Energy regulation requires trade-offs the regulator cannot make alone

At the Institute for Government this week, Jonathan Brearley, the CEO of Ofgem, gave a wide-ranging speech on the lessons the energy regulator has learned from the past few years of extreme volatility in energy prices, and how the sector will need to transform in the future.

Brearley provided a long to-do list for the energy sector. He made clear that while the worst of the current energy crisis may be over, the work needed to make the energy system more resilient – and to decarbonise it by 2035 – has only just begun. 

Ofgem has a large role to play, and it is welcome that Brearley has engaged in the debate around how the energy system needs to change so openly and comprehensively. However, the regulator needs the government to help it navigate inherently political trade-offs. 

Watch Jonathan Brearley's keynote speech

Supplier failures show why the government needs to value resilience more

Ofgem recognises that the collapse of 29 suppliers between July 2021 and May 2022 was partly a result of regulatory failure – not adequately ensuring that new entrants were suitable, and then not providing sufficient supervision of their financial practices. Brearley said that this was because Ofgem had focussed too much on the level of competition within the market, neglecting to properly consider the resilience of the players involved.

Ofgem has now made a commitment to think more about how it makes the trade-off between resilience and efficiency in the future. This is welcome and needs to take place across wider government. A recent IfG report found that UK government struggles to prioritise risk alongside other pressures, sacrifices capacity for the sake of efficiency, and assesses preparedness only when crises occur. 

Ofgem has limited levers to support vulnerable customers

Brearley spent a lot of his speech talking about how to help the most vulnerable consumers, who the regulator has a legal duty to protect.  He called on suppliers to do more for customers, focussing in particular on the practice of forcibly moving them onto prepayment meters when they have difficulty paying their bills. This has rapidly increased during the energy crisis but runs the risk of vulnerable customers being left without power. Often customers have been moved to a prepayment meter remotely without due notice from their supplier, and many have been “self-disconnecting” their homes from energy supply as a result. 

He also called for a social tariff to be introduced in order to limit the impact of extremely high prices and reduce volatility on a defined set of vulnerable groups customers who are simply unable to pay for their basic energy needs. As we have recently highlighted, the government’s current schemes either significantly distort price incentives, or leave huge gaps in support. But Brearley could not set out how a social tariff would work or be funded, saying only that it should be paid for progressively. Choices over funding for such a scheme and how to target the subsidy are not a matter for the regulator; to make progress in this area, Ofgem requires the government to act.

Both issues highlight the political nature of the trade-offs Ofgem must make

Both problems illustrate the challenges Ofgem faces in balancing its objectives. To prevent unnecessary supplier failures, it must balance the level of competition and efficiency in the market (which ought to drive down costs in the short-term) with resilience (which would deliver most benefit to future customers) – that is, to an extent trading off the interests of current and future consumers. While Brearley was keen to stress that Ofgem makes decisions independent of political interference, there was no doubt pressure during the efficiency drives of the 2010s to bring down costs across the public sector, often at the expense of resilience and capacity.

To protect vulnerable customers and particularly those on prepayment meters, Ofgem can force energy suppliers to change their behaviour (for example, by ensuring that they consult customers before they switch them to prepayment meters). But it cannot solve the fundamental problem of people not being able to afford their basic energy needs: preventing energy companies from putting customers onto pre-payment meters would enable vulnerable customers to continue using energy even if they had not paid their bills, but it would not stop them running up large debts as a result of high energy prices. 

Ofgem must trade off the risk of vulnerable customers self-disconnecting on one hand, with the risk of increasing bad debts to suppliers on the other. A social tariff could solve this problem of affordability, which is presumably why Brearley advocated for one – but only the government, not the regulator, can choose to introduce it because it will necessarily involve redistribution either through additional levies on wealthier customers’ bills or from general taxation. Energy secretary Grant Shapps was right to ask Ofgem to investigate suppliers’ use of prepayment meters,  but he must also recognise that it is ministers who hold the most powerful levers that will prevent people self-disconnecting. 

These difficulties in making inherently political trade-offs are likely to intensify in the future – Brearley signalled that several of the reforms that may be implemented to help reach net zero greenhouse gas emissions could come into conflict with Ofgem’s obligation to protect vulnerable customers: for example, by leading to variation in energy prices by time and place. The government must give Ofgem the guidance it needs on the government’s overarching priorities and objectives to make these political choices authoritatively, starting with publication of the long overdue Strategy and Policy Statement for the regulator.