It is distinctly possible a little noticed aspect of the way Ofgem calculated the price cap played a significant role in fomenting the crisis in the retail energy market.

Energy bills are based on a price per unit of energy consumed (the unit rate) and a fixed (‘standing’) charge per day. For some reason the energy price cap lowered only the unit rate, leaving the standing charge (which formed about 15% of the typical bill) unaltered. Setting the cap in this way heightened suppliers’ exposure to the increases in wholesale energy prices that caused them to lose money serving customers protected by the cap.

Perhaps more significant though is how the price cap perpetuated a flawed business model. At around £200 p.a. (excluding VAT) dual fuel (i.e. gas and electricity) standing charges are over £100 more than the costs suppliers incur that don’t depend on the amount of energy supplied. It’s quite possible that a number of the failed firms had entered the market more focused on acquiring customers in order to capture the ‘rent’ of standing charges than on managing their energy costs effectively. Citizens Advice described how many failed suppliers amassed customers very quickly by offering deals that didn’t cover their costs and hadn’t bought enough energy in advance.

Ofgem’s decision to structure the price cap like this had been surprising anyway. The cap covers customers who haven’t actively chosen a tariff so have been put on a default one and a disproportionate number of these are low income households. They use less energy so the standing charge forms a higher proportion of their bills and it means that overall they pay more per unit of energy. By reducing just the unit rate the price cap conferred the biggest savings on the high income consumers who use most energy.

The fact that energy becomes cheaper per unit the more is consumed also increases demand for it, resulting in higher carbon emissions and greater costs of maintaining security of supply. Ofgem’s price cap exacerbated this too.

The cap on default tariffs was introduced because they were excessive, with detriment to the 14 million customers on them estimated at £1.5 billion p.a. (i.e. roughly £100 p.a. each). The Competition and Markets Authority’s Energy Market Investigation in 2016 ascribed this to suppliers’ market power over inactive consumers who failed to engage in the market effectively and identify suppliers offering lower prices. A central feature giving rise to this was their difficulty comparing tariffs, which was said to be made worse by tariffs having standing charges as well as unit rates.

In fact Ofgem had earlier (in 2012) proposed fixing the standing charge in all tariffs. It said “this should make it easy for consumers to understand their tariff options and select the cheapest standard tariff”. In the event Ofgem decided not to because of opposition from respondents to its consultation, presumably suppliers.

Actually it didn’t need to fix the standing charge, just to cap it tightly, at the level of efficient costs, and it may be that doing this for all tariffs is the only way to make the market work well. It would boost competition as consumers would only need to consider unit rates to find the cheapest option and suppliers would have no incentive other than to provide sustainable energy deals. It would thus lead to lower bills for consumers generally and could avoid the need for the more extensive cap on default tariffs.

Unfortunately Ofgem’s scope to reduce standing charges has been significantly reduced by its recent decision that ‘residual’ electricity network charges (those not driven by either the amount of electricity consumed or the number of users) should be recovered through a substantial fixed cost for all consumers rather than the unit rate. As with the price cap, this is ill-conceived. Ofgem acknowledges that it will increase bills for low income households and it will inevitably increase carbon emissions and reduce security of supply.

Ofgem passed up an opportunity to reduce standing charges for all households and businesses by something like £260 million p.a., i.e. approx. £10 each, by failing to take action to address competition problems in the provision of meters. The meter rental charges suppliers pay are passed on to consumers and are higher than they should be because suppliers face significant costs if they want to switch meter provider, potentially having to replace the existing meters, which means the competitive constraint on meter providers is weak.

Ofgem is likely to grant about £2.5 billion to the energy firms that took on the customers of the failed suppliers to compensate them for the costs they incurred in doing this. This will ultimately be recouped from energy consumers’ bills. Ofgem may not be responsible for the increase in wholesale energy costs but its price cap, which was intended to save some households £100 p.a., has contributed to all consumers paying an extra £100. Setting aside whether Ofgem actually knows how to make the market work well, at the very least it must protect low income households by ensuring these costs are recovered through the unit rate rather than the standing charge.

1. The functioning and performance of the ‘energy price cap’ and an assessment of its use in the future

The functioning and performance of the ‘energy price cap’

A little noticed aspect of the way Ofgem calculated the price cap may have played a significant role in fomenting the crisis in the retail energy market.
Energy bills are based on a price per unit of energy consumed (the unit rate) and a fixed (‘standing’) charge per day. For some reason the energy price cap lowered only the unit rate, leaving the standing charge (which formed about 15% of the typical bill) unaltered.[1] Setting the cap in this way heightened suppliers’ exposure to the increases in wholesale energy prices that caused them to lose money serving customers protected by the cap.
Perhaps more significant though is how the price cap perpetuated a flawed business model. Dual fuel (i.e. gas and electricity) standing charges are around £200 p.a. (excluding VAT).[2] This is over £100 more than the costs suppliers incur that should be recovered through the standing charge, those that are related to serving customers rather than the amount of energy supplied. (This is explained in Annex 1.)
It’s quite possible that a number of the failed firms had entered the market more focused on acquiring customers in order to capture the ‘rent’ of standing charges than on managing their energy costs effectively. Citizens Advice described how many failed suppliers amassed customers very quickly by offering deals that didn’t cover their costs and hadn’t bought enough energy in advance.[3] Certainly the biggest company to collapse, Bulb, with 1.7 million customers, was brought down by its high levels of debt, having expanded too fast.
Ofgem’s decision to structure the price cap like this had been surprising anyway. The cap covers customers on default or standard variable tariffs (SVTs)[4] and a disproportionate number of these are low income households.[5] They use less energy, as the following graph demonstrates [6],[7]:-

FIGURE 1

Household expenditure on gas and electricity (£ per week) by disposable income decile

Source: Family Spending 2018 Office for National Statistics (Table A6)

Thus the standing charge forms a higher proportion of their bills and it means that overall they pay more per unit of energy. By reducing just the unit rate the price cap conferred the biggest savings on the high income consumers who use most energy.[8]
The fact that energy becomes cheaper per unit the more is consumed also increases demand for it, resulting in higher carbon emissions and greater costs of maintaining security of supply. By lowering the unit rate while maintaining the level of the standing charge Ofgem’s price cap exacerbated this too. This issue is explored more fully in Annex 3.
It should also be noted that the difficulty of quantifying the level of suppliers’ costs that should be recovered through the unit rate led Ofgem to set the cap above the estimated cost level, reducing the savings to each consumer by approx. £40 p.a..[9]

Assessment of its use in the future

The energy price cap should be re-formulated as a cap on just the standing charge.[10] This would have four powerful beneficial effects:-

1) Low income households would save most.

2) It could be set at the efficient level of costs so would maximise the savings to consumers. The few costs that should be recouped through the standing charge can be estimated much more accurately and transparently than suppliers’ other costs. (See Annex 1.)

