Utility Week - authoritative, impartial and essential reading for senior people within utilities, regulators and government
Issue link: https://fhpublishing.uberflip.com/i/825252
Policy & Regulation UTILITY WEEK | 19TH - 25TH MAY 2017 | 11 Policy & Regulation slated for watering down the manifesto pledge. But if she wins the storming majority anticipated by pundits, she might not worry about such mithering and will still be able to attest that she is acting in the interests of the "just about managing". Once Theresa May signs off an approved structure for the cap, the next question for suppliers is how quickly will it be adopted, and when will it expire? We know the Tories expect Ofgem to do their dirty work in designing and policing the cap. And we know that delivering a new market model will take the regulator time. Experts such as Ryan Thomson, a partner at consultancy Baringa, believes Ofgem will need a minimum of one year to develop and scrutinise its plans for introducing a cap. "I think there is a good chance of it pushing towards a two-year period for full implemen- tation," he tells Utility Week. By the time implementation is complete, it's more than likely "the industry will have moved on", Thomson opines. As for the cap's duration, he suggests that rather than imposing an arbitrary time limit on the cap, it would make more sense for government and Ofgem to agree a set of conditions which would need to be met by the market before the cap is withdrawn. There has been some speculation about whether the implementation of energy price regulation would require amendments to pri- mary legislation, which can be a drawn-out process. Thomson and other industry com- mentators tell Utility Week that while it might not be strictly necessary, if the Conservatives come back to power in a strong position, the government may well go down this road in order to "protect itself from any challenges further down the line". Not all energy market participants are gloomy about the prospect of price regula- tion. Some, such as Bristol Energy's manag- ing director Peter Haigh, hope that a price cap brought to market in "a timely way" and with "robust" performance measures, will throw down "a gauntlet to the big six". Ste- phen Fitzpatrick, chief executive of fellow Bristol-based supplier Ovo Energy, has stri- dently welcomed May's move as a "bold and audacious" answer to a long failure of "light- touch regulation". There's no denying, however, that inves- tors in large firms are jumpy. Their dividends are now in uncertain territory and earnings at the big six are expected to be slashed by hundreds of millions of pounds as a result of price regulation. Executives will need to do all they can to reassure shareholders that internal effi- ciencies are as strong as they possibly can be while revenues are squeezed and policy costs rise – Barclays has run some figures that suggest leanly run big six firms can still hope for slim profits aer a cap is introduced (see graphs, overleaf). They will also need to show they are working closely with govern- ment and Ofgem to tie a non-lethal noose for their necks. Theresa May could seek to fire a warning shot across suppliers' bows, or hit them with the Full Monty of all-out price regulation. T he decision to impose a price cap on domestic energy prices is now central to the Conservative party manifesto. This is now clear, despite cries of frustra- tion from the political le, who say the Tories have stolen their thunder by rebrand- ing the proposals of former Labour leader Ed Miliband, and opprobrium from the right for the policy being both anti-competitive and non- Conservative. As for the utility compa- nies, their criticism has been near universal. Politically, though, the prime minister's price cap pledge did achieve its aim of securing a thumping front page headline in the Daily Mail promising an annual £100 off domestic utility bills. Job done. Nevertheless, Theresa May's fury with energy com- panies – and her response to numerous price rises of late – issues a hospital pass to Ofgem, which will be respon- sible for implementing her mandate on price regulation. Of course, the policy may be watered down or even abandoned, especially if the government is re-elected with a landslide major- ity. But assuming it forges ahead, there are four leading methodologies Ofgem could choose to adopt. 1. It could set a seemingly notional high-bar figure and threaten any company seek- ing to breach it with heavy fines: the aim would be to dissuade any supplier from even going there. This option should also compress the price range that individual companies offer under vari- ous tariffs. 2. Ofgem could prescribe a "crawling peg" system, which would be adjusted, say every six months, to reflect chang- ing purchasing prices. All companies would be expected to offer prices around the crawling peg figure. 3. Ofgem could revert to the pre-1998 domestic energy regulation model, whereby a complex equation was applied, which enabled "cost pass through" of higher electricity and gas purchasing costs. 4. Ofgem could go the whole hog and seek to emulate the water sector by applying the Full Monty of regulatory tools. Centrica's famous weighted average cost of gas (WACOG) acronym could also make a welcome re-appearance under price regulation. For com- mercial sensitivity reasons, it was struck out of Centrica's investor presentations. Theoretically, every licensed energy supplier could be required to publish an audited WACOG figure on a regular basis in a capped market. In the short term, options 1 and 2 look the most likely, although neither of the latter options should be discounted as a last resort. Nigel Hawkins, director, Nigel Hawkins Associates Analysis Nigel Hawkins