Retail market pressures continue while Ofgem comes under fire in new report

Retail market pressures continue with the news that Ofgem has confirmed this year’s record Renewables Obligation (“RO”) mutualisation of £218 million, and Elexon has confirmed the proposed record Credit Assessment Price level of £305 /MWh. There is also bad news for Ofgem as Citizens Advice published a highly critical report into its regulation of the retail market and its failure to protect consumers from the costs of supplier closures.

More cost pressures for suppliers

Ofgem has confirmed this year’s Renewables Obligation shortfall at £218 million for the 2020/21 compliance year, excluding interest, which is more than double the previous record mutualisation amount of £97.5 million in 2018/19. This is quite a bit above my estimate of £187 million which was based on a rough guess at what each company’s demand had been over the relevant period.

“Of the thirty-seven supplier groups across 66 obligations who failed to discharge their obligation by the 31 August and 1 September deadlines, 12 obligations were fully discharged by the late payment deadline of 31 October. The remaining 54 obligations were not met in full,”
– Ofgem

Of the defaulting suppliers, 25 are either in administration or have had their licence revoked. (Bulb was not one of the defaulting suppliers.) Ofgem cannot pursue enforcement action against suppliers which have ceased trading and had their licence revoked, but it can try to recover outstanding payments through their bankruptcy processes. However, the RO legislation does not provide for payments received after the late payment deadline, which means that the amount to be mutualised is calculated with reference to the shortfall at the late payment deadline of 31 October. Any payments made after the late payment deadline are re-distributed separately.

The bad news for suppliers is that they have to find the money for these mutualisation payments – even the most prudent suppliers were unlikely to have budgeted for something double the previous record, and will have had to start setting aside provisions while high market prices began to bite. One of my regular readers made a very good suggestion around this: unlike renewable generators receiving CfDs, those with ROs have been earning windfall returns from the current high power prices, to a point where the subsidy is unlikely to be necessary to support their project finance.

Why not cancel a portion of the 2020/21 RO payments to generators, or claw it back through a windfall tax, in order to insulate suppliers from the costs of mutualisation. RO generators could be guaranteed an income no lower than if the market price rises had not occurred in order to avoid harming investor confidence, and suppliers would be protected from a cost which is outside their control to manage or even meaningfully predict.

Unfortunately such sensible action seems unlikely. In addition to finding the money to cover the RO shortfall, suppliers have also been hit by the news from Elexon that the Credit Assessment Price and therefore the amount of collateral they must post, is going to be raised to on £230 /MWh to £305 /MWh from 17 December.

Elexon consulted on the proposed change last week, and while three respondents disagreed with the proposed value, the Credit Committee decided to do ahead with the increase. The Committee considered the consultation responses without holding a Credit Committee meeting, so the implementation of the increased CAP value would not be delayed – it plans to discuss the responses in detail at the next meeting, which will be held during in the week beginning 13 December 2021.

Damning report from Citizens Advice piles pressure on Ofgem

Citizens Advice has published a report into the crisis in the retail energy market, criticising the way in which Ofgem has regulated the industry for the past decade. The report not only highlights failures of regulation but also of supervision: the number of Ofgem staff working on enforcement fell by 25% in the past 4 years despite record numbers of suppliers in the market, and Ofgem ignored 10 separate warnings from Citizens Advice over Avro Energy, the second largest supplier to fail after Bulb and the largest to go through the Supplier of Last Resort (“SOLR”) process.

Although Ofgem introduced a requirement for suppliers to implement a Customer Continuity Plan in March this year, only 1 of the suppliers that failed since August had such a plan in place according to the SOLRs. Citizens Advice says there is no evidence that the suppliers that failed changed their behaviour in response to new financial stability rules introduced earlier in the year.

