Life continues to be difficult for energy suppliers

Life continues to be difficult for energy suppliers. This week Omni Energy informed its customers that it expects to cease trading by the end of November, and is encouraging its customers to switch before it closes and a Supplier of Last Resort (SOLR) is appointed.

The company primarily supplies customers with pre-payment meters and believes that the SOLR process is poorly suited to these types of customers. It is concerned they may accidentally disconnect themselves, be unable to receive support for any meter problems, or be able to access emergency credit to maintain their supply. It has written to its customers to say that unless they object, they will be switched to another supplier which offers similar capped tariffs.

This is an interesting move, and people in the market have been debating whether it is allowed under the terms of the gas and electricity supply licences, or whether this is a mis-use of customer data under the General Data Protection Regulation (“GDPR”), and in fact the company has admitted that it “may have” breached data rules. Today The Guardian is reporting that Omni Energy has proceeded customers people to other suppliers without their consent, including to troubled supplier Bulb, which is hardly likely to be popular.

An Ofgem spokesperson told The Guardian:

“Suppliers generally cannot switch customers away without their consent, except where a supplier sells some or all of its customer book as part of a trade sale to another supplier.”

Scottish Power is understood to have prevented around 1,600 Omni customers being transferred them and Bulb is also believed to have blocked potentially non-consensual switches. Interestingly, the Omni Energy website still gives the impression the company is accepting new customers.

It’s difficult to see what reasonable sanction Ofgem can apply where energy suppliers act outside their licences when they are on the verge of failure – fines are unlikely to be affordable, and the threat of withdrawing their licences becomes irrelevant when that is likely to happen anyway. It’s possible this was a cynical move to shed high cost consumers in the hope the remaining business might survive, but Ofgem’s actions today have made it clear that this is not acceptable, and the receiving suppliers, who themselves are unlikely to want new high cost customers themselves, are blocking the switches.

This comes after news last week of a supplier failing to honour fixed price business supply contracts, and while there is nothing in energy market regulation to prevent that, it is a breach of contract which leaves the supplier open to legal action.

Unfortunately there is more bad news for electricity suppliers: yet another increase in the Credit Assessment Price, and the likelihood of the highest level of Renewable Obligations mutualisations seen to date.

Credit Assessment Price may increase to its highest ever level

Elexon has announced three further increases in the CAP since I last wrote about the subject. After raising the cap from £96 /MWh to £113 /MWh from 8 September, and then to £113 /MWh from 5 October, three further increases have been announced:

• £137 /MWh from 5 October, replacing the previously announced increase to £113 /MWh
• £184 /MWh from 21 October
• £259 /MWh from 2 November – this change is still subject to a consultation which closes on 12 October

This means that the amount of collateral electricity market participants must provide to Elexon has almost trebled in under two months, and the new amount, if approved, will be highest since the CAP was introduced in March 2001.

The CAP is defined in the Balancing & Settlement Code (“BSC”) as “the price it would be appropriate to use to determine the equivalent financial amount of BSC Parties’ Energy Indebtedness”. The CAP is reviewed if the absolute difference between the CAP and the Reference Price is greater than the current trigger level of ± £18 /MWh. The Credit Committee, which is responsible for all matters under the BSC that relate to the CAP, has decided to escalate the discussion around the current dramatic CAP prices increases to the BSC Panel, so it can review “the CAP process and its sustainability under the current fast market circumstances”.

(The BSC Panel is a group of industry experts and consumer representatives whose role is to govern the BSC and ensure that all Parties comply with its provisions. The Panel assesses BSC rule change proposals (“Modifications”) and votes on whether or not to approve them, and where the change has a material impact on BSC Parties, the Panel makes a recommendation to Ofgem on whether it should be approved.)

The amount of collateral that BSC Parties must pay depends on both the CAP and their levels of imbalance – that is the difference between their actual physical position in each Settlement Period and the amount they had notified to National Grid ESO at Gate Closure in their Final Physical Notifications. For suppliers, those who are able to minimise the difference between the electricity they buy in the forward markets and their actual consumer demand, the change will have a smaller impact than for those who have a larger imbalance.

“We are very conscious that we don’t want to be raising the cap to a point which places an unnecessary burden on suppliers already in a difficult position. It is important that the suppliers’ credit cover is sufficient to protect market participants if the supplier is unable to pay their trading charges, as any charges that are not accounted for with credit cover when a BSC party fails are mutualised across the industry, impacting on the remaining parties and ultimately customers,”
– Peter Stanley, Director of Digital Operations at Elexon

The particularly affects smaller electricity suppliers – some small suppliers do not procure any of their electricity in the forward markets preferring to simply “buy” through the cash-out process. Many small suppliers struggle to hedge their shape risk – that is the intra-day volume variation – because the volumes they need to trade are too small for the market. This means that at certain times of the day they could have large imbalances as a proportion of their overall volumes, increasing the amount of collateral they must pay.

