Domestic Gas and Electricity (Tariff Cap) Act 2018

Policy background

Energy Market Background

2. The term Ofgem is used throughout this document to refer to the Office for Gas and Electricity Markets, which is the regulator of the downstream gas and electricity markets. The Act refers to the Authority which is defined as the Gas and Electricity Markets Authority (GEMA), a group of executive and non-executive members who govern Ofgem, determining strategy, setting priorities and taking decisions on a range of issues. When this document refers to Ofgem and when the Act refers to GEMA, they mean the same thing.
3. The supply of electricity and gas is a licensed activity under the Electricity Act 1989 and the Gas Act 1986 respectively. This Act contains stand-alone provisions that will place a duty on Ofgem to modify the standard supply licence conditions to impose a cap onthe rates that energy suppliers can charge their domestic customers who are on standard variable tariffs1 or default2 tariffs.3 The provisions also provide Ofgem with a power to modify those conditions to enable Ofgem to implement the cap.
4. The process of electricity and gas market liberalisation in Great Britain began with the privatisation and restructuring of the industry in the late 1980s, culminating in the opening of the energy supply markets for domestic and small business consumers in the late 1990s. The freedom for domestic energy consumers to choose their supplier was introduced progressively between 1996 and 1999. In May 1998 the domestic gas market was fully opened to competition, closely followed by the domestic electricity market in May 1999.4
5. Since 2010, the number of new energy supply companies has grown considerably, with some of these companies growing significantly and establishing a foothold in the market. These new entrants often base their business model on attracting customers through low-cost fixed-priced deals, typically lasting a year. This has resulted in a two tier market in which engaged customers are able to benefit from the most competitive tariffs available while those who are unable or unwilling to switch tariff remain on poorer value standard variable and default tariffs.
6. In 2013 the Prime Minister asked Ofgem and the Office of Fair Trading to assess the market. This led directly to Ofgem’s referral of the market for investigation by the Competition and Markets Authority (CMA) in June 2014. The CMA published its final report on 24 June 2016.5
7. The CMA reported that weak consumer response had given rise to an adverse effect on competition in the domestic retail market and that the Big Six suppliers6 had unilateral market power over their standard variable tariff customers. The report set out that customers of the Big Six paid an average total of £1.4bn a year more than they would in a truly competitive market. The CMA reported that this figure was made up of both unjustifiable profits and supplier inefficiencies. The CMA proposed a number of remedies focused on reforming the regulatory framework and enhancing consumer engagement to improve competition, which Ofgem and Government are committed to implementing.
8. However, the CMA acknowledged that their remedies would take time to implement. They also identified that the roll-out of smart meters was a necessary element for addressing the issues their report highlighted.
9. The CMA also concluded that a price cap should apply to domestic customers on prepayment meters for a transitional period (2017 to the end of 2020, subject to review). This was because prepayment customers were not able to benefit from competitive prices in the same way as other customers due to various additional competition constraints, including the availability of tariffs, and the fact that their bills were particularly high. The temporary price cap for customers with prepayment meters came into force in April 2017 and covers approximately 4 million households.7 This cap was extended in February 2018 to include almost a million vulnerable8 consumers.
10. The difference between a basket of the cheapest tariffs offered to customers who actively switch and the standard variable tariffs of the larger energy companies used by customers who do not switch averaged £263 between 2015-2017. In June 2018, the difference between the cheapest tariff on the market and the most expensive standard variable tariff reached £3759. The majority of customers are therefore paying more than they would in a truly competitive market. The majority of people remain on poor value standard variable tariffs and default tariffs, and whilst switching rates are increasing, the annual household switching rate was still only 18% in the twelve months to May 2018, meaning that 4 out of 5 households did not switch. Those who least can afford it are more likely to be affected, such as households with low incomes, people with low qualifications, those in the rented sector and those over 65.10

Government’s commitment

11. In the Queen’s Speech following the 2017 General Election, the Government committed to helping to protect customers until the conditions for effective competition are in place.

    Reference: The Gracious Speech, 2017 "My government will ensure fairer markets for consumers; this will include bringing forward measures to help tackle unfair practices in the energy market to help reduce energy bills."

12. In February 2018, Ofgem extended the price cap for customers with prepayment meters to a wider group of vulnerable customers. Ofgem also amended licence conditions so that suppliers can roll customers coming to the end of their contracts onto another fixed deal instead of a standard variable tariff, provided that it is the same price or cheaper than the standard variable tariff that the customer would have otherwise have been rolled on to.11
13. In October 2017, the Government published a draft Bill to require a temporary price cap on energy prices. The Business, Energy & Industrial Strategy Select Committee in the House of Commons conducted detailed pre-legislative scrutiny on the draft Bill, including taking written and oral evidence from large and smaller suppliers, academics, regulators (including Ofgem), Government and other interested parties. The Committee reported in February, and supported the Bill and the policy but recommended changes to the Bill.
14. This Act therefore reflects the Government’s policy intention and takes into account the recommendations of the Select Committee. The Act requires Ofgem to modify the standard licence conditions for gas and electricity suppliers, so as to include conditions that impose a price cap for standard variable tariffs and default tariffs offered to domestic customers. There is an exception for those who benefit from protections under the pre-payment meter cap (or a replacement for that cap). Ofgem may also put in place an exception for vulnerable consumers who benefit from another cap. In addition, the Act requires Ofgem to consult on exemptions for green tariffs12from the price cap. It also includes a power for Ofgem to exempt green tariffs from the price cap.
15. The cap applies until the end of 2020 but it may be extended for a year at a time, until the end of 2023 at the latest, if the conditions for effective competition in the market for supply contracts are not in place. A procedure for extension is set out in the Act.