3) While those in fuel poverty would be able to afford more energy, the resulting higher unit rates would lead consumers to reduce energy consumption overall. This would lower carbon emissions and improve security of supply.

4) It would dramatically boost competition. Consumers would find it much easier to compare tariffs as they would only need to consider unit rates. This would lead to lower prices for consumers generally. (See Section 2 below.)

Note also that the standing charge is the element of energy bills for which there is the strongest argument for price regulation on economic efficiency grounds. This is explained further in Annex 4.
However, Ofgem’s scope to introduce an effective standing charge cap is threatened by its proposal to introduce a substantial fixed charge for consumers to pay for network costs. As with the default tariff cap, this is ill-conceived: it fails to take into account the adverse effect on low income households, carbon emissions and security of supply or to consider economic efficiency. (See further in Section 3 below.)
The effectiveness of a standing charge cap would be enhanced if Ofgem took action to address competition problems in metering markets. This would reduce the costs suppliers incur in providing meters, which are recoverable through the standing charge. (See further in Section 3 below.)
The benefits of a cap on the standing charge would also be increased if the Government withdrew VAT, currently levied at 5% on all elements of energy bills, from just the standing charge. This would be on the basis that the standing charge confers the ability to access a supply of energy, which is a necessity.[11] If a standing charge cap had been implemented this would save all consumers, including low income households, a further £5 p.a., or £125 million p.a. in total.[12]
A standing charge cap provides a general model for regulation of retail markets for essential services where competition is not effective, such as water.
Capping the standing charge in energy bills to businesses would be similarly beneficial, given that SMEs were found to suffer detriment from excessive tariffs too (see paragraph 16 below).

2. The performance of previous policies introduced to stimulate effective competition within the retail energy market, and an assessment of the impact on competition of proposed future regulatory frameworks

The performance of previous policies introduced to stimulate effective competition within the retail energy market

The cap on default tariffs was introduced because they were excessive, with detriment to the 14 million domestic customers on them estimated at £1.5 billion p.a.[13] (i.e. roughly £100 p.a. each). In addition, detriment to SME customers was estimated at £220 million p.a., of which £180 million related to micro-businesses.[14]
The Competition and Markets Authority’s (CMA’s) Energy Market Investigation in 2016 ascribed this to an adverse effect on competition in the retail energy market arising from weak customer response. Inactive customers failed to engage in the market effectively and select suppliers offering lower prices [15]. This meant energy suppliers had market power over them and exploited this in the pricing of their default tariffs, which were usually more expensive than tariffs that were actively chosen [16].
Large and variable standing charges reduce the competitive constraint on energy bills by impeding consumers’ ability to compare tariffs. The CMA detailed how this led to the weak customer response to which it attributed the adverse effect on competition in retail energy markets. It said an energy tariff with both a fixed and variable component (meaning the standing charge and unit rate) “is likely to be more difficult for a domestic customer to understand than a tariff with just a variable component”.[17] Given that the standing charge is not fixed across tariffs but varies widely, understanding tariffs is likely to be more difficult still.
These complex tariff structures contribute to inhibiting customers’ value-for-money assessments of available options, particularly by those who lack the capability to search and consider options fully, including those on low incomes [18]. The CMA said such difficulty in assessing information was a central feature giving rise to customers’ problems in engaging effectively in the energy markets and identifying suppliers offering lower prices [19].
Both Ofgem and the CMA have previously sought to simplify tariffs to make it easier for customers to understand and compare those on offer but neither considered capping the standing charge:-

Ofgem’s Retail Market Review reforms of 2014 banned complex tariffs and limited suppliers to offering four of them [20]. This was intended to improve customer engagement and thereby enhance the competitive constraint provided by customer switching. The CMA recommended that Ofgem remove the ban on complex tariffs and the four tariff rule [21]. It considered that they made it unlikely that suppliers would offer tariffs with no standing charge or a low one for low volume users.
As part of its reforms Ofgem had considered fixing the standing charge. It said “this was to simplify the structure of standard tariffs” and that it “should make it easy for consumers to understand their tariff options and select the cheapest standard tariff”. [22] However, it decided against doing this apparently because respondents to its consultation expressed concern that this would prevent suppliers reflecting their fixed costs in the standing charge and offering tariffs with low or zero standing charges [23]. Note that the objections to this do not apply to a cap on the standing charge.

The CMA also considered simplifying tariffs to make it easier for customers to compare tariffs. It debated requiring suppliers to structure all tariffs as a single rate (apparently eliminating the standing charge) but decided against that because it might restrict suppliers’ competitive offerings [24].

Actually Ofgem didn’t need to fix the standing charge, as described in the second bullet point above, just to cap it tightly, at the level of efficient costs, and it may be that doing this for all tariffs is the only way to make the market work well.

An assessment of the impact on competition of proposed future regulatory frameworks

It is recognised that price caps are liable to reduce competition. They can have a number of unintended adverse consequences, including:-

Reduced customer engagement as price caps reduce the gain from switching supplier [25] and research shows that the level of switching depends on the savings on offer from doing so [26].
Reduced competition between suppliers to attract customers who are protected by the cap, with a risk that the price cap forms a focal point to which suppliers raise their cheaper tariffs [27]. This could further reduce the savings that can be achieved by switching.

This means many customers on good deals are liable to see their bills increase.

However, these objections would not apply to a cap on just the standing charge in all bills, which would dramatically strengthen competition by making it much easier for consumers to compare tariffs and hence switch to a better value one. Consumers would only need to consider unit rates to find the cheapest option, especially if the cap was set as low as possible and (as seems inevitable) suppliers all set their standing charges at the level of the cap. In addition, by ensuring suppliers did not earn profit from the standing charge they would have no incentive other than to provide sustainable energy deals. A cap on just the standing charge would thus lead to lower bills for consumers generally and could avoid the need for the more extensive cap on default tariffs.

3. The mandate, role and performance of Ofgem in setting regulation and supervising regulated entities

Following a principle adopted by BEIS Ofgem has recently decided that ‘residual’ electricity network charges (those not driven by either the amount of electricity consumed or the number of users) should be recovered through a substantial fixed cost for all consumers rather than, as previously, the unit rate. As with the structure of the existing price cap, this is ill-conceived. It will lead to a substantial increase in bills for low income households and it will inevitably increase carbon emissions and reduce security of supply. It also reduces the scope to introduce a cap on standing charges. This is explained fully in Annex 6.
Ofgem spurned an opportunity to reduce bills for all households and businesses by failing to address competition problems in the provision of meters. The meter rental charges suppliers pay are passed on to consumers and are higher than they should be because suppliers face significant costs if they want to switch meter provider, potentially having to replace the existing meters, which means the competitive constraint on meter providers is weak. Ofgem could further reduce standing charges for all consumers by something like £260 million (i.e. approx. £10 each) p.a. if it took action. This is explained in Annex 5.

