Ofgem’s response to my letter leaves more questions than answers

This evening I received Ofgem’s response to my Open Letter in which I asked it to explain why it is not meeting the objectives set out in the price cap legislation. The reply was brief, containing a summary of my letter, a short response and an invitation to participate in the five consultations launched last week. The pertinent part of the letter is as follows:

Please find my response below to address the issues you raised in your email:

On 19 November, Ofgem published five consultations on adjustments to the energy price cap to ensure it reflects the costs, risks and uncertainties facing energy suppliers in the current climate. The link to these consultations can be accessed on our website below.

At present Ofgem can make changes to the cap methodology but cannot implement these changes outside of our six-month review cycle without a license modification. You will see that one of the consultations is about proposals to modify the licence to introduce an ability for us to amend the cap outside of our routine six-month cycle.

The unprecedented and unexpected rise in gas and electricity prices has put the retail market under strain. As this period of uncertainty continues, and the pressure on the sector grows, we are taking steps to protect the interests of consumers, providing greater certainty for investors, and strengthening the resilience of the sector.

When I read the consultations last week I was struck by the reference to the statutory objectives of the cap:

“The objective of the Act is to protect current and future default tariff customers. In doing so, we must have regard to the following matters:

• the need to create incentives for holders of supply licences to improve their efficiency;
• the need to set the cap at a level that enables holders of supply licences to compete effectively for domestic supply contracts;
• the need to maintain incentives for domestic customers to switch to different domestic supply contracts; and
• the need to ensure that holders of supply licences who operate efficiently are able to finance activities authorised by the licence.

The requirement to have regard to the four matters identified in section 1(6) of the Act does not mean that we must achieve all of these. In setting the cap, our primary consideration is the protection of existing and future consumers who pay standard variable and default rates. In reaching decisions on particular aspects of the cap, the weight to be given to each of these considerations is a matter of judgment. Often, a balance must be struck between competing considerations.” (my emphasis)

This is different from the language in previous consultations, for example in last year’s consultation on the impact of covid, the objectives are listed but there is no mention of whether these objectives must be met. However, in other documents Ofgem has essentially stated that it does not see the need to meet any of these objectives:

“We recognise that each need is in principle desirable. However, we do not consider that the Act requires us to achieve the four statutory needs. Rather, our duty is to consider each of these important needs when setting the cap,”
– Ofgem

As I described in my review of the latest batch of price cap consultations, they really do too little to remedy the situation and whatever the outcome is will come too late to save suppliers from the stresses of high wholesale prices over the winter – particularly as there is no good reason to expect any improvement in market prices in the coming months. And there is no good explanation as to why Ofgem chose to constrain its powers by limiting the changes to the cap to once every six months, rather than retaining the flexibility granted under the Act.

The final sentence quoted above is manifestly false – by maintaining the cap at its current level through the winter, Ofgem is clearly not protecting the interests of consumers, providing greater certainty for investors, or strengthening the resilience of the sector:

• Consumers are not protected when their supplier fails – only credit balances are protected. Any cheap legacy fixed price deals disappear with those suppliers, and the closure of so many suppliers has halved the level of competition in the market in under a year. Under the Government’s measure of consumer benefit this is clearly not desirable;
• Investors do not feel certainty at the moment – although there might be certainty of significant losses until the cap is changed, there is now significant uncertainty around how the £1.7 – 2.1 billion of costs associated with Bulb will be recovered (see below). Andy Mayer, energy analyst at the Institute of Economic Affairs told the Times that the price cap is maintaining “a political fiction of low energy prices” that meant “private investment will drain from the market”;
• The resilience of the sector is not strengthened when more than half of market participants have failed, and there is a prospect of an enormous levy to cover the costs of propping up Bulb, which may actually bankrupt other suppliers.

Finally, the current market conditions are not unprecedented. Both the 1970s and 2000s saw significant price shocks in the oil markets, and price shocks are common in agricultural commodities markets due to adverse weather events and policy decisions, such as the grain price shock in 1996. There is currently an on-going bull run in the iron ore market. The reality is that price shocks in commodities markets are neither unprecedented nor unexpected, and for the energy regulator to have not even considered that gas and electricity prices might be subject to this phenomenon is incredibly short-sighted.

I expected to get the brush-off from Ofgem, but I did not expect such a weak response – it feels as if they couldn’t actually be bothered to think about the points I raised in order to address them, even if it was just with excuses.

More suppliers fold while a special administrator is confirmed for Bulb

Today another two energy suppliers folded: Entice Energy, which comprises both Entice Energy Supply Limited and Simply Your Energy Limited with around 5,400 domestic customers, and Orbit Energy with around 65,000 domestic customers. This now brings the total number of supplier failures this year to 28, which is more than half (54%) of the suppliers that were active at the start of the year.

Earlier this week saw the failure of Bulb Energy, the seventh largest supplier, which has now entered special administration. The Government has granted Bulb a loan of £1.69 billion or £1,000 per customer to enable it to continue trading, while the administrator, Teneo, has estimated it will cost around £2.1 billion to keep the failed supplier trading until the end of next April. The loan was described by Justice Adam Johnson in the High Court as being “of existential importance to Bulb”. More money can be approved by Business Secretary Kwasi Kwarteng if needed.

Since the costs of special administration are intended to be recovered by industry levy, that means a cost mutualisation ten times this year’s record RO mutualisation, which will put significant pressure on whatever suppliers manage to survive the winter. It also means that prudent, well run suppliers (to borrow the Government’s own narrative) will suffer a significant penalty for being well run and not running out of money.

This, together with the enormous regulatory burdens faced by suppliers, and the low margins at the best of times, will hardly incentivise new suppliers to enter the market after the crisis is over, which my well depress competition over the longer term.

So where to from here?

In the House of Commons today, shadow business secretary Ed Miliband called for “a proper external review of the regulation of the market”, but this problem arose as a result of the price cap which was introduced following the Competition & Markets Authority’s review of the market (and the subsequent review by Dieter Helm was largely ignored by the Government). More reviews are not needed, urgent corrective action is what is needed.

More suppliers are almost certain to fail before the end of the winter. Then there is the issue of whether the Bulb administration costs will be recovered by industry levy and if so over what time period. The Government and Ofgem should provide clarity on this as soon as possible, after all, how can well run suppliers budget for costs if they do not know how large they might be and when they will fall due?

Of course, the price cap needs to be increased (or preferably, abolished), and Ofgem needs to recover its powers to adjust the cap as often as needed to ensure wholesale costs can be properly recovered by suppliers.

But better still, regulation of the retail market should be moved to the Financial Conduct Authority, under the supervision of the Treasury.