerations compared to GB.

What Specific Questions are Ofgem Asking?

As with all consultations, Ofgem have laid out some specific questions for people to answer, but you do not have to answer these questions, you can just email them your thoughts or you can choose to just answer the ones you want.

Here is the specific list of questions they’ve included in this document:

1. What other examples or evidence from relevant sectors or international energy markets should we consider as part of our review?
2. What options for amending domestic cost allocation and recovery should we explore in more detail and why? What options should we rule out at this stage and why?
3. How would changes to the underlying rules and approaches for allocating and recovering system-wide costs be expected to translate into the tariffs offered by suppliers?
4. What options for amending non-domestic cost allocation and recovery should we explore in more detail and why? What options should we rule out at this stage and why?
5. Should we consider alternative methods for splitting network costs between domestic and non-domestic consumers? If so, what methods should we consider and why would these alternative methods benefit consumers?
6. What do you think of the five criteria we have proposed to assess and the descriptions we have provided for their scope? How should we balance the trade-offs between these?
7. What evidence should inform our options assessment? You are encouraged to share information, analysis and evidence with Ofgem to inform our assessment.
8. What are the main trade-offs between our proposed assessment criteria? What are the main positive interactions?
9. Do you agree we should consider impacts up to 2035?

These questions come from different sections of the document and some may not make sense to you without the context of the preceding paragraphs in the document, so feel free to go read some more, or find most of the information in this article.

How Do I Tell Ofgem My Thoughts?

To get involved, simply email Ofgem your thoughts. Use the following details:

Email: costreview@ofgem.gov.uk

CC: Richard@TheRegulatorGuy.co.uk

Subject: My Thoughts on the Energy system cost allocation and recovery review

Then, just put your thoughts into the email, whatever you think is the best way for energy bills to be charged in the future. It can be a mash up of any of the ideas Ofgem have provided, or it can be a brand new idea. I’d love to see your ideas too so please do CC me into your email.

My Response

My response is in italics below, in case you’re interested or want some ideas of what to put.

Good afternoon Cost Review Team,

I’m writing regarding your Call For Input on the energy system cost allocation and recovery review. This is a non-confidential response. I will be responding only to select questions from the provided document.

Important note: As Ofgem are shaking up the market in an unprecedented way, I think this is an excellent opportunity to move consumers and suppliers onto the same page for the first time since privatisation. Under the current cap structure (and previous structures), suppliers are incentivised to want higher costs. The costs are all passed to consumers through the price cap but the profit element of the cap is calculated as roughly £20 + 1.1% of costs. This means if the price cap is £2,000 then a supplier gets £42 per household profit, but if the price cap is £1,000 then the supplier only gets £31 profit… this pits supplier interests against consumer interests, as suppliers get more profit if the price cap is higher. I’d recommend rather than a “floor plus cost” approach to the profit element, you should implement a “roof minus cost” approach. i.e. set the profit element as something like £50 – 1.1% – this would mean when the cap is £2,000 then suppliers will get only £28 profit per household, but when the cap is £1,000 then the suppliers will get £39 profit per household. This incentivises efficiency improvements from suppliers, it puts suppliers and consumers on the same side – benefitting from lower costs.

Question 2: What options for amending domestic cost allocation and recovery should we explore in more detail and why? What options should we rule out at this stage and why?

There was reference to the Swedish system which split out the electricity tariffs into four elements, I’d like to suggest you rule this out as an option. This will cause much more confusion and is likely to result in a lot more consumer disengagement in the market, which isn’t what we want.

I would like to see Ofgem look more at a cost allocation that varies with the amount of energy used and DOESN’T vary with location. I think one national price would simplify the system a lot, it’ll spread the higher network costs experienced in the North across the more populous areas that currently enjoy lower standing charges. Additionally, it’ll make consumer engagement easier, currently we have the problem of consumers seeing the Ofgem news that standing charges are (for example) 53.2p per day then consumers get confused and think their supplier has done something wrong because they are being charged 54.9p per day (again, numbers are just random and for illustration of the point), because a large number of people do not understand that Ofgem’s numbers are an average of regional variations. Removing this confusion would likely result in lower customer service costs for suppliers, as well as fewer complaints to Ofgem, Citizen’s Advice, various consumer groups and charities and to the Ombudsman.

The idea of a single flat price is the most interesting to me as it directly allocates higher costs to the highest users. I understand that this will mean households that require a lot of electricity for medical equipment are going to be negatively impacted, but that is for the Government to figure out targeted support to that slim minority to ensure they are protected. For the overwhelming majority of people, a simple single price across the country that is equal per unit of energy gives far greater control of their energy bills and is entirely fair. It seems mad that a 6-bedroom manor in Devon would pay the same standing charges as a 1-bedroom flat in Skegness.

