I figure that nobody reads this blog anyway so what’s the harm in devoting a post to a dull but rather important issue; the simplification of energy tariffs in the UK. As I noted last week, this is a commitment in the Labour Party manifesto, although one which is left unclear as to how exactly simplification could occur. Under OFGEM’s recent retail market reforms the tariffs that energy providers can offer have been limited in number and simplified in format. Each retailer can now only offer four types of tariff and each one needs to be clearly displayed with the unit price, standing charge and ‘tariff comparison rate’. I will argue here that the most effective further simplification of tariffs would be to abolish the standing charge.
How do consumers compare electricity tariffs?
The standing charge is the one aspect of electricity tariffs that makes consumer understanding most difficult. If the standing charge were to be abolished, all consumers would need to know would be the kWh unit price (or prices if a time of use meter is installed) and a few simple details about the contract. Instead consumers are presented with a number of competing comparative metrics, none of which give an indication of the tariff cost alone. Most prominently displayed is the estimated yearly cost of the tariffs and the savings compared to what the customer is currently paying. This price is useful for consumers but disguises the components behind the figure and leads to a lack of understanding about what actually determines the electricity price. It also is based on current consumption and makes it difficult for consumers to see which tariffs would be preferable if they were to undertake energy efficiency measures in the future. The second two metrics are the tariff unit rate and the standing charge. In order to work out the best rate based on these two figures consumers would need a calculator and a bit of brain power, which is not conducive to easy understanding.
In the recent retail market reforms OFGEM introduced the ‘Tariff Comparison Rate’, an attempt to make a single metric that would allow consumers to compare electricity tariffs. Not surprisingly this hasn’t been widely adopted on price comparison websites (as it is a single figure that doesn’t take into account the actual amount of energy used by consumers). It isn’t even included on OFGEM’s own ‘comparison notepad’ for switching energy. As a result any comparison made by anyone other than the ‘average’ consumer may end up with a more expensive tariff than they anticipated. The root cause of all the issues outlined above is the mischievous standing charge, the one significant factor that stops the relationship between unit price and yearly bill price being easy to understand for consumers.
The table above also illustrates how much work there is to be done in making energy tariffs easier for consumers to understand. It is extremely telling that this complex table is the simplest way the regulator themselves can find to help ‘energy shoppers’ when switching electricity. For a recently produced tool by OFGEM it is also telling that it ignores the tariff comparison rate entirely, something that was specifically introduced recently for the very purpose of making comparison easier. If the above was meant to represent the system after being simplified, one can only imagine something went very wrong somewhere in the policy process.
But don’t some suppliers offer ‘no standing charge tariffs?’
Some small suppliers do offer tariffs with no standing charges, or technically standing charges that are set to zero under the retail market reform regulations. This includes suppliers such as Ebico energy and Utilia, but not any of the larger household name brands. This is important for two reasons. The first is that customers are often skeptical of new brands offering innovative pricing models so may not choose to sign contracts with them even if it is in their best interest. It also may be difficult to tell which tariffs offer a zero standing charge option on a pice comparison website as the information is displayed on a pop up for each retailer. Second is because consumers often don’t even change electricity provider at all, and simply renew their contracts with their current provider. This is partly a result of the complexity inherent in selecting a new supplier but also because individuals tend to place a higher utility on services they are familiar with and are using currently, known in behavioural economics as the ‘endowment effect’. Because of these two factors it is important that standing charges are abolished rather than optional.
There would be loads of other benefits of abolishing the standing charge. If consumers find pricing data more accessible then it would encourage switching, and ultimately a better deal for consumers. It would also reduce energy bills for consumers with low energy consumption such as the elderly and those on low incomes. There are also significant benefits in terms of energy efficiency which will be explored in another post in the next few weeks. I have only considered energy markets here, but there’s no reason to think that applying this same logic to water or telecoms would be unreasonable.