4. The future of Bulb and the recovery of public funds and the cost to consumers of other energy supplier failures

Ofgem is likely to grant about £2.5 billion to the energy firms that took on the customers of the failed suppliers to compensate them for the costs they incurred in doing this. This will ultimately be recouped from energy consumers’ bills. Ofgem may not be responsible for the increase in wholesale energy costs but its price cap, which was intended to save some households £100 p.a., has contributed to all consumers paying an extra £100. Setting aside whether Ofgem actually knows how to make the market work well, at the very least it must protect low income households by ensuring these costs are recovered through the unit rate rather than the standing charge.
At the time of writing the Government is reported to be considering increasing the Warm Homes Discount to help low income households cope with higher energy bills. Note, however, that the costs of this scheme are also passed on to other consumers (see Annex 2) and, in particular, feed through to the standing charge, thereby adversely affecting low income households.

5. The role of retail market reform in the context of the UK’s net zero transition and domestic energy security requirements

By lowering the unit rate rather than the standing charge the default tariff is likely to have significantly increased energy consumption and thus to have increased greenhouse gas emissions and worsened domestic energy security. This is in contravention of its principal objective and one of its statutory principal duties to protect the interests of existing and future consumers, including their interests in the reduction of greenhouse gas emissions and in security of supply. Moreover Ofgem appears to have attempted to downplay these effects. This is explained in Annex 3.

By contrast, a cap on the standing charge rather than the unit rate would reduce emissions and improve security of supply.

Similarly, Ofgem’s decision to recover residual electricity network charges through a fixed charge will also increase greenhouse gas emissions and worsen energy security. (See paragraph 24 above and Annex 6.)

Annex 1: The efficient level of the standing charge

The efficient level of a cap on the standing charge depends on which elements of the costs incurred by suppliers should be recovered through it. This essentially depends on whether they are incremental costs of serving customers or, rather, related to the amount of energy consumed, in which case they should be recouped through the unit rate instead.

It is shown below that prior to the introduction of the default tariff cap the average dual fuel standing charges levied by suppliers in default tariffs for non-PPM customers of £164 p.a.[28] was over £100 more than the efficient level of costs appropriately recovered through it of £60 p.a. (incl. VAT). Since then standing charges have risen significantly (see paragraph 3) so it is likely that £100 is now a conservative estimate of the mark-up.

Cost elements of the standing charge

In 2012 Ofgem considered which cost elements might be included in a fixed standing charge as part of its Retail Market Review reforms aimed at simplifying tariffs [29]. It assessed costs incurred by suppliers according to whether they varied with energy consumption and consulted on whether to adopt a narrow or wide definition of a standardised standing charge.

Ofgem said that under a ‘narrow’ definition the standing charge would include only network costs [30]. It estimated those costs that might be included under the widest definition of the standing charge [31] as shown in the following table [32]:-

TABLE 1

Ofgem’s estimate of costs to be included in the standing charge

		Illustrative annual cost for average consumer (£)	Recovered through
		Illustrative annual cost for average consumer (£)	standing charge	unit rate
Network costs:	Gas transmission	6	X	
	Gas distribution	122	X	
	Electricity transmission	19	X	
	Electricity distribution	81	(£13)d	(£68)
Policy costs:	Energy Co. Obligation* Obligation* (ECO) (((ECO(ECO)(ECO)	29 (gas), 29 (elec)		X
Policy costs:	Warm Home Discount*	7 (gas), 7 (elec)		X
Metering costs*		23 (gas), 15 (elec)		X
Other supplier fixed costs*		25 (gas), 25 (elec)		X

* Not included under a narrow definition of the standing charge

m Metering costs estimates were based on traditional meters, not smart meters

d The Distribution Use of System (DUoS) fixed charge

Source: The Standardised Element of Standard Tariffs under the Retail Market Review (February 2012) Ofgem (Table 2.1 p.11).

However, Ofgem did not conclude on whether to adopt a narrow or wide definition as it decided against fixing the standing charge (see paragraph 20 above).

Considering the possible elements of a fixed standing charge:-

i) Network (transmission and distribution) costs

Ofgem determined that the bulk of the charges incurred by suppliers for use of the transmission and distribution networks should be recovered through the unit rate as they varied with the amount of energy consumed. Just a small element of electricity distribution costs were to be included in the standing charge [33].

The CMA’s Energy Market Investigation went further. In setting the pre-payment meter (PPM) price cap for nil consumption at the average standing charge of the Big Six energy firms’ PPM tariffs it broke the standing charge down into its components. It stated that “the value of the price cap at nil consumption does not include, nor need to include, network costs since these are volume driven”[34]. It said that the network charging statements of the network companies defined ‘use of system’ charges to be nil at nil consumption [35].

Thus it has been acknowledged that almost all (if not all) network costs should be recovered through the unit rate.

ii) Costs of government policies: the Energy Company Obligation (ECO), Feed-in tariffs (FITs), the Warm Home Discount (WHD) and the Renewables Obligation (RO).

These are all aimed at tackling fuel poverty and/or reducing carbon emissions. Annex 2 describes how suppliers are charged for each of these policies.

Ofgem has confirmed that the costs that suppliers incur under three of these four schemes (ECO, FITs and RO) as well as for Contracts for Difference, the Capacity Market and AAHEDC depend on the amount of energy supplied rather than the number of customers served. Thus they would efficiently be recovered through the unit rate rather than the standing charge [36]. It said that it would expect to design the default tariff cap to reflect this.[37]

The WHD was the exception. However, it is counter-productive for the costs of measures aimed at reducing fuel poverty or emissions to be included in the standing charge rather than the unit rate. This itself makes energy less affordable for low income households while incentivising higher consumption and emissions overall.

Smaller suppliers are exempt from the costs of three of the four policies (ECO, FITs and WHD). There is no justification for smaller suppliers’ standing charges to reflect these costs given their exemption from them. Ofgem offered the justification for small suppliers’ standing charges including these costs that it would enable the smaller suppliers to recover their higher than average fixed costs.[38] However, it is not appropriate to require low consumption / low income households to shoulder the burden of rectifying that problem.

Thus it may be said to be inappropriate for these policy costs to be recovered through the standing charge.

iii) Metering costs

The costs incurred in providing meters clearly relate to serving customers so are appropriately recovered through the standing charge. The cost suppliers incur for providing domestic gas meters is regulated by a price cap, which was set at £15.93 p.a. for 2017-18 [39]. Electricity meters appear to be cheaper to provide: they are less sophisticated than gas meters, which involve a hazardous substance, and the CMA allowed less for electricity meters when it set the PPM price cap [40].

Suppliers also need to pay for the smart meter rollout. The cost of this was estimated at £1.50 per customer per year [41].

Metering costs are considered further in Annex 5 of this paper.

iv) Other fixed costs

Ofgem calculated these simply by subtracting the above costs from the typical standing charge levied by suppliers [42]. Given the lack of constraint on the amounts suppliers levy as standing charges this estimate is not meaningful and is liable to be a significant over-estimate.

