Should the Price Cap be updated monthly?
Updated: Nov 13, 2021
What would happen if the OFGEM Price Cap was a monthly tracker?
Recap from yesterday: The Price Cap is a loss making tariff at the Gross Margin level, and energy suppliers will need to subsidise customers energy bills.
We also touched on the fact that the methodology used on the wholesale cost elements is unhedgable. And, the hedge is expensive - tying up considerable amounts of credit and collateral.
I'll go back to good practice again, which may not be a popular sentiment. If you're selling a 12 month fixed product, without fixing (hedging) your costs for 12 months then you are speculating on the market. Which is the role of a trading business, rather than the role of a retail energy supplier.
Without wanting to get hackles up - I'm all too fully aware that in order to win customers, suppliers have had to offer 12 month fixed tariffs when they cannot hedge all of their energy.
Some variable tariffs have taken a bad rap, but the team at Bulb have demonstrated very strong growth with a single, variable tariff.
Variable tariffs tie up less credit collateral, and allow you to move prices down faster in a falling market. But, those prices will go up in a rising market. Similar to say, Petrol.
Let's put it out there. Setting a price cap is hard. You won't please everyone. You probably won't please anyone.
But a price cap which creates a situation where suppliers have to retail their energy for less than cost doesn't make any sense.
So as a thought experiment we've put together some very rough analysis, on what would happen if the Price Cap was a monthly tracker on the wholesale costs - with the policy and third party costs fixed for a six month period as they are now (there's less volatility).
You can see in periods of more 'normal' volatility, a Monthly Tracker is quite close in each period to the Cap - some periods are cheaper, some more expensive, and excluding W21 - the total difference would be ~£100 adverse for customers spread over those six cap periods.
In Winter 21, we see how the volatile gas prices have pushed the monthly tracker up to a bill of ~£1,000 for that period. So that's ~£985 of costs being borne by the energy supplier, and in exchange they would make the princely sum of ~£12 for the period.
The current W21 cap is Gross Margin negative. Which means up to ~£200 of cost has to be swallowed by each supplier.
The current market design is going to create consolidation this winter, which is very different outcome to the original 'design' of limiting the profits which can be made by energy suppliers.
This topic is clearly more complicated than can be addressed via a short blog post, it would be great to get views and feedback on what are the possible routes forward.