Utility Week

18 | 23RD - 29TH MARCH 2018 | UTILITY WEEK Policy & Regulation Market view T he past few years have been difficult for UK utility companies. Brexit negotia- tions, the absence of new subsidies in the renewables sector and talk of national- ising key parts of the UK energy sector have dented investor confidence – and affected stock prices. Recently another part of the changing market environment, the energy cap bill, was debated in Parliament, with cross-party sup- port for legislation designed to fix a "broken" energy system that "rips off " consumers. Is this the final nail in the coffin of traditional utilities, or the push that the industry needs to move away from incumbent positions and more rapidly shi to bundled energy man- agement solutions? Although the proposed energy price caps will result in a significant reshaping of the market – and affect profits – key players are not waiting for the changes to come into force before reacting. Suppliers are already moving away from standard variable tariff (SVT) prod- ucts – remember the announcement from British Gas last November. We expect this trend to continue with a move toward shorter- term fixed and tracker tariffs to minimise commodity risk and more effectively price for prevailing market conditions. This will start the transition away from SVT products, but it is still unclear how the cap on pricing will be administered. So further change is inevitable as the bill moves into law. One thing that is clear is that this move by the government in support of price caps indi- cates a policy shi away from market choice towards direct intervention. This approach seems driven in part by the historic apathy of UK energy customers. Despite the high- est switching rates since 2010, only 15.8 per cent of households compared prices and switched supplier in 2017. This apathy tends to undermine the ability of competition to bring down prices over time. As a result, the government intends to force rates down by legislating for lower ones. From a regulatory standpoint this is going to create more complexity. With green tariffs exempt and a large number of vulnerable customers already operating under a cap of their own, managing the cap is not going to be straightforward – decisions are needed on both the approach to switching and tariff design. It will also be interesting to see how the regulator manages time-of-use tariffs under the cap, because that could make a far bigger impact on both pricing and open the door to some of the market changes neces- sary to support more effective energy man- agement across the industry. This policy shi is already having an impact. Customer activity in the market has improved, and switching has increased sig- nificantly in the past few months. Around 400,000 customers switched supplier in January, a 14 per cent increase on the same month in 2017. This is likely a consequence of media coverage of the SVT changes and increased communication from suppliers. With a potential shi to shorter-term fixed and variable tariffs, consumers are going to have to engage more with their suppliers. From a customer standpoint, this is going to get more invasive for less return as the sav- ings they will see are likely to be smaller and more dependent on broader market dynam- ics. However, increasing engagement could create the demand for, and opportunities to sell, bundles of products to drive customer value – from energy management to fully connected homes. From an operational perspective, effi- ciency is going to be the key moving for- wards. More products for shorter periods of time will make things like customer commu- nication and administration more complex and time consuming, so the cost of admin- istering these new tariffs will increase. This is going to make it more difficult for smaller players and more costly for all providers, fur- ther depressing margins. The risk profile is also going to change. With SVTs disappearing, managing ele- ments like commodity risk is going to be increasingly important. Developing tariffs that minimise exposure and energy trading approaches that offer some protection will be key to delivery. More significantly, proposed price caps may reduce the number of competitors in the market. Some large suppliers are already facing losses. They include EDF Energy and Npower, which were in the red in 2016 and would see further erosion aer the imposi- tion of a cap. We have already seen some changes in the market. Some smaller play- ers have disappeared, some new players such as Shell and BP have taken positions, and even larger providers are considering their options. By constraining prices in the market, this series of caps will give a competitive advantage to suppliers with low operational costs, those that can eke out profits even in a restricted pricing environment. For some smaller power suppliers, the only option may be to consolidate to increase scale and provide capital for investment in digital sys- tems that can reduce customer service costs. What's the bottom line? The government has concluded that customer choice has not driven down prices as hoped, so it's designing a protectionist customer approach. Reduced choice in energy retail seems the inevitable outcome in the short term, but the price cap bill may usher in some of the broader market changes that are needed to drive longer-term energy market performance. Keric Morris, partner, Oliver Wyman More than just a price cap Energy price capping means more than lower energy bills – could it be the final push the industry needs to embrace the new energy future? Keric Morris reports. Key points Government plans for an energy price cap have cross-party support. Suppliers are already moving away from standard variable tariffs toward shorter- term fixed and tracker tariffs that they hope will to reduce commodity risk and let them more effectively price for prevailing market conditions. Consumers will have to engage more with their suppliers, presenting an opportunity to market bundles of products that drive customer value. Price caps may reduce the number of competitors in the energy market.

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