Ofgem has said separately that suppliers’ other operating costs include the costs associated with billing nd bad debt and costs associated with depreciation and amortisation [43]. It is not possible in this short paper to quantify all such factors and assess what proportion of them might be attributable to the standing charge. However, billing costs undoubtedly would be, while bad debt might be mainly attributable to charges for energy consumed, especially following a standing charge cap, as charges for energy supplied account for the bulk of energy bills.

Meter reading costs form another category of costs that are clearly attributable to the standing charge. However, the rollout of smart meters will reduce this and the costs of serving customers generally [44].

Ofgem said suppliers earn a margin on their sales of energy too [45]. It does not seem appropriate for suppliers to earn a margin on the standing charge given that this merely enables a customer to receive supply of energy and does not itself confer benefit to consumers.

Thus metering costs appear to be the main category of costs that do not vary with the level of consumption so are justifiably recouped through the standing charge. Other elements may be (possibly) a small element of electricity distribution costs; meter reading costs; billing costs; and some fraction of other overheads / other fixed costs.

Of the costs in Table 1 above, the only ones that are rightfully included in the standing charge are:-

a) (possibly) electricity distribution costs (£13)

b) some proportion of the metering costs of £38, although note that this may be an over-estimate given the amounts cited in (iii) above, and

c) some fraction of the other fixed costs of £50.

This suggests that the appropriate level of the dual fuel standing charge for non-PPM customers prior to the imposition of the default tariff cap was of the order of £50-60 (say £60 including VAT). This was over £100 less than the average dual fuel standing charges levied by suppliers in default tariffs for non-PPM customers of £164 p.a.[46] .

Annex 2: How suppliers are charged for the costs of government social and environmental policies

This feeds into section (ii) of Annex 1.

The policies in question are:-

The Energy Company Obligation (ECO)[47]

This aims to reduce carbon emissions and tackle fuel poverty. It requires large energy suppliers (more than 250,000 domestic customers) to install energy efficiency measures such as insulation. Each supplier’s obligation is determined according to how much gas and electricity it supplies to its customers [48].

Feed-in tariffs (FITs)[49]

These encourage small-scale, low carbon generation. Large suppliers (more than 250,000 domestic customers) are required to make payments to individuals and organisations for both generating and exporting low carbon electricity. The costs of the FIT scheme are spread across all electricity suppliers according to each supplier’s share of the electricity market in terms of the amount of electricity supplied (taking into account FIT payments they have already made)[50].

The Warm Home Discount (WHD)[51]

This requires large suppliers (more than 250,000 domestic customers) to provide support, primarily through bill rebates, to customers who are in or at risk of fuel poverty.[52] Each supplier’s costs are liable to vary with the number of its customers so Ofgem considered there would be merit in this cost being recovered through the standing charge.[53]

Renewables Obligation (RO)

This requires suppliers to source a specified proportion of their electricity from eligible renewable sources or pay a penalty.

Annex 3: The effect of the default tariff cap on carbon emissions and security of supply

It is important to dispel a frequent misconception that, as a necessity, consumption of energy is largely unaffected by its price. The CMA cited [54] a study [55] which found that in the short run a 1% rise in domestic electricity prices reduces demand by around 0.35% (i.e. an elasticity of 0.35). Elasticity is significantly greater in the long run (0.85) as consumers are able to respond to increased prices by installing energy efficiency measures. The CMA also cited a review [56] of studies of elasticities across households for electricity and gas which concluded “on average, natural gas price elasticities are greater than electricity or fuel oil elasticities”.

Ofgem’s principal objective and one of its statutory principal duties is to protect the interests of existing and future consumers, including their interests in the reduction of greenhouse gas emissions and in security of supply [57]. However, Ofgem’s consultation on the default tariff cap in May 2018 did not even mention greenhouse gas emissions or security of supply, let alone attempt to reduce emissions or improve security of supply as Ofgem is required to [58]. Guidance on conducting impact assessments is very clear that the effect on total energy use and greenhouse gas emissions should be quantified and costed [59]. Yet Ofgem had appeared to downplay the likely effect on consumption (which would determine emissions and security of supply)[60].

Greenhouse gas emissions

Ofgem’s final impact assessment estimated that the default tariff cap would increase total UK domestic greenhouse gas emissions by 0.40% with a value of £17 million p.a. based on the price of carbon [61]. This assumed that the cap did not lead to prices of tariffs not covered by the cap rising to the level of the cap. However, it was based on estimates of energy price elasticities that were either at or below the lowest figures in the ranges of estimates in surveys of the studies of energy price elasticities that Ofgem cited:-

For gas Ofgem referred to a review of price elasticities carried out for BEIS [62].This found that studies of the price elasticity had produced estimates between -0.1 (in the short run, with the corresponding long run estimate being -0.17) and -0.28. This review also found evidence in the form of an additional study that the elasticity lies towards the lower magnitude end of the range. Ofgem used -0.1.
For electricity Ofgem referred to the paper the CMA had cited which summarised previous studies and yielded price elasticities of between -0.35 in the short run and -0.85 in the long run [63]. Ofgem’s September 2018 consultation had adopted -0.35 [64] but its November 2018 decision document also mentioned three other studies which estimated the short run price elasticity of demand as ranging from -0.20 to -0.24. Ofgem used -0.26, which was apparently the average of the (now four) studies although the paper it had previously relied on was based on 36 previous studies.

Ofgem’s choice of elasticities to use in modelling the effect on greenhouse gas emissions appears highly selective:-

Ofgem offered no justification as to why the lowest figures (which are applicable only in the short run) were the most appropriate.
Ofgem did not include various other studies that had been brought to its attention in response to all of its consultations and which found energy price elasticities of -0.27 and -0.48.[65]
Ofgem did not incorporate the CMA’s finding based on a review of studies that gas elasticities are greater than electricity elasticities, which had been found to lie between -0.35 and -0.85 (see above).

In addition, estimates of the effect of changes in overall energy bills on consumption may under-estimate the effect on consumption and emissions. Demand may be even more responsive to reductions in the unit rate (as the current default tariff cap brings about) than the overall bill (i.e. including the standing charge) because it is this that determines how much consumers save by foregoing consumption.

In consequence Ofgem’s estimate of the potential effect of the default tariff cap on greenhouse gas emissions is likely to be misleadingly low. Using instead the corresponding long run elasticity estimates from the studies cited (0.85 for electricity and 0.28 for gas), which may be said to be more appropriate as they capture the entire effect of the price cap, would suggest an increase in UK domestic emissions due to the cap of approx. 1.2%, with a carbon value of approx. £50 million p.a..

Ofgem did not conduct a full environmental impact assessment and said that conducting one would be “disproportionate”[66]. However, it is clear that its cap may have had a very significant impact on greenhouse gas emissions.

