A new direction is needed for retail energy regulation

While energy news has been dominated by talk of last week’s blackout, there have been some important developments in the retail space which are worth highlighting, and which underline the need for a new direction in retail energy regulation.

Earlier this month Ofgem announced the first reduction in the retail energy price cap since its inception, although researchers at the Universities of Exeter and Warwick believe the cap is stifling competition.

The Big 6 all continue to suffer in their retail businesses, with SSE confirming that it is in talks with Ovo Energy regarding the sale of its consumer segment, while three small energy companies have all ceased trading – minnow Cardiff Energy Supply closed its doors, while Solarplicity and URE were both forced to exit the market, the former due to failure to meet its Feed-In-Tariff obligations, among other things, while the latter has had its supply licence revoked after failing to meet its Renewable Obligation.

A new direction is needed for retail energy regulation. The price cap should be abolished and replaced with new obligations on suppliers to inform consumers about alternative, cheaper tariffs when their contracts expire, or at least annually for those on standard variable tariffs.

And all non-supply related obligations should be removed from suppliers, allowing them to focus on the supply of energy to consumers, and whatever ancillary activities they choose. This would mean an end to recovering policy costs through energy bills, and no more responsibility for administering the rollout of smart meters and other energy-related schemes devised by governments from time to time.

Allowing suppliers to focus on energy supply without these other obligatons would make tariffs more reflective of the actual costs of energy supply, and would stimulate innovation as resources are no longer diverted to policy-driven activities.

Small suppliers struggle with a difficult market and regulatory burdens

Cardiff Energy Supply became the fourth energy supplier to case trading in 2019, after Economy Energy, Our Power and Brilliant Energy, saying the reasons for its closure were “complex and in part personal”. The company served only 815 customers who have been transferred to SSE as the supplier of last resort (“SoLR”). The two other closures this month both relate to failures to meet regulatory obligations.

Solarplicity finally closes after struggling for some time

There has been a lot of noise around Solarplicity in recent weeks, in part because of the large number of related companies, several of which have been the subject of winding up orders by HMRC as a result of failing to file their accounts. Some of these have entered administration according to Companies House, and an additional winding up order was expected in respect of Solarplicity Supply Limited whose accounts were also overdue.

The late filing of accounts might suggest financial difficulties, however, the company had said there was no specific reason for the delay, and that the accounts are with the auditors for signing.

“They have not suggested any changes to what Solarplicity originally submitted. As such, we expect to be able to be in a position to sign off these accounts very soon.”

However the company has since announced that it would cease trading.

Problems at the group, which also installs domestic solar panels, have been brewing for some time. In February it was restricted by Ofgem from taking on new customers for 3 months due to high levels of complaints and problems with switching. Solarplicity was the subject of a very large number of complaints to the Energy Ombudsman with over 3,000 complaints since the beginning of the year and 583 in July alone – generally a sign of trouble in a supply business. The company agreed not to take on any new customers until early August other than those joining through community energy schemes.

In May, Ofgem also issued a provisional order against Solarplicity Supply after it failed to make a number of feed-in tariff (“FIT”) payments. Ofgem was told by several FIT generators that they had not received the FIT payments due to them for Quarter 3 of FIT Year 9 (1 October 2018 – 31 December 2018). Many payments due by 21 February 2019 were also not made. Solarplicity entered into payment plans with some of the affected generators, however it then failed to honour the terms of these.

At the beginning of August, Ofgem confirmed the provisional order, requiring the company to make all existing and future FIT payments when they become due, and to immediately make any payments that are overdue; to continue to provide a weekly report to Ofgem evidencing that FIT Payments are being made on time; and not to give preference to any FIT generator that is in any way connected with the company.

Failure to make FIT payments under these circumstances was a further sign of financial distress, and at the end of July, the company agreed to sell around 43,000 of its 60,000 customers to rival Toto Energy. Just over a week later, it confirmed that it was exiting the Utility Services and SPTMY businesses and restructuring the company to focus on its core operations in renewable energy.

“First and foremost we are a renewable technology business striving to fight fuel poverty and make renewable energy available to everyone. We will be announcing exciting new developments for our business as well as for our retail energy customers in the coming days.”

The arrangement with Toto Energy was not without problems, with some of the transferred customers continuing to be charged by Solarplicity after the move. Solarplicity was reported to be experiencing problems with its billing systems with some customers having bill payments under direct debit taken twice.

On 13 August, it announced the rest of its supply business will close, with Ofgem determining that EDF will take on those customers that were left with the company at the time of its closure.

