The last few years have seen extraordinary changes in the energy market. Prices spiked to levels that would have been unthinkable just a short time ago, leading to the UK government stepping in to directly subsidise energy bills at a huge cost to taxpayers and round after round of supplier failures, with the costs pushed onto consumers.

However, there’s a very important aspect of this crisis that has mostly flown under the radar, according to the CPS – competition has all but disappeared from the retail market.

Before the energy crisis, consumers could make substantial savings on their bills by switching tariffs or suppliers; but now, competitively priced rates are nowhere to be seen. While volatility in wholesale prices certainly has a lot to do with this, there’s another culprit in the mix, continues the CPS – the industry regulator Ofgem’s energy price cap (EPC).

Like so many government interventions, the price cap was introduced with the best intentions and was only ever meant to be temporary. It was designed to tackle the ‘loyalty penalty’, whereby customers who had been with a supplier for many years were often paying more for their energy under a supplier’s standard variable tariff than new customers that were able to access introductory deals. For those savvy enough to shop around, there were big savings to be had; but many, often elderly customers, found this process too confusing or complicated.

As a result, the price cap was introduced (following from an earlier cap for those on prepayment meters), essentially as a proxy for competition for those who couldn’t ‘engage’ in the market. The cap was meant to be Ofgem’s best guess as to what a ‘fair’ price should be for such customers, and to genuinely function as a cap, with competition thriving below this level. It was only ever meant to be temporary, while the government put in place other initiatives to tackle disengagement, such as the smart meter rollout and improved switching processes.

For the early years of the cap (2019–2020) this is indeed how it worked. And then the energy crisis changed everything. With wholesale prices skyrocketing, many suppliers went bust. Some were undone by risky business practices, but others by the rigidity of the EPC, whose six-month review periods were too infrequent to allow suppliers to adjust their prices to match wholesale volatility (Ofgem subsequently updated this to quarterly).

Moreover, the EPC level quickly became the cheapest price in the market rather than a cap, as fixed tariffs (not covered by the EPC) became ever more expensive, before most suppliers finally pulled them. Switching rates thus fell off a cliff and now nearly the entire market is covered by the EPC, with rates set at or just below the capped level. Meanwhile, the government stepped in with the Energy Price Guarantee last winter (superseding the cap), until it expired in June.

Competition in the market has thus all but disappeared. While a few fixed price deals have started to trickle out, for the most part they are priced within 1% of the capped level. That in itself is partly by design; Ofgem is so concerned about the risk of supplier failures stemming from wholesale volatility that it has activated a measure known as the ‘market stabilisation charge’. This requires suppliers to reimburse each other any time a customer switches (at a weekly rate set by Ofgem), in order to guard against financial losses from the hedging requirements of the EPC. ‘In other words, Ofgem is directly disincentivising competition in the market in order to safeguard suppliers’ finances,’ comments Dillon Smith, Researcher for Energy and Environment Policy, CPS.

‘These and other contortions are designed to make the EPC work in a world it was not designed for. Fundamentally the EPC was conceived of in yesterday’s (benign) market – in today’s world it is self-evidently no longer fit for purpose,’ he continues. Experts warn that higher prices could be with us throughout this decade and beyond, while volatility could well return this winter if the weather doesn’t cooperate and Putin continues to ‘weaponise’ Russian gas supplies. ‘If so, this is a recipe for another “temporary” intervention to become permanent, while the public becomes used to the state setting the price of energy, undoing much of the hard work of privatisation,’ warns Smith.

As a result, the CPS is calling on the UK government to abolish the price cap in its current form, helping to stimulate competition, lower prices for consumers and fight inflation. It has also proposed other ways in which the government could tackle the ‘loyalty penalty’ in a less damaging way, such as making the current ban on acquisition-only tariffs permanent, or the idea of a ‘relative tariff’.

Moreover, it is calling for reforms to the price cap to go hand-in-hand with expanded support for lower-income and vulnerable customers, a ‘social tariff’ with more sophisticated targeting aimed at those spending an excessive proportion of their income on energy bills.

‘Fundamentally the government needs to build a resilient regime which more effectively balances support for vulnerable customers with thriving competition. After all, as any economics textbook will show, the best protection for consumers is competition, not state price controls,’ concludes Smith.