Security of supply

Ofgem’s consultations on the default tariff cap did not consider at all the effect of the increased energy consumption resulting from the default tariff cap on security of supply. The impact assessment that formed part of its decision document said that there was “a limited risk of an increase in energy consumption affecting security of supply over the potential period of the cap”[67].

It seems that Ofgem sought to avoid its duty to protect the interests of consumers by reducing greenhouse gas emissions and improving security of supply.

Annex 4: The economic rationale for regulating the standing charge

The standing charge is the element of energy bills for which there is the strongest argument for price regulation on economic efficiency [68] grounds. Ideally the prices charged for different products equal the costs of producing them. Thus energy suppliers would recover through the standing charge the costs incurred in arranging to supply customers, while those costs that depend on the amount of energy supplied would be recouped through the unit rate.

It is clear that the standing charges suppliers levy are substantially greater than the costs of serving customers (see paragraph 3 and Annex 1).

As set out earlier (see paragraphs 16-19), suppliers’ default tariff prices reflect the exploitation of their market power [69] over passive consumers. Market power complicates considerations of economic efficiency as it means suppliers’ revenue exceeds their costs. In these circumstances the most economically efficient outcome is achieved by Ramsey pricing, which minimises the distortion of consumption patterns relative to those that would occur if competition was effective. It involves regulating prices so that mark ups are lower for those consumers who reduce their demand most in response to higher prices (i.e. those whose price elasticity of demand is highest).

Price elasticity of demand for energy varies according to households’ income and consumption (which are closely correlated, as demonstrated in paragraph 5). It is higher for lower income / consumption households, as evidence presented below shows. This may be explained by the effect of energy spending on consumers’ budgets: it forms a higher proportion of the budget of lower income households so a variation in the price of energy will have a greater effect on their budgets and hence on how affordable energy is.

Efficiency thus calls for mark-ups to be lowest for low income / consumption households, which entails capping the standing charge more tightly (in relation to the relevant costs) than the unit rate, if indeed the unit rate should be capped at all. It also means preventing suppliers offering lower unit rates for higher levels of consumption, which would be necessary in any case to prevent them effectively raising the standing charge by charging high rates for the first units consumed.

How households’ own-price elasticity of demand for energy varies with their income level and energy consumption

Price elasticity of demand for energy varies according to households’ income and consumption (which are closely correlated, as demonstrated in paragraph 5 above). It is higher for lower income / consumption households, as Ofgem noted in describing analysis undertaken by the Department for Business, Energy and Industrial Strategy (BEIS) of gas price elasticities:

“BEIS noted the lack of established research on differences between income groups but concluded that ‘initial indications suggest that lower income groups possess higher price elasticities and are more sensitive to changes in price compared to higher income groups’.”[70]

Similar results were found by the Institute for Fiscal Studies, which estimated the change in energy consumption that would have resulted from the imposition of VAT on domestic energy at 15 per cent for each income decile. The results and the implied own-price elasticities were:-

TABLE 4

Own-price elasticity of demand for energy by income decile

Decile	Change in fuel consumption (%)	Implied own-price elasticity

Lowest	–9.61	–0.64
2	–9.50	–0.63
3	–8.26	–0.55
4	–6.83	–0.46
5	–4.84	–0.32
6	–4.11	–0.27
7	–3.43	–0.23
8	–1.97	–0.13
9	–0.06	–0.00
Highest	1.09	0.07
Average	–4.12	–0.27

Source: The Distributional Consequences of Environmental Taxes, Institute for Fiscal Studies pp. 8-16.

Another study when VAT was first introduced on domestic fuel suggested that a VAT rate of 17.5 per cent would reduce energy consumption among the poorest fifth of households by around 9.2 per cent, compared with a reduction of just 1.1 per cent among the richest fifth of households.[71]

Similarly, the price elasticity of demand for energy has been observed to decrease generally with the level of expenditure on a group of commodities including fuel, as shown in Table 5. This, too, suggests that the demand for energy of low income households (who consume less energy than high income households) is more price responsive.

TABLE 5

Own-price elasticity of demand for energy according to level of expenditure on energy (and other commodities)

Total expenditure*	Own-price elasticity (with standard error in parentheses)

low 5 per cent	–0.680 (0.020)
6–10 per cent	–0.641 (0.034)
11–25 per cent	–0.599 (0.027)
middle 50 per cent	–0.486 (0.026)
76–90 per cent	–0.369 (0.082)
top 10 per cent	–0.425 (0.159)
all	–0.479 (0.025)

* ‘Total expenditure’ is expenditure on food, clothing, services, fuel (household energy), alcohol, transport and other non-durables. Data are drawn from the annual British Family Expenditure Survey (FES) 1970–84.

Source: ‘What do we Learn About Consumer Demand Patterns from Micro Data?’, The American Economic Review vol. 83, no.3, pp. 570-97. Table 3 Part D p.582.

Annex 5: Metering costs

Standing charges could be reduced further, in which case the benefits of a cap would be further enhanced, if Ofgem took action to resolve competition problems in markets for the provision of metering products and services to suppliers. This would reduce the costs suppliers incur in providing meters, one of the categories of costs that are rightfully recovered through the standing charge.

A report published by Ofgem in 2016 [72] expressed concern that competition in the provision of gas metering products and services at non-domestic premises was not as effective as it should be [73].

In particular, gas suppliers incur significant costs when they switch meter provider. Incoming providers appointed by suppliers are not generally able to adopt meter assets in situ so must replace them [74]. These switching costs weaken competitive constraints on metering providers and form a barrier to entry [75]. The limited competition, costs incurred in replacing meters and raised financing costs for meter provision (as shorter asset life means riskier investment) result in higher meter rental charges to suppliers. These are likely to feed through to end customers in their energy bills.[76]

The rental charges on gas meters provided at domestic premises are regulated, although the report included evidence which indicates that meter providers’ margins on domestic-size meters may actually be higher than for other meters.[77]

The same issues affecting suppliers’ metering costs may be expected to apply in relation to electricity meters at both domestic and non-domestic premises and to smart meters once they are installed.

(Ofgem’s then Chief Executive) gave a commitment to the Public Accounts Committee in June 2014 (in relation to smart meters) that there should be a requirement (as opposed to just a commercial incentive) for suppliers to use the same physical metering equipment when a customer changes supplier [78]. Note that this means that metering equipment should be transferred between providers and does not relate to whether smart meters are interoperable, which merely refers to whether different companies would be able to operate meters (if given permission by the meter owners).

Ofgem said in the report that it intended to take a number of actions to address its concerns [79] such as exploring the scope for encouraging meter providers to sell or rent meters in situ to incoming providers [80]. It said that in due course it would review progress and the effect of its actions on the state of competition in the market. If progress was not evident it would consider whether it might be appropriate to take other actions, including consulting on a market investigation reference to the CMA [81].

However, it is not apparent what Ofgem has done in relation to these various commitments.