“The large number of small energy suppliers and the harsh way the market is regulated make it difficult for companies like Solarplicity to survive. Ofgem’s recent actions stopped it from raising the funding it needed, unfortunately leaving it no option but to cease trading,”
– Solarplicity

Solarplicity has been highly critical of Ofgem’s approach to regulating the business, and has suggested that business models for smaller suppliers are unsustainable against a backdrop of over-crowding and onerous regulation.

URE Energy joins the list of suppliers closing after failing to make RO payments

URE was one of a number of suppliers that failed to meets its commitments under the Renewables Obligation (“RO”) scheme last year. 14 suppliers failed to make their RO payments by the late payment deadline of 31 October leading to a record scheme shortfall of £58 million.

Three suppliers, Ampoweruk (£368), Brilliant Energy (£77,446) and Planet 9 Energy (£1) paid in full after the deadline, although two of these have since ceased trading. Enforcement action was launched in November against Economy Energy (owing £15.7 million to the RO and £1.4 million to RO Scotland (“ROS”)), and Spark Energy (owing £13.4 million to the RO and £1.0 million to ROS), both of which subsequently ceased trading.

A further six suppliers ceased trading while in default of their RO/ROS payments: Future Energy Utilities (owing £0.6 million to RO and £322 to ROS), GEN4U (owing £19,143 to RO and £782 to ROS), Extra Energy Supply (owing £14.3 million to the RO and £1.3 million to ROS), Iresa (owing £8.9 million to RO and £0.6 million to ROS), Electraphase (owing £0.2 million to the RO, £6,765 to ROS) and Snowdrop Energy Supply (owing £0.2 million to the RO and £736 to ROS);

Click Energy (owing £0.8 million to NIRO) was referred to the Utility Regulator in Northern Ireland (mutualisation does not apply to the Northern Ireland fund), and in early August, the regulator issued a consultation to confirm the provisional order it issued against the company. Last year was the second consecutive year in which Click had failed to meet its RO payment obligations.

Two suppliers were placed on payment plans, with a requirement to make monthly payments to clear their obligations by the end of March: URE Energy (£209,014) and Eversmart (£367,150). Eversmart confirmed back in April that it had made its outstanding payments, however URE continued to be in breach of its obligations.

On 8 March, Ofgem issued the company with a final order requiring the supplier to pay the outstanding amount by 31 March. As no payments were made, Ofgem has now revoked the company’s supply licence, effective from 14 September. Its gas supply licence has also been revoked. There has been speculation that the URE essentially ceased trading back in December, although its accounts, filed in April this year, make no mention of this.

In total, of the 14 suppliers in default of their payment obligations under the RO, only 3 are still trading (Ampoweruk, Eversmart and Click Energy), and one of these (Click Energy) is still at risk of having its licence revoked.

More suppliers may be at risk

Consumer advocacy platform A Spokesman Said has reported that half of energy suppliers could fail over the next few years due to overcrowding in the market. Mark Todd, co-founder of comparison site Energyhelpline, warns that more firms will go out of business in the next few years.

“With the energy price cap dropping, and even huge suppliers such as npower, British Gas and SSE all in trouble, we are expecting a spate of suppliers to fold or exit the market over the next six months. We are expecting a dramatic change this autumn and it could be something like a Game of Thrones showdown. At 60 suppliers there are simply too many for the market to sustain. This is likely shake down to 30 to 45 over the next few years in a huge consolidation. Prices are likely to rise with more bankruptcies as competition weakens,”
– Mark Todd, Energyhelpline

Smaller suppliers often seek to compete on price, under-cutting their competitors in order to gain market share, however, these low prices tend to be unsustainable, particularly as smaller companies struggle to hedge against wholesale price rises. Fast acquisition of new customers on cheap tariffs can be difficult to manage operationally, so problems with billing can lead to complaints, which attract the attention of the regulator. The significant regulatory obligations they face can also present challenges, as seen above.

In April, Ofgem announced a tougher regime for new energy suppliers to try to ensure they have sufficient resources to operate effectively in the market – when a supplier fails customers can be moved onto more expensive tariffs by their new supplier, and the costs of supplier failures are borne by consumers.

These stricter rules are welcome, but reflect the fact that the retail energy market is challenging. It is ironic that while promoting competition is at the heart of retail energy regulation, the design of the regulatory landcape is in many ways itself inhibiting competition.

Big 6 also finding the market challenging, blaming the price cap

The Big 6 suppliers are not immune from the difficult trading environment, with all of them continuing to lose customers and money in their retail supply businesses.

