Getting Technical: Why market reforms should span both the downstream and upstream electricity market

In a welcome move a fortnight ago, the UK Government published a call for evidence on how to future proof ‘default tariffs’ for household energy customers.

All default tariffs – including Standard Variable Tariffs (SVT) – are currently subject to the price cap set by Ofgem. The need to future-proof them stems from the fundamental changes we are seeing in patterns of electricity supply and demand.

On the supply side, much of our electricity now comes from the notoriously variable British weather. Sometimes wind and sun are abundant - and electricity cheap. Sometimes it's dark and still – so electricity is expensive. These trends will only continue.

On the demand side, customers are expected to use more electricity and at different times, for example because of the requirement to charge their electric vehicle or run their heat pump.

Given these patterns in electricity supply and demand, it makes sense to offer customers time-of-use tariffs to enable them to take advantage of electricity when it’s cheapest – and greenest. Companies like British Gas are already doing this – such as through our ‘PeakSave’ offerings.

A key question is whether to reform default tariffs including the price cap to cater for this ‘time of use’ or ‘type of use’ world. And if so, how?  

Centrica has been looking at this question for some time. Last June our CEO Chris O’Shea argued that the price cap needs to be simplified, by abolishing the standing charge and getting rid of regional variations. Standing charges and regional variations are complex and unnecessary. Time of use offers on the other hand, are complex but useful.

Since then, we’ve also looked at other potential reforms to future-proof default tariffs and the price cap. One such idea was a ‘relative price cap’, which caps the difference between any given supplier’s cheapest and most expensive tariff. We don’t think that the relative price cap is the way to go for a number of reasons, including its incompatibility with Time of Use tariffs. The whole point of Time of Use tariffs is that there are variations between what different customers pay at different times – as suited to their needs.

To help interrogate our thinking, we commissioned Frontier Economics to look at the compatibility between a relative price cap, Time of Use tariffs and retail competition. Frontier’s report is published here.

We have also been thinking about the interaction between the retail market and reforms to the upstream electricity market that are being considered by the Government. Again we commissioned Frontier Economics to consider the compatibility between nodal wholesale pricing, the price cap, and retail competition. Frontier’s analytical paper is published here, and the empirical study here.

Among other things, Frontier finds that it is very difficult to reconcile nodal wholesale pricing - where electricity wholesale price is different in lots of different areas across the country - with a retail energy price cap.  

Following these studies, our view remains that reform of upstream energy markets needs to be at least compatible with – and ideally complementary to – reform of downstream markets. It’s difficult to justify supporting both a retail price cap and nodal wholesale pricing. It’s similarly difficult to justify supporting a relative price cap and time of use tariffs.

For Centrica’s part, we continue to support an ongoing p/kWh price cap that is compatible with Time of Use tariffs, but at the same time strips out unnecessary complexity by abolishing standing charges and regional variations in household charges.