The course of action open to Ofgem to rectify the situation is to make a market investigation reference to the CMA of metering markets (as it had done with the energy market). Given the relatively straightforward nature of the competition problems [82] it is reasonable to assume that the CMA would be able to impose remedies to rectify them. An estimate of the likely savings to consumers is £256 million p.a..[83]

Annex 6: Ofgem’s Targeted Charging Review of network costs

Following a major review of electricity network charges Ofgem is replacing some usage related charges (i.e. charges related to the amount of energy supplied)[84] with a substantial fixed charge per consumer [85]. This policy is ill-conceived, will increase bills for low income households and carbon emissions and will greatly diminish the scope for an effective cap on the standing charge.

Ofgem distinguished between the costs of running the electricity network that have a clear cost driver (which it calls “forward looking costs”) and those that don’t and are in effect fixed (“residual costs”). The network companies’ charges to suppliers should reflect the forward looking costs so that (on the assumption that these are passed through in the unit rate) consumers are incentivised to use the network only if the benefit to them is greater than the additional cost they impose on the network.

The residual costs, which amount to about 40% of network charges, have previously been recovered from suppliers by a usage-related charge, like the forward looking costs. However, to the extent that these charges are passed on to end consumers in the unit rate users who have their own generation (typically businesses and better off households) have been able to avoid paying them while still being able to make use of the network as and when they wished to. Such reductions in usage do not cause any reductions in residual costs so other users have ended up paying more. This problem was expected to grow as the amount of such distributed (or ‘behind the meter’) generation increased.

Seemingly following a principle articulated by the Secretary of State for Business, Energy and Industrial Strategy that there should be no ‘free riders’[86], Ofgem has decided that these costs should instead be recovered through a fixed charge per customer.

However, this will have various adverse effects and, notwithstanding the basic rationale outlined above, this policy is ill-conceived. Moreover Ofgem's impact assessment justifying this decision appears opaque and contrived:-

The decision and impact assessment document [87] did not quantify the adverse effect of electricity consumers with their own generation avoiding paying the residual costs, which was the reason for the new policy. In fact only a very small proportion of users have their own generation, and this typically reduces their consumption by only a fraction, so it is difficult to understand the justification for such a significant change in policy.

The decision and impact assessment document described the resulting fixed charge per customer on an “illustrative” basis as £67 p.a.[88] but it also stated that residual charges amounted to around £4 billion p.a., 10-15% of a typical user’s electricity bill, in which case the amount per customer is liable to be significantly more.[89]
Ofgem acknowledged that this policy will increase bills for households that use least electricity. [90] As pointed out in paragraph 5 above these tend to be low income households. Indeed a paper published by Grid Edge Policy [91] had highlighted that consumers who use less than the average amount of electricity (low income households) would pay more while those on high incomes would pay less, in some cases significantly less.

However, Ofgem disingenuously attempted to argue that recovering residual charges through a fixed charge would not in general adversely affect vulnerable consumers as these were found at all levels of consumption [92]. While it is true that even the highest consuming households are liable to include some vulnerable consumers there will undoubtedly be fewer than among those who consume less given the very clear link between levels of consumption and income (see paragraph 5) and the fact that income is a key determinant of vulnerability.[93]

Increasing the standing charge rather than the unit rate will inevitably increase carbon emissions and reduce security of supply, although Ofgem did not acknowledge this or even provide any assessment of this issue [94]. This was in contravention of Ofgem’s principal objective and its statutory principal duty to protect the interests of existing and future consumers, including their interests in the reduction of greenhouse gas emissions and in security of supply (see Annex 3).

Ofgem’s decision to recover residual charges through a fixed charge rather than a volume-related charge appears highly contrived. For example, it asserts that “there was a strong theoretical basis for fixed charges, as they cannot be easily avoided other than by disconnecting from the grid”[95]. This is not a ‘theoretical basis’.

Ofgem did not correctly consider the alternative charging options in terms of a general framework of the optimal, economically efficient outcome, namely that of competition, in which prices reflect costs.[96]

In a competitive outcome prices would equal the marginal (i.e. ‘forward looking’) costs but this wouldn’t recover the fixed (i.e. ‘residual’) costs. The large fixed costs mean the electricity network is a natural monopoly and the network operator (National Grid) has market power, which is why its charges are regulated.

The ‘second best’ solution adopted by regulators in such situations is Ramsey pricing. This minimises the distortion of consumption patterns relative to those that would occur under competition by adding mark-ups to cover the fixed costs that are inversely proportional to consumers’ price elasticity of demand.

Lower income/consumption households have the highest price elasticity, as evidence presented in Annex 4 shows, so economic efficiency calls for them to face the lowest mark-ups. This entails restricting the standing charge and recovering fixed costs largely through the usage charges.

Ofgem did refer to ‘Ramsey pricing’ as the guiding principle for the economically efficient recovery of the residual costs in an annex to its decision paper. However, it mistakenly took this to mean that residual charges should be recovered more from fixed charges than volume-related charges because the former were less price elastic than the latter.[97] (Price elasticity refers to the price sensitivity of consumers, not of the charges themselves!)

To the extent that some households (and businesses) come to face higher usage charges than others this is indeed a distortion of consumption patterns but one which needs to be set against the wider efficient charging framework. Ideally Ofgem would seek to rectify this issue by other means as the charging method it is proposing is liable to produce much greater distortion.

Incidentally, some of the costs Ofgem described as ‘fixed’ are in fact variable in the long run. Indeed Ofgem describes the residual charges as “for the maintenance and investment for the longer term”[98] (whereas forward-looking charges reflect short-term circumstances). This means projected reductions in usage incentivised by higher usage charges will lead to lower residual costs as less investment in the network will be called for. Thus, for example, Ofgem’s proposal refers to the level of micro-generation, which includes on-site and household solar generation, increasing more than ten-fold by 2040.[99] This forecast is based on assumptions of rapid decarbonisation and high decentralisation (such as might be incentivised by high usage charges).

It is also worth noting that this is National Grid’s own forecast [100] and just one of four ‘scenarios’ they posit. In the other scenarios growth is substantially less. Indeed the current scale of the problem of consumers having their own generation so avoiding residual costs remains small in the domestic sector.

January 2022

[1] Ofgem set the standing charge in the default tariff cap at the current average level of the standing charge in SVTs and actually higher, at £175 p.a., during the first cap period in 2019. (Statutory Consultation – Default tariff cap – Overview document September 2018 Ofgem paragraph 2.76; Decision – Default tariff cap – Overview document November 2018 Ofgem paragraph 2.94.) It justified this on the basis that it apparently estimated the cost-reflective level of the standing charge at £220 p.a. in 2017 terms. (Decision – Default tariff cap – Overview document November 2018 Ofgem paragraph 2.96.) However, it did not explain how this cost estimate was arrived at and it appears implausible given that Ofgem agreed with analysis set out in this paper that almost all network and policy costs depend on the amount of energy supplied (see Annex 1), in which case they should not be recovered through the standing charge. This estimate is plainly not credible in any case: it suggests that profit-maximising energy suppliers with market power over passive consumers currently price at below cost the part of energy tariffs which consumers cannot avoid paying.