Centrica moves into a loss as CEO Conn steps down

Iain Conn has agreed to step down as chief executive of Centrica after the company moved into a loss for the first half of this year with the company’s market value just a quarter of what it was when he took the job in 2015. Since then its retail arm, market leader, British Gas, has lost over 1 million customers and made thousands of staff redundant, however, many argue that the seeds of the problem were sown when his predecessor, Sam Laidlaw, invested heavily in oil and gas production and focused rather less on the growing markets for renewable energy.

Under Conn, Centrica has followed a strategy of moving away from traditional energy businesses towards selling energy services and devices, with plans to sell its nuclear, oil and gas business units to pay off debts. Supplying power to British homes now generates only 15% of Centrica’s operating profit.

City analysts are reportedly unconvinced that the plan will be effective, but this might be a timing issue – traditional supply, particularly to domestic consumers, is a low margin business, and over time, higher-value services may well prove to be more lucrative. Centrica’s new deal with Ford to provide electric vehicle tariffs and charge points was an example of the company’s new approach.

Conn had predicted that the “smart home” business, which includes its Hive smart thermostats, would generate £1 billion in revenues by 2022, however so far the business is only generating a fifth of what he predicted.

“Energy customers are interested in more than just energy. Some of our customers only want energy at the cheapest price and they don’t care who it comes from. But others actually want more than energy. They’re willing to buy insurance services from us; boiler cover, home cover, Hive [smart meters]. They are taking an interest in the things that help their lives run better. Converting energy customers into customers for new propositions is the direction of travel. We have gone from energy company to energy and services company. One day, we might be a services company with energy as one of those services,”
– Ian Conn

The company posted a pretax loss of £569 million for the six months to 30 June compared with a profit of £415 million last year, citing an “exceptionally challenging” environment including the government price cap and additional pension contributions. Although British Gas lost 178,000 UK home energy supply accounts over this period, the figures mark a slowdown in losses compared with recent years.

npower losses widen while all options for the business are considered

Losses at npower increased in the first six months of this year as customers continue to leave. Half-year results from its parent company Innogy SE show the UK retail arm lost €81 million in adjusted earnings before interest and tax, compared to a loss of €18 million for the first half of 2018.

The results state that the “main negative impact” on its earnings was from the energy price cap and lower customer numbers, with npower losing around 135,000 electricity customers in the first six months of this year, down from 2.43 million in December 2018.

In January, the company announced around 900 jobs were due to be cut because of the “extremely tough UK retail energy market conditions”. In March, Bernhard Günther, Innogy’s CFO, said the company was still trying to sell npower, but that all options for the company remain open, including winding it down.

E.On sees profits fall in an “unsustainable” market

E.On has blamed “keen competition” and the increase in the level of the price cap as its UK earnings slumped by £77 million. Its customer solutions business in the UK “remained under considerable pressure” after UK sales fell by £173 million decline over the three months to March 2019. Adjusted earnings before interest and tax in the UK business fell from €202 million to €71 million in the first six months of the year, as company lost about 400,000 of its 4.3 million British customers.

E.On’s CFO has said that regulators needed to realise that the current system is “unsustainable”:

“For decades, Britain stood for a reliable energy policy. For about two years we’ve been seeing the exact opposite,”
– Marc Spieker, E.On CFO

EDF and Scottish Power both see sharp declines in UK profits

EDF has attributed a sharp decline in UK profits during the first half of 2019 to a “deterioration of conditions” in the market including the introduction of the cap on standard variable tariffs, suspension of capacity revenues and a downturn in nuclear generation.

Earnings before interest, tax, depreciation and amortisation for the group’s UK operations was down by a huge 75.9% in organic terms to €128 million in H1 2019, compared to €485 million for the first half of 2018.

EDF’s UK sales saw a slight decline in the first half of the year, down 2.2% in organic terms as it lost 200,000 customers in 2018 – EDF Energy’s residential accounts for gas and electricity fell to 4.9 million combined.

The company also said the suspension of payments under the capacity market had cost it £69 million pounds.

Scottish Power announced the loss of 120,000 customers in the year to June, to 4.75 million, as price competition saw customers switching to other firms. Its pre-tax earnings in the division including electricity and gas retail fell by 71% to £49million.

SSE profits fall as a sale of its retail business to Ovo is mooted

SSE’s pre-tax profits fell by 38% to £725 million in the year ending the 31 of March 2019, as a result of increased competition and rising costs, driven by new regulation such as the energy price cap and higher gas prices.

