Having a lower cost base enables an energy supplier to offer lower prices to its customers and to gain market share from less efficient suppliers. However, if the cost difference results from government policy or regulation rather than company efficiency, are consumers really made better off when the lower cost firm gains market share?
Significant differences in average cost to serve between energy suppliers can also result from suppliers having a different mix of customers, with some customers having a much higher associated cost to serve than others. With a cap on retail tariffs that does not reflect such differences, can competition still work effectively for the customers with a higher cost to serve?
The number of active domestic energy suppliers increased from 12 to 66 between 2005 and 2018. Exemptions from certain social and environmental levies for smaller suppliers have spurred this trend and made it easier for new entrants to gain market share. ScottishPower required robust economic analysis of potential unintended consequences of levy exemptions for competition in the energy retail market, with a view to argue for an approach to levies that does not distort the level playing field between suppliers.
At around the same time, a Government Bill to cap domestic gas and electricity tariffs was laid before Parliament. Concerned about the potential for the price cap to distort competition if differences in cost to serve for different customer groups are not reflected in the cap, ScottishPower required analysis of such differences and their effects on energy retail market competition to demonstrate the potential impact on suppliers of a tariff cap that does not account for such differences.
Baringa produced estimates of the value of different levy exemptions for smaller suppliers and undertook qualitative and quantitative analysis of impacts of levy exemptions on retail market competition. We used our assessment to build a compelling economic argument for change in the design of levy exemptions for small suppliers.
We also used company financial information and detailed data on the client’s customer base to calculate differences in cost to serve between different customer groups. We used the results of our analysis to demonstrate the potential unintended consequences of a default tariff price cap, framing our arguments within a coherent overarching economic framework.
Baringa quote: "I am glad that we were able to deploy our understanding of energy retail markets and our economic analysis toolkit to help ScottishPower make a robust and compelling set of arguments for better design of energy market interventions." (Vladimir Parail, Senior Manager, Baringa)
Client quote: "Using clear economic reasoning and robust analysis of data, Baringa helped us to demonstrate in a compelling way how inappropriate design of energy market regulation can distort competition between energy suppliers." (Richard Sweet, Head of Regulation, ScottishPower)
Outcomes and impact
Baringa’s full confidential report was shared with Ofgem and BEIS, and a non-confidential version was published on ScottishPower’s website.
Our work articulated the economic consequences of key design choices in levy exemptions and the default tariff price cap, helping ScottishPower to make a compelling argument for a more economic design of these interventions to minimize the possibility of unintended consequences that could distort competition and damage consumer welfare in the long-run.
Following the publication of Baringa’s report – the exemption for the Warm Homes Discount obligation was amended to restrict it to a smaller subset of suppliers as part of a government review.