[2] The default tariff cap level (31 October 2021 to 31 March 2022) for gas at nil kWh is £107.02 for standard credit and £90.81 for other payment methods (essentially direct debit). For electricity (single rate metering arrangement) the average of all 14 regions for nil kWh is £102.53 for standard credit and £86.48 for other payment methods. (Source: https://www.ofgem.gov.uk/publications/default-tariff-cap-level-1-october-2021-31-march-2022) Thus the dual fuel totals are £209.54 for standard credit and £177.29 for other payment methods. NB Low income households might typically pay by standard credit rather than direct debit.

[3] Market Meltdown How regulatory failures landed us with a multi-billion pound bill Citizens Advice January 2022 p.3.

[4] SVTs are default tariffs for domestic customers (i.e. households). If a customer does not choose a specific plan, for example after a fixed tariff (that provides a locked-in rate for a designated term) ends, the supplier moves them to a default tariff. The rates in default tariffs are typically variable but may also be fixed although in this paper ‘fixed tariff’ is generally used to refer to tariffs that are actively chosen, i.e. non-default.

[5] The domestic customer survey carried out by the CMA during its Energy Market Investigation found that 75% of low income consumers (those earning below £18,000 p.a.) are on SVTs compared with 68% for all respondents when the survey was undertaken. (CMA final report paragraph 9.14.) Ofgem’s consumer survey similarly found that low income (below £16,000 p.a.), disadvantaged and financially struggling consumers are most likely to be on SVTs. (Source: Consumer engagement in the energy market since the Retail Market Review - 2016 Survey Findings (Report prepared for Ofgem) August 2016 Ofgem [(hereafter called ‘Ofgem survey report’)] https://www.ofgem.gov.uk/publications-and-updates/consumer-engagement-energy-market-retail-market-review-2016-survey-findings p.77 and Table 12 of data tables.)

[6] Once households’ spending on energy bills (as depicted in Figure 1) is adjusted for the high cost of the standing charge and default tariffs (see paragraphs 3, 16) it is apparent that energy consumption of low income households is even lower relative to high income households than energy spending is.

[7] Ofgem confirmed that low income households consume less than higher income households. (Default Tariff Cap: Policy Consultation Appendix 11 – Headroom May 2018 Ofgem paragraph 2.3.) Similarly, a DECC paper reported a research finding that “evidence that a relationship between income and demand for domestic gas does exist”. (Annex D Gas price elasticities: the impact of gas prices on domestic consumption – a discussion of available evidence June 2016 DECC p.9.)

[8] Ofgem acknowledged that the default tariff cap provides the smallest savings to low income households: Default Tariff Cap: Policy Consultation Appendix 14 – Initial View on Impact Assessment May 2018 Ofgem paragraphs 4.70-4.71.

[9] Setting the unit rate in the default tariff and PPM price caps has meant quantifying the many costs faced by an efficient supplier that vary with the amount of energy supplied, which is challenging. As a result Ofgem added extra amounts to the level of the default tariff cap in order to mitigate variation in operating costs and uncertainty as to the efficient level of costs:-

Together, these measures have increased the level of the default tariff cap and reduced savings for consumers by approx. £39 p.a. (incl. VAT) across all customers. (For the derivation of these numbers see footnote references in paragraph 23 of The Case for a cap on the standing charge in energy bills June 2019 IdealEconomics.com.)

[10] A cap on the standing charge would need to be supplemented by a ban on energy suppliers offering lower unit rates for higher levels of consumption in order to prevent them effectively raising the standing charge by charging high rates for the first units consumed.

[13] Default Tariff Cap: Decision – Appendix 11 – Final impact assessment November 2018 Ofgem paragraph 1.11. The final report of the CMA’s Energy Markets Investigation in 2016 had estimated the detriment to customers of the Big Six energy suppliers conservatively at £1.4 billion p.a. (CMA final report paragraphs 10.125-10.126.)

[19] CMA final report paragraph 9.562. See also paragraphs 9.167-9.169. These cite results from the CMA’s customer survey that of those (24%) who found it either fairly or very difficult to shop around, 85% found it difficult to make comparisons between suppliers and 74% found it difficult to understand the options open to them. Similarly, Ofgem’s customer survey found that 36% believed it was difficult to compare tariffs.

[20] Under Ofgem’s Retail Market Review reforms (see CMA final report paragraphs 9.478-9.513; paragraphs 12.356-12.452 and Appendix 9.7) tariffs were required to consist of a standing charge and either a single unit rate or time-of-use tariffs that could not vary with consumption (see CMA final report paragraph 2 of Annex A to Annex 9.7).

[21] It considered that they restricted innovation and competition between suppliers. It said they prevented suppliers from offering new products or tariffs that would be beneficial to certain segments of the customer population, particularly in relation to energy usage (see CMA final report paragraphs 12.380 and 12.382). The CMA appears to have objected to them partly because they curtailed the ability of suppliers to offer tariffs with no or a low standing charge for low volume users (see also CMA final report paragraph 9.509(c)).

[22] The Standardised Element of Standard Tariffs under the Retail Market Review (February 2012) Ofgem paragraph 2.27.

[23] The Retail Market Review – Updated domestic proposals (October 2012) Ofgem. Paragraph 3.11.

[24] The CMA considered requiring suppliers to structure all tariffs as a single unit rate in pence per kWh. It is assumed here that this meant no standing charge: the CMA said elsewhere that the existing tariff structure – with a fixed and variable element – was more difficult to understand than a tariff with just a variable component (CMA final report paragraph 9.165). The CMA decided against this because it considered that limiting tariff structures had the potential to stifle innovation and restrict competition and would limit suppliers’ ability to respond to the smart meter roll-out by offering time-of-use tariffs (CMA final report, paragraph 12.381).

[26] Both the CMA and Ofgem used survey evidence to estimate the amounts consumers need to save in order for switching to be deemed worthwhile. The CMA survey found the minimum savings needed to encourage respondents to switch supplier had a median of £120 and a mean of £204 as some customers responded with very large amounts (CMA final report Appendix 9.1 Table 12 and paragraph 120 p.38). The Ofgem survey report found that consumers feel they need to save, on average, just under £300 per year to make it worth changing their supplier or tariff (p.71).

[28] Statutory Consultation – Default tariff cap – Overview document September 2018 Ofgem paragraph 2.76.

[37] Working paper #4: Treatment of environmental and social obligation costs under the default tariff cap (April 2018) Ofgem paragraph 1.6, Table 2, paragraphs 4.8-4.9.

[39] Metering charges from 1 April 2017 National Grid p.6. (http://www2.nationalgrid.com/UK/Services/Metering/Publications/Metering-Charges/).

[46] Statutory Consultation – Default tariff cap – Overview document September 2018 Ofgem paragraph 2.76.

