Customer Default Service with Competitive Retail – is this the way forward in GB?

Catherine Mitchell, IGov Team, 11th July, 2014

About Catherine: http://geography.exeter.ac.uk/staff/index.php?web_id=Catherine_Mitchell

In general, the merits of retail regulation versus retail competition is framed in a 2 by 2 matrix whereby retail regulation protects customers but undermines innovation and retail competition stimulates innovation but reduces customer protection. For those of us who lived with the fat-days of the Central Electricity Generating Board pre-1990, supporting innovation has, in principle, (slightly and uncomfortably) trumped customer protection.

However, the failure of the restructured electricity system to produce innovation has raised the questions about whether a competitive retail market is the best governance structure for the move to a secure, affordable and sustainable energy system, and whether there might be a third way? There has been an abject failure to reduce total energy use overall in Britain and to increase energy efficiency across all building stock. Because of this failure, the transformation to an efficient and low carbon system has not been rapid enough to meet our various targets. Moreover, there are also substantial concerns that the powerful incumbents have maintained too high retail prices at the expense of customers, now a subject of a Competition and Markets Authority Review.

A large number of US States offer a default service (sometimes known as a basic service or a standard offer service (SOS)) alongside retail competition. While design details of the default service clearly matter (1) for success, some form of default service combined with vigorous support of the competitive retail market might be the way forward for Britain to break the dominance of the Big 6 in supply and inject some real change into the British energy system.

Arguably, having a combined default service and a competitive retail market option in Britain might bring a number of benefits: (a) in theory, a default service should not undermine innovation or competition in the retail markets; (b) a default service sets a ‘price / service to beat’ for retail suppliers. If competitive retail suppliers are worried that having a default service will mean that no one will choose their product, then one could argue that there is a problem with their product; (c) a default service based upon a US Commission / European regulator -approved price and / or service (achieved through various mechanisms) provides a place to land for customers who do not understand, do not want to understand, or don’t have the time to understand how to pick a provider or for customers which are vulnerable in some way. The default service should ensure that those customers will be protected with a reasonable rate and service; (d) provided the profit margins on the default service provider are low enough (ie nearer 1% than 5% real), innovative, competitive service should provide a greater source of revenue to suppliers. Default service should become the no-frills (airline) companies of the energy system. Those suppliers not interested in this might exit the market, thereby potentially freeing up customers for the competitive retail market / new entrants, or hand over its provisions to other companies; (e) a default service could be a way to provide incentives to reduce total energy demand and increase energy efficiency in a way that the current competitive market is not able to do. While some consumers do switch in Britain, a significant proportion do not. A default service which combines a price regulated provision with an increasing step tariff would connect energy efficient incentives to customers who currently are not got to (i.e. the Heineken effect). Moreover, a default energy service could be a mechanism to provide a service to the fuel poor (ie Belgium has just tried a free first 500 kWhs), thereby protecting them and, finally, doing something tangible about fuel poverty.

If the default service is implemented alongside a strongly supported competitive retail market strategy, suppliers can distinguish themselves by the type of product they provide: 100% renewable or some increment thereof; variable priced product where the consumer takes the risk of volatility and fixed price where the retailer takes the risk; and guaranteed discount off of the default rate price, to name a few. An innovative company (such as Good Energy) which has created a strong image for positive service should thrive in such a market.

Electricity restructuring in the US has occurred in some States and not others. There are 17 States that have both wholesale and retail competition (for example, Ohio, Pennsylvania, Washington DC, Maryland, New Jersey, Delaware, New York, Illinois to name a few). At the same time, the majority of States with a competitive retail market provide some form of default service along. Only Texas provides a wholly competitive retail market without some form of default service.

Those that support pure competitive markets would not support a Default Service. Moreover, there is evidence that certain designs of Default Service suits incumbents better than others – ie maintain the stranglehold (1) of the incumbents at the expense of innovation – which would be the worst of all worlds. Furthermore, a default service which allowed a large profit margin (ie 5% real) may well be some suppliers idea of the perfect situation: a way to institutionalize a secure, risk-free income from their captured customers. Design, as with everything, would therefore be central to its success.

However, movement towards competitive retail market is slow in Britain, and, meantime, the needs of a sustainable, secure and affordable energy system are not being met. Britain (and the globe) is no longer in the position where we can trade-off environment, security and affordability goals. We have to meet all those goals simultaneously and we need to think of new ways of meeting this challenge.

The concerns of undermining the benefits of competitive retail are balanced to some degree by the benefits of an appropriately designed default service in the specific British situation. The executors of energy efficiency programs in Britain – the suppliers – are also those which do not benefit from reduced sales or more knowledgeable and connected customers. Those suppliers dominate the retail market, and there are serious concerns about the impact of this on energy prices and questions of affordability, not just for the fuel poor but also for wider society. Moreover, Britain has to reduce its carbon emissions and a central way forward is to make its energy use more efficient, something which is not currently happening fast enough. One possible way to do this, and improve the situation for the fuel poor at the same time, is to institute a low margin default service with an increasing step tariff.

If a customer were to settle for this – then, we know there is some incentive on them to think about their energy use. However, the competitive retail market might offer an improvement on this – a Californian example is a tariff particularly for solar prosumers or customers with electric vehicles – but still based on the rising block tariff. Britain needs to find a mechanism to ensure all homes have a direct incentive to minimize their energy use – default service is one option which should be examined.

Note:

(1)  Chapter 12, Young Kim, Unfinished Business: the evolution of US competitive retail electricity markets in F. Sioshansi, 2013, Evolution of Global Electricity Markets, Elsevier

Posted by: rhoggett

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