Millions of households could see their energy bills slashed under proposals to cap prices after the competition watchdog found suppliers have been overcharging customers by around £1.2 billion a year.

The Competition and Markets Authority (CMA) said it was considering setting a maximum price limit for standard variable rate tariffs, which could see prices cut or frozen for around 70% of customers with the big six providers.

Its year-long inquiry into the energy sector found tariffs offered by the main suppliers - British Gas, SSE, EDF Energy, RWE npower, E.ON and Scottish Power - were overcharging customers by around 5%.

This means residential customers have been overpaying by around £1.2 billion a year - an estimated £40 per household.

The CMA outlined plans to encourage customers to switch, but stopped short of recommending a break-up of the energy giants, saying competition in wholesale markets was working well.

It said it uncovered "widespread consumer disengagement", with the majority of customers on default standard variable rate tariffs despite better deals available.

More than a third - 34% - of 7,000 people polled by the CMA have never considered switching, according to the report.

It found dual fuel customers could save an average of £160 a year by switching to a cheaper tariff but often failed to do so because of a lack of awareness of which deals are available, "confusing and inaccurate" bills and worries over the difficulty of changing supplier.

Roger Witcomb, chairman of the CMA energy market investigation, said: "There are millions of customers paying too much for their energy bills - but they don't have to.

"Whilst competition is delivering benefits to increasing numbers of customers, mainly through the growth of smaller suppliers with cheaper fixed-price deals, the majority of us are still on more expensive default tariffs."

He added: "The confusing way energy is measured and billed can make comparing deals understandably daunting.

"The result is that some energy suppliers know they don't have to work hard to keep these customers."

Consumer group Which? called the report "a damning indictment of how the energy market is failing consumers" and welcomed plans to put a limit on variable rate deals.

But British Gas owner Centrica said it had "questions and concerns" over some of the proposals, while the GMB union dismissed the provisional findings as "tinkering".

Under the most radical of its proposals, the CMA will look at temporarily scrapping "relatively high priced" variable rate deals and replacing them with capped "safeguard" tariffs until competition is working as it should be in the market.

This would provide "direct protection" to so-called sticky customers who fail to switch, some of whom are on low incomes or are vulnerable, including those on pre-pay meters, according to the CMA.

But it cautioned over potential risks from introducing price controls in the energy market.

Mr Witcomb said: "We wouldn't introduce such a move lightly and would need to consider its effect on competition, but it is something we feel is right to look at closely."

In direct criticism of energy regulator Ofgem, the CMA said it planned to scrap recently introduced rules restricting suppliers to offering just four tariffs, saying they have in fact ended up reducing competition.

Its report found the introduction of the four-tariff rule has led to a number of the big six energy firms withdrawing a number of tariffs and discounts, which may have made some customers worse off.

The CMA said it also would focus on measures to prompt customers to shop around, such as by using smart meters, which allow households to monitor what they are using and when.

Smart meters are already being rolled out nationwide to the majority of UK households by 2020.

The CMA also plans to make changes to the way the market is regulated, with Ofgem potentially running its own independent price comparison service to help boost switching.

But the report has not recommended that the big six should be dismantled to separate power generation and supply.

There were fears that the firms were colluding to increase profits by using their so-called vertical integration benefits - where they own both power generation and supply businesses.

The CMA said: "Competition in the wholesale gas and electricity generation markets works well, and the presence of vertically integrated firms does not have a detrimental impact on competition."

It added there was no strong case for returning to the old "pool" system for the wholesale electricity market.

Iain Conn, chief executive of Centrica, said: "We welcome the possibility that this review will have a constructive and positive influence on competition in the energy market.

"While we have questions and concerns about some of the proposals we look forward to engaging with the CMA in the next phase of this process."

The CMA probe into the energy market was launched in the wake of a pledge by Labour in 2013 to freeze prices if it won this year's general election.

Suppliers have eagerly been awaiting the outcome of the report, which had the potential to drastically change the shape of Britain's energy market.

While the CMA did not find the need to break up suppliers, its findings on pricing and competition in the supply market made for painful reading for the big six.

Its research found that while residential customers were being overcharged by around 5% between 2009 and 2013, small businesses were paying around 14% more.

This means residential small firms are forking out around £500 million too much a year for their energy.

But it found smaller energy suppliers competing with the big six often offered cheaper prices, with the lowest tariff offered by these firms £30 to £40 lower than the least expensive tariff offered by the big six.

The CBI business group said the investigation was a "good opportunity to restore public confidence in the energy market".

But Gary Smith, GMB national secretary, said: "As we fiddle about trying to fix a market that doesn't actually exist, we are losing generating capacity and can't get new power stations built."

He added: "The whole process is little more than fiddling whilst providing a convenient smoke screen for the Government's betrayal of the UK energy sector and and manufacturing supply chain."

Electricity prices have risen by around 75% and gas prices by around 125% in the last 10 years, according to the CMA.

It said moves towards cleaner energy were needed, but would have a "significant" impact on driving up bills.

Mr Witcomb said: "We need to ensure that the process of bringing clean electricity into the market is carried out efficiently and transparently and at the lowest possible cost."

He added that there also needed for greater transparency in the market to address a lack of trust.

Energy watchdog Ofgem welcomed the CMA's findings, adding: "We will work with them, to develop and implement their final remedies, where they fall within our jurisdiction, to deliver a more competitive market for consumers."

The CMA said its investigation saw it survey 7,000 residential energy customers, while it received more than 100 submissions from interested parties, such as energy suppliers, government and consumer groups, as well as academics.

It will now consult on its proposals and publish a final report before the end of the year.

David Cameron's official spokeswoman made clear that the Prime Minister does not favour a cap on energy prices.

The spokeswoman told a Westminster media briefing: "The starting-point here is how do have a competitive market that keeps bills down and makes it simpler for consumers to switch? The PM's view on a price cap hasn't changed. He doesn't think that price regulation across the market is the right approach.

"(With) those consumers who can't or won't switch or are vulnerable consumers, we are looking at efforts and steps needed for them."

The CMA's report was "an important milestone" and ministers will consider its provisional findings and "look at what further action can be taken to make sure we are delivering a fair deal for consumers", she said, adding: "The Prime Minister has been clear that we should be doing more to make sure that consumers get a better deal."

The spokeswoman said that actions taken under the coalition had helped 1.5 million consumers switch electricity supplier during the first half of this year. And she said that more than £38 million was saved by 130,000 households who switched during a single month of a Government campaign on the issue.