[50] Feed-in Tariff Annual Report 2015-16 (Dec. 2016) Ofgem p.5 and Feed-in Tariff: Guidance for Licensed Electricity Suppliers (Version 8.1) (May 2016) Ofgem chapter 9.

[51] CMA final report paragraphs 3, 24-27, 29 of Appendix 8.1 of and Standardised Element document paragraphs 1.31-1.36.

[52] Those on the Guarantee Credit element of Pension Credit receive automatic rebates. (In winter 2017-18 these are for £140 off electricity bills.) Energy companies can set their own rules about which other vulnerable groups can apply for a rebate, typically those on means-tested benefits with young children or a disabled member. (CMA final report paragraph 2.108).

Ofgem also claims to aim to deliver through its regulation a consumer outcome of reduced environmental damage. Op cit p.10.

[58] In the 413 pages of consultation documents for the default tariff cap Ofgem devoted just three small paragraphs to the possible impact “on the environment”. Default Tariff Cap: Policy Consultation Appendix 14 – Initial View on Impact Assessment May 2018 Ofgem paragraphs 4.162-4.164.

[59] The Green Book Central Government Guidance on Appraisal and Evaluation 2018 HM Treasury p.69.

[60] It said that “For most customers, it might be expected that price elasticities are low as energy is an essential good.” Default Tariff Cap: Policy Consultation Appendix 14 – Initial View on Impact Assessment May 2018 Ofgem paragraph 4.24. It cited “a range of studies” implying that domestic demand for gas in the UK is relatively inelastic (in fact just two studies) and made no mention of the CMA’s (much larger) estimates (see opening paragraph of this Annex) or those cited in Annex 4 of this document.

[61]Default Tariff Cap: Decision – Appendix 11 – Final impact assessment November 2018 Ofgem paragraph 7.54, 7.56.

[62] National Energy Efficiency Data Framework (NEED) report summary of analysis Annex D Gas price elasticities (June 2016) DECC (now BEIS) p.10. (https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/532539/Annex_D_Gas_price_elasticities.pdf)

[64] Default Tariff Cap: Statutory Consultation Appendix 11 – Draft Impact Assessment September 2018 Ofgem paragraphs 5.85-5.91.

[65] The case for a cap on the standing charge in energy bills by (IdealEconomics.com) June 2019 Annex 5.

[66] Default Tariff Cap: Decision – Appendix 11 – Final impact assessment November 2018 Ofgem paragraph 7.53.

[67] Default Tariff Cap: Decision – Appendix 11 – Final impact assessment November 2018 Ofgem paragraph 7.65.

[68] Economic efficiency is achieved when nobody can be made better off without someone else being made worse off. It maximises social welfare by ensuring resources are allocated and used in the most productive manner possible.

[69] Market power is a cause of market failure, where the market mechanism alone cannot achieve economic efficiency. Another is externalities, where an activity produces benefits or costs for others. Examples are energy consumption producing carbon emissions and necessitating investment in additional generation and network capacity.

[70] State of the energy market report (October 2017) Ofgem p.73. The BEIS report referred to is National Energy Efficiency Data Framework (NEED) report summary of analysis Annex D Gas price elasticities (June 2016) DECC p.10. (https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/532539/Annex_D_Gas_price_elasticities.pdf)

[77] It said analysis of one meter provider’s costs and prices (which appeared to be representative of the industry) suggested that additional mark-ups that were unrelated to costs were being added to what were already comfortable rates of return net of inflation. (Market review report p.30.) These mark-ups were 20% for domestic-size meters and 15% for other meters (market review report footnote 43 p.30).

[82] Similar to those revealed in the market investigation of the domestic bulk liquefied petroleum gas market in 2006.

[83] This estimate is calculated as 40% (additional mark-up on domestic-size gas meters referred to in footnote above + corresponding adjustment for lack of competitive pressure on costs) x £16 (National Grid rental charge for domestic-size meters in 2017-18) x 25 million (approximate number of domestic and non-domestic premises) x 1.6 (as meter rental charges for electricity meters are less than for gas meters).

[84] Residual charges are recovered from smaller users, such as households and small businesses, via per-unit consumption charges and from larger users by a mix of per-unit consumption charges and peak demand charges for transmission.

[85] The Targeted Charging Review: minded to decision and draft impact assessment Ofgem November 2018.

[86] BEIS and Ofgem have adopted a principle that users of the network should pay their fair share of the costs of the energy system. This corresponds to a principle articulated by the Secretary of State, in November 2018 that there should be no ‘free riders’.

[87] Targeted charging review: decision and impact assessment November 2019 Ofgem.

[88] Targeted charging review: decision and impact assessment November 2019 Ofgem p.70.

[89] Targeted charging review: decision and impact assessment November 2019 Ofgem p.31.

[90] “Those who use least electricity [will] see an increase in their residual charge. Those who use the most will see a decrease.” (Targeted charging review: decision and impact assessment November 2019 Ofgem pp. 68, 71.) “We recognise that charges for some low-using consumers will be higher than they are today – around £24 for our illustrative low user, while for others they will fall further – around £40 for our high user.” (Op cit p.73)

[91] Understanding the Impacts of Ofgem’s Targeted Charging Review January 2019 Grid Edge Policy. The paper is co-authored who, as Senior Partner Networks at Ofgem until 2016, was responsible for, among other things, network charging.

[92] Thus Ofgem stated that it had found vulnerable consumers to be present in all consumption categories. (Targeted charging review: decision and impact assessment November 2019 Ofgem p.10.) Similarly, it said:-

[93] Ofgem’s definition of consumer vulnerability as “when a consumer’s personal circumstances and characteristics combine with aspects of the market to create situations where he or she is:

[94] Ofgem merely stated “The modelling we have undertaken suggests that overall the combined impact of the TCR changes will reduce carbon emissions compared with no reforms.” (Targeted charging review: decision and impact assessment November 2019 Ofgem p.15.) However, it provided no evidence in this document to support this and it did not compare the effects of increasing the standing charge relative to the effects of increasing the unit rate.

[95] Targeted charging review: decision and impact assessment November 2019 Ofgem p.34.

[96] A report commissioned by Ofgem concurred: “The key economic principle behind the optimal recovery of sunk costs is… that such charges should have as an objective creating minimal changes in behaviour relative to a set of efficient, cost-reflective charges, i.e. minimising distortions.” Distributional and Wider System Impacts of reform to Residual Charges” November 2018 Frontier Economics/LCP p.7.

[97] Targeted charging review: decision and impact assessment November 2019 Ofgem Annex 3 – Academic research and international comparisons pp. 3-4.

[98] The Targeted Charging Review: minded to decision and draft impact assessment Annex 1 – Targeted Charging Review (TCR) Principles November 2018 Ofgem paragraph 1.5.

[99] The Targeted Charging Review: minded to decision and draft impact assessment November 2018 Ofgem paragraph 2.11.