Moving to outcomes-based retail regulation: three questions to consider

Ofgem has recently consulted on how to implement outcomes-based regulation of the retail energy market.

Ofgem has said a change to the regulatory regime is needed because detailed rules have become complicated and overly burdensome, have not consistently delivered good consumer outcomes and may struggle to keep pace with the new types of products and services emerging. Ofgem’s consumer-outcomes proposals set out a vision for a framework which is intended to give suppliers more freedom over how they serve customers, in exchange for stronger accountability for the outcomes customers actually experience.

The idea of outcomes based retail regulation is not new. In the mid-2000s, Ofgem tried to move towards a less prescriptive, more principles-based approach to retail regulation. This was subsequently followed by the Energy Supply Probe and Retail Market Review, which saw the sector move back towards more detailed rules. This does not undermine the case for outcomes-based regulation, but it does mean that the implementation questions being considered by Ofgem now are particularly important. Designing and implementing a new regulatory regime is a difficult task. Ofgem’s proposals sensibly recognise that developing a new regime will take time, and its staged approach builds in scope to test, learn and adapt the framework over time.

Ofgem proposes to start its implementation of its new approach with billing, using it as a first test of the new approach. Looking beyond that initial phase, three questions stand out.

How will fair value be assessed?

Ofgem’s initial proposals suggest consumers should pay prices that represent ‘fair value’, with actual prices paid monitored against the Default Tariff Price Cap. However, this may be too limited an approach. First there is the issue of timing. Since the cap changes over time as market conditions evolve, this comparison will need to focus on the information reasonably available to customers and suppliers at the time the contract was entered (‘ex ante’). Second, the comparison also may not be meaningful for differentiated products. A tariff may sit above the cap for a variety of reasons such as providing longer-term price certainty, more complex time of use structures or services bundled with the energy contract. The fair value test will need to consider the additional benefits and risks of those products, and consider how to make the default tariff comparison (e.g. is it a screening tool to highlight potential issues for investigation or a mechanistic benchmark?). It risks failing to be an appropriate benchmark for all but the most vanilla of products.

How should supplier responsibility be defined?

Ofgem’s proposal that consumers should receive information that supports genuine understanding and informed choices is sensible. Suppliers clearly have a responsibility to provide consumers with clear, accurate and understandable information. But different levels of supplier responsibility are possible – for example a supplier might explain clearly how a dynamic tariff works and that savings depend on shifting consumption, or go further by considering whether a particular consumer is actually able to shift their demand. Even if the appropriate level of information is agreed, monitoring of achieved outcomes will need to draw the line between suppliers ensuring that customers have the information needed to make an informed choice and being held responsible for ensuring that they ultimately make the best choice, or achieve the expected benefits (e.g. by shifting their demand).

The increasing use of AI may also complicate what constitutes sufficient information. Where AI is used to make recommendations, consumers may need to understand not just the product being recommended, but what the recommendation is seeking to optimise and the trade-offs involved. In some cases, customers may use AI that is outside of the supplier’s control to make decisions – which blurs the lines about what suppliers can be held accountable for. 

How will the framework assess compliance without recreating prescription?

Moving away from prescriptive rules also changes how suppliers demonstrate that they have complied. Under detailed rules, compliance can often be shown by demonstrating that a specified process has been followed. An outcome is less straightforward as it often relies on evidence of the outcomes consumers actually experience. And as AI is increasingly used in ways that affect those outcomes, Ofgem may also need visibility over what those tools are designed to optimise, the trade-offs they make and the guardrails applied to them. This makes the balance particularly important: Ofgem needs to be clear enough about the evidence it expects to assess compliance, without those expectations becoming detailed requirements about the processes, systems or governance suppliers put in place. If demonstrating compliance requires suppliers to adopt particular systems, customer journeys or metrics, prescription could re-emerge through the compliance framework rather than the rules themselves.

Finding the balance

These are tricky questions which may not have a single answer and will likely evolve as the framework is developed. However, a successful framework will need to create the conditions for trust on both sides. Suppliers need enough certainty to understand the boundaries within which they can innovate, and enough discretion to do so, and Ofgem needs sufficient oversight and safeguards to be confident that this flexibility is delivering good outcomes for consumers.