Citizens Advice has amassed significant evidence of rule-breaking by suppliers, yet Ofgem consistently fails to take enforcement action:

• Ofgem has never taken enforcement action over back-billing although Citizens Advice helped over 1,000 customers affected by this in the past year. The last formal investigation into domestic billing was over 5 years ago;
• Despite rules requiring suppliers to provide telephone lines for customer service, several suppliers have removed telephone lines altogether. It is over 2 years since Ofgem opened an investigation into quality of service;
• Citizens Advice has evidence of suppliers repeatedly breaking rules around prepayments and debt, but there has been no formal enforcement action in the past 3 years.

“Ofgem allowed unfit and unsustainable energy companies to trade with little penalty. Despite knowing about widespread problems in the market, it failed to take meaningful action…. An effective regulator would have seen these problems coming and acted to prevent them…”
– Citizens Advice

Citizens Advice estimates that supplier failures since August will cost consumers £2.6 billion, or around £94 per customer from 2022, excluding the £1.7 billion cost of Bulb’s failure. A large part of this cost arises from the habit of using customer credit balances to fund working capital – effectively borrowing from customers at no cost rather than borrowing from banks or increasing shareholder funds. Ofgem’s own analysis found that £1.4 billion was held in surplus credit balances as early as October 2018. In recent months there have been widespread reports of suppliers hiking direct debits despite accounts being in credit, and subsequently going out of business leaving those balances to be refunded by the SOLR and ultimately all consumers (including the ones whose credit balances had been lost).

The report also highlights flaws in the collection of RO payments, where suppliers make a balloon payment after the end of the compliance year rather than paying in instalments, despite this increasing the risks of default significantly. What the report doesn’t mention is that Ofgem actively prevents suppliers that want to act prudently from making regular payments.

The report makes the following recommendations that should be taken to restore consumer confidence in the energy market:

• An independent review of the causes of the market turmoil which considers the role of delays in policy changes, Ofgem’s approach to compliance and enforcement, and recommends improvements;
• Introduction of a new consumer duty, similar to that being introduced in financial services by the Financial Conduct Authority (“FCA”), which would put the onus on companies to ensure good consumer outcomes in future;
• Consumer protection from immediate bill hikes resulting from recent supplier failures; and
  
• Clear strategies for the retail market and its role in supporting de-carbonisation which consider how to enable consumer engagement and innovation in a more consolidated market.

While of course I agree with borrowing from financial market regulation, and would go further by transferring retail energy regulation to the FCA, I don’t agree that consumers should have their tariffs protected if their suppliers ends up in SOLR – this would impose un-manageable costs and risks onto the SOLR and would reduce the number of companies willing to take on the customers of a failed supplier. The better approach to protecting consumers would be to limit supplier failures in the first place by imposing the sorts of capital adequacy, risk management, skill, care and diligence, and protection of client money rules that are set out in the FCA Principles.

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There are growing calls for an investigation into the retail market crisis and Ofgem’s role in it. But we don’t need a review to see that Ofgem has consistently failed to both create appropriate regulation and to enforce its own rules appropriately.

Time and again Ofgem has shown that it does not understand fundamental aspects of the market, and, together with BEIS, it has taken an extremely adversarial approach to suppliers. Clients and industry colleagues tell of highly burdensome information requests from Ofgem, many of which are irrelevant to their businesses, but which take significant time and resources to deliver. Like the five consultations issued recently, this is all “busy-work” – time-consuming, expensive, but not productive, particularly since this apparent oversight failed to prevent the bankruptcies of more than half of the domestic supply market.

In his recent evidence to the House of Lords Industry and Regulators Committee, Jonathan Brearley, CEO of Ofgem admits that “we have a retail sector that needs to become much more financially resilient” and sets out some thoughts on greater prudential regulation. But at this point, surely the obvious solution is to engage an organisation that already has the expertise and the systems and process in place to deliver prudential regulation, specifically aimed at capital adequacy and risk management?

Rather than wasting time on yet another review into the market, the Government should take decisive action, removing retail market oversight from BEIS and Ofgem to the FCA and the Treasury. Perhaps that will inject the competence and market knowledge that has been so badly lacking.