Retailers urge Ofwat to take more mid-sized users out of retail price caps

Retailers have told Ofwat the current Retail Exit Code (REC) retail price caps for business customers are not delivering fair prices and are constraining competition.

The UK Water Retailer Council’s (UKWRC) response to Ofwat’s REC review consultation urged the regulator to set out a pathway to a more competitive market – as seen in other sectors where businesses do not benefit from price protections – with transitional steps to achieve this. It disputed the premise that small customers may never be engaged in the market because their bills are too low, pointing to Everflow’s success in this space. It has secured 7% of the market from a standing start, and half its customers consume less than 0.1Ml a year.

The UKWRC consultation response sets out the following key points:

Unengaged customers – interim price protection for Group 1 customers is acceptable, if it:

• Features fairer, cost reflective pricing – moves away from the use of ‘efficient’ average costs as a means of setting maximum retail price caps, to an approach that allows all customers the opportunity to participate in the market, regardless of their service choices; removes cross- subsidies and so is fairer to all customers; and provides the opportunity for retailers to incentivise customers to be more efficient – both in terms of their water use, and their billing and payment behaviours.

• Makes the market more attractive to new entrants and allows existing players to be more innovative, efficient and responsive to customer needs – e.g. removes historic billing and payment method benchmarks, and facilitates tariff innovation and the provision of water efficiency support to customers.

• Is more flexible – so it can adapt to changes in economic conditions and underlying costs, as prices do in competitive markets, and gives retailers a route of appeal to the Competition and Markets Authority in the same way as other utility sectors, in the event of a dispute. 

• UKWRC also said Ofwat’s proposal to replace the variable element of the Group 1 allowances with a series of entirely fixed bands to incentivise greater water efficiency would not solve the problem. “Instead, it would create unnecessary complexity for customers as well as weakening the incentive on them to reduce their consumption.” 

Group 2 – This covers a hugely diverse range of customer types and sizes, from those with bills of £2,800 to £180,000. These customers have very different cost-to-serve profiles and the average approach leads to considerable cross subsidy within the group, which is unfair.

UKWRC proposed: “As a minimum the Group 2/3 threshold is reduced to 5Ml, and that consideration is given to reducing it to 1Ml, so that the price controls are removed from a proportion of mid-large Group 2 customers. For the remaining customers in this group, we believe that a backstop price designed to safeguard those who are unengaged would be fair to customers and conducive to competition, removing cross-subsidies and increasing the scope for new entry and innovation.”

Retailers argued that if the Group 2 upper threshold was brought down to 1Ml, it may be possible to have a generic backstop price based on the current Group 1 methodology. If the threshold remains above 1Ml, use of a gross margin backstop should continue “but we need to ensure that it is set at an appropriate level to reflect the costs of the revised customer group”. 

Group 3 - UKWRC supported Ofwat’s proposal of no change.

Bad debt – This is a particular problem for retailers. They called for the REC review to: 

• Adequately reflect the magnitude of the costs incurred by retailers for specific customer groups with higher propensity to pay late or to leave without paying, so that retailers are able to charge customers appropriately. 

• For a subset of customers who never pay and cannot be disconnected (for instance, where the wholesaler is unable/unwilling to disconnect because of shared supplies etc), the market code should be changed so the retailer is no longer liable for the wholesale charges associated with this site. Wholesalers could spread the cost across the wider customer base in a way that retailers cannot.

Non-price protections – Retailers would like these moved out of the REC and into the Customer Protection Code of Practice. Given Ofwat intends to stick with its ‘no worse off’ principle, retailers said this should be updated to mean customers will be no worse off in 2027 (when the new REC comes in) than they are currently, instead of meaning no worse off in 2027 than before market opening. Retailers said looking back a decade lacks relevance given market developments and in particular wholesale price increases.