Utility Week

10 | 21ST - 27TH SEPTEMBER 2018 | UTILITY WEEK Policy & Regulation Analysis I t could have been worse. That seemed to be the verdict of the stock market in the wake of Ofgem's long-awaited announce- ment earlier this month setting the level of the cap on standard variable tariffs (SVTs). On 6 September, Ofgem revealed that the dra cap has been set at £1,136 for the typical dual fuel default tariff, lopping an estimated £75 off the average dual fuel customer's SVT. Perhaps surprisingly, energy suppliers' share prices rallied on the day. The market leader, Centrica, saw its share price rise by 5 per cent. "It suggests they and the analysts were expecting something tougher," says one energy boss. "At some of the suppliers, they were popping the champagne corks." However, the shine came off this rally the following week when SSE issued an unscheduled profits warning, which iden- tified the looming cap as one of the factors weighing on the company's earnings expec- tations. Centrica's share price at the end of last week was 143p, back to where it had been before the cap was announced. Alongside the figure of £1,136 itself, Ofgem published the methodology that it has used to calculate the magic number. The cap will be updated each April and October. These six-month periods reflect indus- try practice, says Ofgem, pointing to how the large suppliers have updated their SVT prices on average between once and twice a year since the energy market was liberalised in the 1990s. The biggest variable in the formula is the cost of wholesale energy, especially in the current volatile market. The regulator is using a half-year snapshot of wholesale prices, the cut-off for which will be two months before the April and October cap updates. Ofgem's paper says that this timeframe will mean that large suppliers will "most likely" already have bought much of the energy SVT customers will use. In the current market climate, says the paper, a more up-to-date gauge of wholesale prices would expose customers to the risk of paying "significantly more" than suppliers' underlying costs. The other big factor Ofgem takes into account is suppliers' operating costs. The regulator has said it will work these out with a benchmarked sample of operators' costs in 2017. The operating costs allowance in the formula will be based on the lower quartile of costs provided by suppliers. The regulator has then lopped off another £5 for dual fuel customers in a bid to "create better incentives to improve efficiency", says the paper. More uncomfortable reading for sup- pliers was the regulator's decision that the smart meter rollout costs should be wrapped up into this operational allowance. This is because the regulator judges that smart meters are fast becoming an "intrinsic and integrated part" of suppliers' operations. Ofgem has however promised to carry out a review of the smart meter rollout costs and benefits well before the October 2019 update of the cap. And suppliers have an added bit of leeway in the form of a £12 allowance for "headroom". Greg Jackson, chief executive of chal- Pondering all the variables David Blackman looks at how the energy regulator set its recently announced cap on standard variable tariffs – and gauges the reactions of industry pundits and energy suppliers of all sizes. STOCK MARKET REACTION UK LISTED, ONE MONTH 155 150 145 140 1,300 1,200 1,100 Centrica (pence) SSE (pence) 20 Aug 28 Aug 4 Sep 11 Sep 20 Aug 28 Aug 4 Sep 11 Sep 2017 direct debit default tariff cap baseline, and 2019 comparator Ofgem's estimated baseline benchmark and cap level for 2017. Cost component 2017 electricity 2017 gas cap 2017 dual fuel January single rate cap (implied) cap 2019 cap Wholesale 170 197 367 444 Policy costs 97 19 117 137 Network 135 122 258 258 Operating costs 79 90 169 189 Payment method 11 9 21 23 Normal profit 9 8 18 20 VAT 25 22 47 54 Benchmark 527 469 996 1,124 Headroom 5 5 10 12 Cap level 533 474 1,007 1,136

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