The company’s household electricity customer accounts dropped from 3.82 million to 3.46 million over the period, while gas accounts fell from 2.53 million to 2.32 million, leading to a drop in profits in its household energy supply business from £278.7 million to £89.6 million.

SSE has confirmed last weekend that it is in talks with Ovo Energy as it attempts to exit domestic energy retail. The company has been seeking buyers for its domestic retail book since it abandoned plans to merge the business npower last December.

“SSE is actively progressing a number of options for the future of SSE Energy Services, having determined that its best future lies outside the group. In line with this, and noting recent media speculation, SSE plc can confirm it is in discussions with Ovo Group over the possible sale of the SSE Energy Services business, which supplies energy and related services to around 5.7 million household customers across Great Britain. These discussions are continuing, however no final decisions have been taken and no agreements regarding the terms of any transaction have been entered into.”

The company said it would provide no further comment on the talks until a conclusion has been reached.

If it goes ahead, this deal could see Ovo buy SSE’s retail arm for a reported £250 million, to become Britain’s second largest supplier behind British Gas. SSE has 5.7 million energy customers , which would give Ovo around 7 million in total post merger. Ovo has grown to become one of the main challengers to the Big Six, and received a boost earlier this year when giant MItsubishi acquired a 20% stake in the business, valuing it at around £1 billion.

Former npower CEO Paul Massara has suggested that Ovo appears to be taking advantage of a “depressed market” in a move he described as “audacious and bold”:

“If someone has got a long-term vision or strategy then this probably isn’t a bad time to be buying something. I see this as Ovo believing that the future market will be one that sells services and electric vehicle (EV) charging and essentially maximises and optimises homes. They have got a view that they will be more innovative. They want to essentially be able to integrate EV charging, batteries, solar, water heaters and manage all of that for somebody’s home and if you want to do that you need to have scale and so this is a chance to get scale in one swoop. Essentially they have structured a deal which is a cheap way in terms of getting a big base.”

Massara does however have concerns about SSE’s IT systems and how this could be potentially problematic for the buyer, something that has led to the downfall of challenger firms in the past.

There are differences of opinion in the market as to whether taking SSE’s slot in the Big 6 would undermine Ovo’s innovative business approach as it takes on a larger and more conservative customer base. It may struggle, as the Big 6 suppliers have done, to continue its focus on smart energy.

There are also questions about whether other interested parties might emerge, and if there could also be potential buyers for npower. The only other mid-sized energy business with the potential scope to make an acquisition of this size would be Shell, through its First Utility business, however another oil major or even a technology company might see an opportunity to enter the space. Oil majors may decide, as Shell did, that this would provide a hedge against the threat potential climate action poses against their traditional businesses, while technology companies might see this as a means of capturing a customer base for home energy services.

Meanwhile new research suggests the price cap is also harming consumers

Ofgem has announced the first fall in the retail price cap since its introduction, telling suppliers to reduce the bills of customers on their standard variable tariffs (“SVTs”) by 6% from 1 October. This follows a drop in wholesale gas and power prices this year and would see the price cap for average annual consumption fall by £75 to £1,179. In April the cap was raised by more than 10% to £1,254. Around 11 million customers are on SVTs.

Last month, the Competition and Markets Authority reduced the pre-payment meter cap by £25 a year, affecting a further 4 million customers.

The news of this reduction in the price cap came at the same time that academics at the universities of Exeter and Warwick have found that the price cap is undermining competition in the market leaving consumers worse off, particularly vulnerable people who are less likely to switch tariffs. This is because all energy suppliers are “pricing to the cap” – in other words, sticking to the maximum level.

The study, Energy Price Cap – a Disservice to Consumers is published in the Journal of European Consumer and Market Law, and points out that the fact some customers are prepared to pay a higher than necessary price does not in itself indicate market failure, as cheaper tariffs are readily accessible to many consumers and energy firms have made it easy for them to switch.

“The Government seems to have assumed the energy market is broken, this is wrong. The move to cap prices was meant to increase competition, but it will have the opposite effect. Consumers will have less incentive to switch providers as fewer savings can be achieved through switching, while providers are likely to set prices towards the maximum ceiling of the price cap, further diminishing potential gains from switching,”
– Dr Timothy Dodsworth, University of Exeter Law School

The study suggests it would be better to instead regulate the way consumers renew their contracts with their gas or electricity suppliers, requiring suppliers to contact the customer at renewal to tell them if they should move to a different, potentially cheaper contract. The regulator could support vulnerable customers by referring them to social services or by placing them on a pre-payment meter.