I’m do not like the idea of either of the block tariffs. As I stated in a previous consultation response, both types of block tariff cause additional confusion for consumers and additionally complexities for suppliers. Additionally, a falling block tariff puts too much burden on low energy users, which is unfair, and it removes incentive to reduce energy usage for high energy users, so this should be ruled out entirely. A rising block tariff is definitely better than a falling block tariff, in that it doesn’t disadvantage lower users so much, but it still has additional complexities and I agree it may become difficult to ensure suppliers do not under-recover costs. Hence, I think a flat single price is the best idea.

When it comes to considering time-of-day prices, I think that is something that is best left to suppliers. Octopus Energy offer the Agile tariff, which charges consumers different prices every half hour based on the wholesale cost price. This is an excellent tariff for those that want to wake up every day, see the prices for the day and then allocate their electricity usage accordingly, but let’s be honest, that is a small percentage of the population. Having the price cap vary by time of day would require an enormous investment from suppliers to build platforms that inform consumers of what the day-head prices are, it’ll massively complicate billing and price comparison and it will cause huge amounts of consumer disengagement due to the extreme complexities.

I understand, and do not hate, the idea of varying energy prices based on ability to pay, but then you end up in a system where gas and electric become a state-benefit of sorts. I’m not sure this would be well received by the wider public. It’ll also be difficult to implement, and may give rise to other complications if connected to council tax bands, such as suppliers having to give refunds to consumers who have their homes re-banded (fairly common in new builds, especially apartments).

Overall, I think we need to have a system that customers can engage with, simplicity and fairness needs to be at the core of whatever pricing structure is implemented.

Question 3: How would changes to the underlying rules and approaches for allocating and recovering system-wide costs be expected to translate into the tariffs offered by suppliers?

I would expect that suppliers would offer tariffs that can be compared to the price cap at unit rate and standing charge level. If the price cap became a £0 standing charge tariff structure then I would expect to see most suppliers move to offering £0 standing charge fixed rate tariffs.

I think it would be smart for Ofgem to consult on whether new rules should be implemented that force suppliers to offer tariffs that have the same structure as the new price cap, whatever that ends up looking like. This may or may not be a necessary rule, but if it isn’t implemented then we may see the market ignore the new structure and continue to only offer fixed rate tariffs with extortionately high standing charges but lower unit rates. We run the risk of having a price cap that is set on a structure we think works for the future, but fixed rate tariffs being cheaper across a year but still on the current structure, resulting in losing the non-price benefits of the new structure (such as simplicity and fairness).

Question 4: What options for amending non-domestic cost allocation and recovery should we explore in more detail and why? What options should we rule out at this stage and why?

I don’t have a lot of input here, but I do think that non-domestic costs should be borne by non-domestic consumers. I was, and still am, firmly against the British Industry Supercharger Package, pushing 90% of network costs for energy-intensive industries onto consumer bills is entirely unfair. I understand the purpose is to improve international competitiveness of these industries, but surely that is their problem. They need to improve their efficiencies in order to reduce costs or improve quality, to become more competitive. Forcing consumers to pay additional fees to cover the costs of businesses is immoral.

Question 6: What do you think of the five criteria we have proposed to assess and the descriptions we have provided for their scope? How should we balance the trade-offs between these?

I agree with the 5 proposed objectives. Arguably, I’d say that all 5 are well inter-connected, I don’t think there should be much trade-off to consider if you go for making the new structure as simple as possible. If you make the system simpler it will be more efficient then you lower the overall cost of the system (fewer customer service complaints, less implementation required, less monitoring and regulation required), this is fair to consumers who get to pay less for their bills (you may see suppliers complain though as profit is currently calculated as a percentage of costs, suppliers are incentivised to want high customer costs). A simple tariff structure is implicitly more practical to implement and understand. With wider consumer understanding, you’ll see wider consumer engagement which will assist on the path to net zero, people will understand that reducing their usage reduces their costs and will therefore move us closer to net zero. Finally, economic growth is obvious, if overall costs fall due to a more efficient and practical structure then people will have more disposable income and businesses will have lower costs, so there is more money flowing.

Question 9: Do you agree we should consider impacts up to 2035?

I only agree with 2035 if there are regular reviews between now and then. If the plan is not to review the cost-allocation system until 2035 then I would recommend moving this review date to being 2031, giving 4-5 years of evidence on whether the new system works as intended. What we don’t want is to end up with a massively inefficient system that isn’t reviewed for the better part of a decade because of an arbitrary decision.

Thank you for taking my opinions into consideration, please let me know if you have any questions.

Kind regards,
Richard Winstone
The Regulator Guy

Thanks everyone. Just a reminder that this is one of eight constulation responses this month, Ofgem have been busy which means we need to be busy! I’ll be back shortly with the next response.

Richard Winstone
The Regulator Guy.