The privatisation of many of our utilities has widely come to be judged a failure, with the water companies’ industrial scale discharges of sewage into our rivers the most graphic illustration of that.
The privatised firms’ incentive to maximise profits wouldn’t necessarily have been a problem if the various regulators had been effective in safeguarding performance standards and investment and restricting price increases.
I was an economist at Ofgem, the energy regulator, which has just announced a major review of how to recover the costs of the energy system from consumers in a fairer way. This marks a complete U-turn on the policy it had re-affirmed only as recently as February and is just the latest instalment in the story of how Ofgem has gone about setting the price cap.
It’s a tale that provides an insight into the regulatory mindset, revealing an innate tendency to appease powerful stakeholders while safeguarding their own interests, but neglecting the very consumers they are supposed to be helping.
The price cap was introduced to protect consumers who don’t engage in the market and select good value energy tariffs. That tends to mean those who use least energy as they save the smallest amounts by switching supplier. These households are typically on the lowest incomes so they are also the consumers most in need of protection from high prices.
This dictates capping the daily standing charge as tightly as possible because it forms a larger proportion of the bills of those who consume least. That in turn entails capping the price per unit of energy less stringently in affording companies a reasonable rate of return.
And that has the additional benefit of reducing energy demand, which lowers carbon emissions, improves the U.K.’s energy security and decreases the investment needed in generation and network capacity.
It's a no-brainer, which is why it’s interesting that Ofgem did the exact opposite. When it introduced the price cap in 2019 it reduced the unit rate but left the standing charge at the prevailing market rate even though tariffs were known to be excessive (that’s why the price cap was being introduced).
This amounted to a gift to the energy suppliers. Standing charges were set at £170 p.a. (excluding VAT) for gas and electricity combined, which was over £100 p.a. more than it cost suppliers to serve each customer, notably in providing meters. This was based on a review Ofgem had undertaken in 2012 to assess which costs should be recovered through the standing charge.
Ironically, it is because standing charges were so generous to the suppliers that they are likely to have contributed to the collapse of many of them during the energy crisis. They encouraged the growth of companies that were more focused on gaining customers in order to capture these payments than on managing their energy purchases and so were caught out when wholesale prices increased.
The cost of clearing up the mess by paying other suppliers to take on the customers of the failed companies? You’ve guessed it: added to the standing charge (an additional £34 p.a. per customer in 2021-22). Then in 2022 Ofgem loaded up each household’s standing charges with a further £66 p.a. of network costs that had previously been recouped through the unit rate.
Ofgem was taking its lead from Greg Clark who, as a Conservative energy minister, had said in 2018 that there should be no “free riders”. What he meant was that those who had installed solar panels and thereby reduced their energy consumption should not contribute any less to network costs so these should be recovered through the standing charge rather than the unit rate.
The standing charge in the price cap is now £315 p.a. (plus VAT) but the costs that should be recovered through it amount to only about £85 p.a..
In November 2023 Ofgem finally acknowledged a groundswell of public discontent about this and consulted on reducing the standing charge in the price cap. While Ofgem routinely engages with government ministers and the energy companies it's as though it could only take consumers’ interests into account if it formally constituted them.
Yet still the consultation document conveyed an unmistakeable sense that Ofgem was in denial. It said “there is no ‘Ofgem standing charge’” because suppliers are free to set it below the level of the cap and it “encouraged” them to do so. This betrayed a naivety as it was no accident that suppliers had chosen not to. Standing charges are ‘free money’: even allowing for the costs that were added in 2021-22 suppliers still make about £100 p.a. profit on every customer before supplying any energy.
Over 30,000 people responded to the consultation, which Ofgem rightly described as “extraordinary”, and they overwhelmingly called for Ofgem to reduce standing charges.
You would think this was very clear. The British public had been given a voice and had spoken loudly and it was now down to Ofgem to go away and do its job, applying its expertise to work out the appropriate level of the standing charge. Not a bit of it. Ofgem’s response was to run another consultation, this time asking the public to tell it [what the level of the standing charge should be, in the process delaying any reduction in standing charges for a further few months.
In December 2024 Ofgem announced its intention for there to be TWO price caps from this winter, one with a standing charge (presumably at its current level) and one with no standing charge for anyone who "opts to change to this tariff". Brilliant! It had found a way to avoid crossing either set of stakeholders – the companies or the consulted consumers – by appearing to give both what they want.
There was just one problem as far as consumers are concerned. The reason the price cap was introduced in the first place was to help disengaged customers who don’t switch tariff, which means that many of them are likely to end up staying on the price cap with high standing charges. We’re back to square one and Ofgem has deferred to the most powerful stakeholders (the energy companies) again.
Ofgem defended its decision on the basis that some people have to use large amounts of energy for medical or health reasons so need unit rates to be low. But they are a very small proportion of all consumers and it wouldn’t have been impossible either to restrict a price cap with high standing charges and low unit rates to them or to negotiate a rebate for them.
The impression of Ofgem contorting itself to satisfy its stakeholders is reinforced by its announcement on 30 July of yet another review and consultation. It follows Energy Secretary Ed Miliband being urged by more than 100 MPs just the previous week to reduce the standing charge in order to help lower income households.
Ofgem’s press release appeared to acknowledge that its new review is the result of political pressure: “Many choices are made jointly by government and regulator, shaping what goes into energy bills and how costs are recovered.”
Regulators are supposed to be independent, so why is Ofgem so accommodating and, in the jargon, prone to ‘regulatory capture’ by particular interest groups?
Like other regulators, it is staffed by civil servants whose modus operandum is collaboration. Thus, for example, civil service ‘success profiles’ for senior staff expect them to influence stakeholders to “secure mutually beneficial outcomes”. In these terms Ofgem will feel vindicated. Its income, which mostly comes from licence fees paid by the companies it regulates, was £227 million in 2024-25, more than double what it had been four years earlier, and it now employs 2,276 staff.
But this approach is actually ill-suited to effective regulation. Regulators are inherently in a position of conflict, potentially with ministers but unavoidably with the firms they regulate. Resisting companies’ attempts to gain higher returns at the expense of consumers is intrinsic to their role.
This calls to mind the Monty Python sketch about the accountant who wanted to be a lion tamer until it was pointed out that lions are big and scary. Ofgem has gone to great lengths to avoid having to face down powerful interests over the price cap and we're unlikely to see risk averse senior civil servants standing up to corporate and political beasts on other issues either.
The Government is carrying out a review of Ofgem’s role but lasting improvement in the performance of all regulators (and hence of the companies they regulate) won’t come about without radical changes to the way senior managers and board members are selected and their performance assessed.