Dr Dodsworth went on to say that consumers can be nudged towards making “better” choices through provision of better information. The existence of the price cap might lead some people to think they don’t need to keep switching to get a better deal because the regulator is protecting them instead, which is not the case.

This echoes analysis carried out by The Energy Shop, a comparison website, which calculated how much money customers would have saved if they had simply switched to the best deals on the market rather than stay on their current tariffs. It found that they could have saved £214 if they had switched in January, however if they remain on the default tariff from now until October, they will be paying £33 a month more. Once the new cap comes in, they would still be £27 a month worse off – instead of relying on changes to the price cap, customers should shop around for cheaper fixed-rate deals.

“The new level of the cap will reduce energy bills by 3.4% compared with where they were before the cap came into effect. Coincidentally standard variable tariffs are right back to where they were at this time one year ago. A reduction in the energy cap might make for nice headlines, but it doesn’t get away from the fact that it is a really lousy deal for energy consumers. Worse still, it creates a false sense of security that you are getting a good deal when the reality is the opposite,”
– Joe Malinowski, the founder of the Energy Shop

None of this is surprising, and largely bears out the findings of this 2017 report by KPMG into the possible impact of a price cap, prior to its introduction. Not only is the price cap not helping consumers to save money, it is also harming competition, as expected before its introduction, and as suggested by the previous experience with the prepayment meter cap.

Will the new Government herald a change in retail energy regulation?

Boris Johnson’s government is all about Brexit, so it is hard to see many changes in energy policy in the short-medium term. The dying days of the previous administration saw the launch of several consultations, including one into ‘Flexible and Responsive Energy Retail Markets’. The consultation suggests that retail market design, including the “one size fits all” supply licence, may be starting to hold back progress by preventing some consumers from benefitting from innovation, and is slowing down de-carbonisation.

“We want a future energy retail market where innovation brings greater choice to consumers, allowing them to take advantage of the increased flexibility and lower costs of the smart, low carbon energy system. It is also a market where a combination of healthy competition and appropriate safeguards ensure that all consumers pay a competitive price for their energy and consumers in vulnerable situations are properly protected,”
– BEIS, Ofgem

The consultation recognises that some policy costs are applied disproportionally to larger suppliers, which creates market distortions, where the prices those suppliers set to recover these costs can be uncompetitive for reasons that do not reflect the underlying efficiency of their businesses.

However the overall tone is still that competition is not working well for all consumers and that further regulatory interventions may be needed to correct this, and there is an ongoing assumption that success will be viewed as vulnerable consumers in particular beginning to engage in energy markets.

This is disappointing. The analysis described above clearly indicates that the Government’s assumptions around the perceived failures of the retail market are wrong. It is likely that there will always be consumers who are unable to or simply chose not to engage in the markets, and this is not necessarily a sign of market failure.

The proposals to remove customer thresholds for some policy costs are positive, as are any moves that remove artificial differentiation between suppliers, however that would make life still more difficult for new entrants that already struggle with a complex regulatory regime.

A more radical and effective approach would be for these costs to be removed from bills altogether and recovered through general taxation. This would allow vulnerable consumers who are outside the income tax regime to be exempt from these costs, while simplifying energy bills aligning them better with the costs of supply faced by the suppliers. The “polluter pays” principle is ineffective among consumers who have little discretion over their consumption, being at the limit of affordability and lacking the resources to invest in efficiency measures such as new appliances or home improvements.

This would therefore benefit vulnerable consumers whose bills would fall, and although smaller suppliers currently benefit from some exemptions they would avoid the complexity of administering the recovery of those costs from which they are not exempt. Larger suppliers would face a more level playing field, as all suppliers would base their tariffs on their actual costs without having to exclude charges that are outside their control.

The price cap should also be abolished, and replaced with new obligations to provide simple and clear information to customers about alternative tariffs, as their contracts expire (and at least annually for those on standard variable tariffs). The responsibility to install smart meters and administer various other energy-related policies should also be removed from suppliers.

Streamlining the retail energy sector so that suppliers are able to focus on supply of energy and those energy-related services they choose as part of their business models is likely to stimulate innovation as genuine opportunities for differentiation emerge. There would still be challenges, particularly for new entrants around access to appropriate risk management tools to limit their exposure to wholesale price rises, but removing the many non-supply related obligations would be a huge improvement on the status quo.

Unfortunately, nothing the new Government has said provides any suggestion that it might be thinking along those lines, and to the extent the focus is on Brexit, it seems unlikely that there will be any radical changes in the direction retail energy policy and regulation.