Why an Expensive Gas Supplier Might Be a Rational Choice

Even the German chancellor is not exempt from losing track of the complex details of the gas price cap. Recently, Olaf Scholz mistakenly concluded from the regulations, in effect since March, that households “do not have to pay more than twelve cents per kilowatt hour.” But that is not correct. The cap actually entails households receiving a payment based on 80 per cent of the previous year’s heating gas consumption multiplied by the customer’s current gas price minus twelve cents, irrespective of current consumption. Every kilowatt hour consumed today must be paid according to the current tariff.

The gas price cap, proposed by the German expert commission on gas and heating prices (“Gas und Wärme”), aims to encourage energy conservation by offering full price savings for each unit of gas reduced. However, it also has undesired side effects.

Specifically, it significantly diminishes the incentive to switch to a cheaper supplier. The government subsidy received is directly linked to the customer’s current contract price, meaning that higher prices result in a larger subsidy. This is particularly attractive for households consuming less than 80 per cent of their previous year’s usage. They receive a subsidy based on 80 per cent of their consumption but only pay for their current usage. In that case, it may even be rational to choose the most expensive gas provider available. The situation is similar with the electricity price cap, which stands at 40 cents per kilowatt hour.

Competitive pressure emerges in a market when consumers switch providers due to poor performance or high prices. When there is little or no willingness to switch, companies feel less pressure to lower their prices. This is evident in Germany, as reported by the consumer association last year, stating that “switching providers came to a standstill”. Only recently has there been an increase in switching activity.

Currently, gas suppliers charge existing customers prices above the mentioned twelve cents. This means that the high costs from long-term contracts are at least partially passed on. The households affected are often long-term customers with little willingness to switch. They accept higher prices – also in view of the search and transaction costs – despite the presence of many new competitors offering prices below twelve cents.

So, what can be done? One obvious solution to enhance the willingness to switch is to simplify the process for electricity and gas customers. For instance, Klaus Müller, the President of the Bundesnetzagentur, proposes reducing the time limit for switching suppliers from ten days to 24 hours.

However, it’s important to acknowledge that past negative experiences have also contributed to customer inertia. Many consumers still recall how gas discounters abruptly terminated contracts for numerous households at the start of 2021/22. Improving transparency and providing better information about the legal situation could address this issue. For instance, customers now have the option to choose basic supply when terminating their contract, rather than being forced into costly substitute supply. Moreover, companies are no longer allowed to differentiate between existing and new customers in their basic supply tariffs.

In conjunction with the price cap, politicians have implemented a limit of 50 euros for switching premiums. This measure aims to prevent suppliers from luring new customers with high bonuses and then taking advantage of public subsidies by charging excessive prices above the price cap. However, it is necessary to consider the trade-offs involved. Since prices for new contracts have significantly decreased, removing the bonus restrictions could promote greater competition in the electricity and gas market, potentially resulting in lower prices.

Nevertheless, the Federal Cartel Office also bears responsibility in this matter. Not only is it considered an abuse of market power to unjustifiably raise prices, but failure by suppliers to lower prices when feasible can also attract scrutiny from competition watchdogs. In December, the Cartel Office initiated the establishment of a department dedicated to monitoring the prohibition of abuse concerning gas, electricity, and district heating price caps. This represents an important step, despite the challenges of substantiating violations.

The energy price cap, effective until 30 April 2024, has alleviated the financial burden on many households. Nevertheless, we should take away valuable insights for future policies from its confusing design and unintended side effects.