This further reinforces the argument that scale is necessary in order to survive in these markets. Larger suppliers have more resources: they are able to finance some of their activities with debt and letters of credit which in particular can help bridge situations where the price cap limits their ability to recover costs from customers; they have the technical and financial the ability to hedge their market risks effectively; and they can benefit from economies of scale in their back office systems and customer service.

Largest ever Renewable Obligations mutualisation on the cards

If an electricity supplier fails to either submit Renewable Obligation Certificates (“ROCs”) or pay into the buyout fund, the shortfall is recovered from all other suppliers through the mutualisation process if it exceeds the relevant threshold. When the Renewables Obligation (“RO”) was originally introduced, the threshold for England & Wales was set at £15.4 million, roughly 1% of the value of the scheme.

Since then, the scheme value increased significantly, with the value of the threshold falling relative to the total scheme value. The threshold was breached in each of the compliance years from 2017/18 – 2019/20. This year the scheme rules were changed to restore the threshold to 1% of the scheme value, this time explicitly, to avoid the risk of it de-coupling again. The intention was to make mutualisation less common.

From 1 April 2021 until the end of the RO in 2037, the threshold for Scotland will be £1.54 million, and in England & Wales it will be calculated as:

1% x A x B, rounded to the nearest £100,000 with £50,000 being rounded upwards, where:

A is the total obligation, measured in ROCs, for the relevant period; and
B is the buy-out price for the relevant period

However, for the compliance year 2020/21 which ended on 31 March, the old threshold of £15,400,000 (England & Wales) still applies. This means that mutualisation is almost certain to take place given the large number of suppliers exiting the market in addition to a further 5 that have failed to satisfy Ofgem they can meet their obligations by the late payment deadline at the end of this month.

The entire shortfall is recovered up to the level of the mutualisation ceiling which is set by Ofgem each year. These ceilings have risen steadily from £222 million for England & Wales, and £22 million for Scotland in 2010/11 to  £306 million and £31 million respectively in 2021/22.

Most suppliers meet their obligations by submitting ROCs, but many smaller suppliers choose to make financial payments instead, and since they typically wait until the last minute to pay for cash flow reasons, it can be assumed that none of the suppliers that ceased trading met their obligations. This particularly applies to the 10 that closed in August and September.

Looking at the suppliers that have exited the market since the start of the last compliance year, and those five currently in default on their obligations, I have estimated a shortfall of around £187 million. Cornwall Insight has a slightly higher estimate of just over £200 million – either way, well above the mutualisation threshold, meaning that all remaining suppliers need to anticipate a further payment demand from Ofgem in proportion to their market shares based on the number of suppliers that remained in the market at the end of the late payment period:

Supplier’s Mutualisation Payment = Total Mutualisation Amount x (A/B)

where:

A is the Number of ROCs the Supplier would have had to submit if it made no payments to the buyout fund; and

B is the Total number of ROCs that would have been submitted by all suppliers that had been in the market during the compliance year and had met their obligations in part or in full at the end of the late payment period

This ratio excludes both the electricity suppliers failing to meet their obligations and the ROCs they would have had to submit.

This will be by far the largest shortfall amount to date, with the previous highest being £97.5 million for compliance year 2018/19, and may well push small suppliers who were only just able to avoid their own obligations over the edge.

On top of this, the amounts for the current compliance year likely to be owed by the 10 suppliers that have ceased trading since April is already higher than the mutualisation threshold for the 2021/22 compliance year which ends on 31 March next year, meaning that mutualisations will be trigged for five consecutive years despite the increase in the threshold from this year onwards.

The Government should stop blaming others and fix a broken market

However much the Government wants people to believe the problems energy suppliers are facing are down to poor management, poor policy decisions are more to blame. Suppliers were allowed to enter the market with no capital and no market experience using a “supplier-in-a box” model.

They are not only allowed to delay the very large Renewables Obligation payments until 5 months after the end of the Compliance Year, they are prevented from making regular early payments. The interest on late payments is so low it is rational for suppliers to defer payments until the late payment deadline.

Any prudent system would require suppliers to make regular payments throughout the year and avoid building up large balances which, if remain unpaid, are socialised across all other suppliers. Similarly, a prudent system would not allow suppliers to use customer credit balances as working capital – the costs of which are also socialised if a supplier fails. No prudent system should permit such moral hazards to exist.

Finally, if the Government truly understood the energy market, it would realise that energy supply is a low margin, highly commoditised business. Rather than layering cost upon cost on suppliers through all the non-supply activities they are required to carry out, it should allow suppliers to focus on simply supplying energy, remove the price cap, and protect consumers by requiring suppliers to be sufficiently capitalised, and stop them from using their customer’s money to fund their operations. That would be a good place to start.