Martin Lewis – Warning: Energy price comparison savings are WRONG due to the price cap – and how it needs to be fixed
The new energy price cap (following on from the prepay price cap) for millions of customers on a standard tariff will begin on 1 January 2019. It's already been wrongly reported, but there's a bigger worry that it will make the savings on comparison sites wrong.
Last week I called the head of Ofgem to warn him about this, as it's something that hasn't been thought of. He was very responsive, and has agreed to urgently look at it. Below is the letter I followed up with to have it all on paper.
As this is quite complex, there's something I need to explain first.
Before the letter – a briefing on the new price cap:
- On 1 January, the cap starts at £1,137 for someone with typical use. Yet the cap does vary by region and payment method, and of course if you use more, your cap will be higher or if you use less, your cap will be lower. This will cut bills for most big six standard tariff customers by a typical £80 a year.
- On 1 April, the cap is likely to rise to £1,250. That initial cap only lasts three months, after that it is reviewed every six months. So the next cap lasts until 1 October 2019.
The rate of the price cap is based on an already published algorithm from Ofgem, which factors in average wholesale prices (the price energy firms pay) over a prior six-month period. For the cap starting on 1 April, it is prices from 1 August 2018 to 31 January 2019. So we are already halfway through that period.
Using that data, at the current run rate the new cap will rise to £1,250, and it'd take a huge price crash now for it to not rise.
Letter to Dermot Nolan
Below is the letter I wrote to Dermot last Friday. It does not represent MSE's solid plan for the future – more our initial thought process about the problem, and a direction of travel to fix it.
I should note that even since writing it things have moved on, as we do more work and go through more issues that are being thrown up – but I think it is useful to expose the issue all comparison sites are facing right now – and the new thinking that needs doing.
Thanks so much for doing the call so quickly today, and promising to get back on Monday. This is a really urgent one so we're very grateful. As requested I've bashed out some notes so you've something solid to go through.
As explained the price cap has left a dilemma over how to estimate a consumer's costs over the next year, for those already on SVRs [Standard Variable Rate tariffs] (and in the rare event someone may switch to them). And this is a crucial figure in the comparison, as without this base price we can't calculate a saving.
By only factoring in the price of the existing cap we risk substantially underestimating the potential saving and incorrectly dissuading people from switching.
And equally in future if the cap is set to drop, we risk over-estimating the saving and thus in effect 'mis-selling' a switch.
This is further complicated by the fact that if different comparison sites adopt different approaches, the lack of consistency would be very off-putting to users who use more than one site to compare (as many do).
What is needed in our view is for Ofgem to either dictate how this sum should be done or at least give some best-practice guidance.
As I promised below are some suggestions that I have worked on with the team, which may be helpful to show you one way through this.
Though there is one urgent note before that…
Suppliers with tariffs that will be affected by the cap must be pushed to publish their prices at speed.
Currently even though the cap has been announced we only have E.on's prices. Therefore even though we know with most SVR tariffs the cost will drop substantially on 1 January, we can't factor it in – there is too much regional variation for us to make assumptions.
How to estimate future pricing.
We must accept that future prices will be estimates, but if we do it based on all the information available, then it will be as close as possible to the price consumers will pay.
Below is our idea of a best-practice solution.
To explain this I will base it on the current timeline, but a read-across can be done for any time in the future that the cap applies.
To calculate the price for the next 12 months we would propose...
- For the portion of the cost from today to 1 Jan: We will simply use the current price.
- For the portion of the cost from 1 Jan to 1 April: We will use each companies published prices for each region once we have it.
That's the easy bit. The difficult bit is for the remainder of the time.
I need to be straight and say that our proposed solution is not one we could put into play immediately as it needs some substantial back-end development work – another reason for wanting guidance from you ASAP. So at the moment this is only a theoretical model.
In the meantime we will probably simply default to using the 1 Jan onward price (once suppliers send it) for the remainder of the year (which of course has the likely result of underestimating the potential saving).
- For the portion of the cost from 1 April onward: As a) the calculation window for this period has already started and b) you have published your cap calculation methodology, we can work out the future main cap with increasing accuracy each week based on the wholesale forward curve.
So we would propose to do that on a weekly update basis. For example on 1 January we will already be five months into the six-month calculation window so the steer should be pretty accurate.
There is still a difficulty here that providers do this on a regional basis. Our proposal for that is simply to take their 1 Jan – 1 April price for each region, and do a multiplier based on the future cap – not perfect as they could change their ratios, but the best possible estimate on the available info.
Eg, if the future cap is 10% higher and British Gas is £1,120 in one region and £1,170 in another, we would simply assume those regions will be £1,232 and £1,287 in the next period.
It would be even better if Ofgem were to undertake the weekly 'direction of travel' calculation and communicate this to the market in its daily newsletter. This approach would remove any inconsistencies.
It is also worth noting that using this methodology would mean using prices that are technically a licence breach as they are not 'provider given' – if that is correct obviously your help would be needed on that.
- From 1 October onward: As the calculation period here hasn't started, we would simply assume it stays at the same rate as the 1 April cap.
I hope that all makes sense.
Happy to chat it through further if it helps,
I hope you can see the complexity of the problem. Do put any thoughts in the discussion box below.