Just the bill please – who picks up the costs of market exits?

This article is an extract from our Energy Spectrum Nutwood. find out more about a subscription to Energy Spectrum here.

Between 9 August 2021 and 19 November 2021, 22 energy suppliers exited the market impacting more than 2mn mainly domestic customers. Supplier exits result in a number of costs being left behind, some are commercial and creditors will have to take their chances on what administrators recover. Many industry costs, especially for policy and networks, are socialised for remaining suppliers to pick up. In this Nutwood we explore how these costs are recovered and who picks up the bill.

Put it on the tab

If a supplier exits the market without having made provisions for the future supply of customers (such as arranging a trade sale beforehand), the Supplier of Last Resort (SoLR) process is activated. Ofgem chooses to either direct a supplier to act as SoLR; or run a competitive process to appoint one. This decision is based on the size of the customer base, as a competitive process may not be cost-effective for a very small one. The appointed supplier can choose to recover costs incurred from acting as SoLR through a Last Resort Supply Payment (LRSP). Historically these cover costs relating to customer credit balances; emergency wholesale procurement; and IT systems. Between January 2018 and January 2021, Ofgem approved nine LRSPs with an average of ~£75 to be recovered per customer going through the SoLR process. Since August 2021 more than 2mn domestic customers have gone through the SoLR process, with 22 suppliers exiting the market in that time.

This significant market exit has been driven in part by extraordinary wholesale prices, and any supplier taking on new customers through the SoLR process at this time will have had to procure emergency wholesale energy at prices well above the average historic wholesale price. Ofgem confirmed in an open letter on 29 October that suppliers would be able to recover these extraordinary costs through future LRSPs. While costs at this stage are estimates, the need to procure additional wholesale costs at short notice will definitely have increased costs for suppliers acting as SoLR.

In addition to this, in the open letter Ofgem signalled its intention to make changes to the LRSP process. The regulator is proposing to allow multiple claims where SoLRs could submit an initial claim and then a true-up claim. Ofgem expects that the initial claim would only include costs that have actually been incurred, and so be primarily comprised of wholesale costs and the second “true up” claim would include other cost categories in addition to any further wholesale costs incurred that had not been included in the initial claim. Ofgem also notes that, given the extraordinary market conditions and timescales it may not consult on its decisions for initial claims and is proposing to allow payments to the SoLR to commence from April 2022 providing claims are made, decided upon and received by the networks prior to the end of 2021. All this points to the expectation that not only are LRSP claims likely to be higher per customer going through the SoLR process than has been seen historically, but they will likely be recovered at much shorter notice.

Paying by card?

LRSPs are recovered through use of system charges. In electricity, Distribution Network Operators (DNOs) are required to make alterations to their distribution use of system (DUoS) models to recover the required amount and subsequently make payment to the LRSP claimant. In gas the duty lies with the Gas Distribution Networks (GDNs). A modification (DCP332 Appropriate Treatment and Allocation of Last Resort Supply Payment Claim Costs) implemented in April 2020 means that in electricity, costs are recovered through fixed charges for all domestic customers. It was considered that the SoLR process has historically mostly impacted domestic customers and the greatest cost for an SoLR was protecting domestic customer credit balances, meaning that spreading this cost on domestic customers was the fairest option. In the gas industry, costs are spread across all consumer groups. A similar gas modification (UNC687 Creation of New Charge to Recover Last Resort Supply Payments) is proposing that a new distribution charge be created called the “SoLR Customer Charge”, which will have a value set each year. Separate values will be determined for both domestic and non-domestic customers, allocated depending on current market sector flags in Xoserve’s data. UNC687 is currently with Ofgem for decision although has been deprioritised because the regulator is trying to decide an appropriate system solution to deliver it. As it stands costs will remain spread across all consumer groups. While LRSPs allow suppliers acting as SoLR to recover costs associated with them taking on new customers, there are a number of costs that may be left behind by the exiting supplier.

Leave without paying

The supplier hub model that exists in the GB market means suppliers are responsible for passing on system costs to consumers. This includes but is not limited to transmission and distribution charges; policy costs; as well as ultimately the cost of purchasing wholesale gas or power. One of the regular headlines in regards to supplier failure is Renewables Obligation (RO) payment shortfalls. The RO is settled on an annual basis and, although BEIS has recently raised the mutualisation trigger and is looking at the potential for more regular settlement, there has been sufficient shortfall to trigger mutualisation for four consecutive years. While mutualisation protects the RO certificate value for RO generators, suppliers are required to make quarterly payments to cover any shortfall. In the same vein, while considerably smaller than amounts under the RO, payments made under the Feed-in Tariff (FiT) scheme are mutualised across suppliers and it is expected that the shortfall for the latest levelisation period (July – September 21) is enough to trigger mutualisation for the quarter. Mutualisation can also be triggered for the Warm Home Discount, and similarly, any untraded, unmet Energy Company Obligation (ECO) is added to the following year’s obligation to be spread proportionally by ECO obligation.

Two additional schemes that suppliers are required to foot the bill for are the Capacity Market (CM) and Contracts for Difference (CfD). Under the CfD the frequency of payments is more granular and there are more substantial credit/collateral requirements (e.g., reserve payments are required from every supplier in the market). In addition to this, costs for the scheme lately have either been very low, zero, or even negative amid high wholesale prices. Furthermore, regarding the CM, suppliers are required to lodge 110% of their monthly charge with credit under the scheme. This reduces the likelihood of significant shortfalls in payment, but there are some outstanding payments owed on the non-payment register – Non-Payment Registers | Low Carbon Contracts Company.

According to the register, relevant as of 28 October, the outstanding amount of non-payments for suppliers that have ceased trading was £4.9mn. It is perhaps interesting to note that, while not directly comparable, more regular settlement (as under FiT, CfD and CM) can reduce the total payment shortfall left behind by exiting suppliers, although adding an additional level of protection through credit cover/collateral requirements can bring even greater security. This does somewhat end in a bit of a catch-22 situation for suppliers where they either face large mutualisation bills or are required to lodge sufficient credit cover. Credit cover is not a silver bullet though; in fact, while credit cover is required for BSC charges, a number of suppliers have been in credit default before exiting the market, and on a couple of occasions, the BSC Panel has moved to expel a party for failing to clear credit default in the required timeframe. These costs must then still be socialised across the industry.

Split the bill

While the costs of the above schemes are placed on the electricity bill, the gas industry has been under the microscope in recent weeks with concerns that a large shipper exit could result in significant costs for those remaining in the market. The SoLR process does not exist for shippers and currently, if a supplier is left without a shipper for its sites, it must enter a “Deed of Undertaking” and National Grid Gas (NGG) as the residual balancer must procure the required gas volumes. Given that NGG can only procure gas on the On-the-day Commodity Market (OCM) which in turn feeds into calculating the imbalance price, taking significant actions on the OCM could result in shippers being faced with much larger than normal imbalance charges. Two urgent modifications have been raised to address this issue, which we covered in last week’s issue of Energy Spectrum (ES785, p.13).

I’m not paying that much!

Current market conditions can certainly be described as extraordinary. A lack of hedging has left many suppliers exposed to much greater costs, coupled with the inflexibility of the price cap to pass on increased costs to domestic customers in the short term. While Ofgem is now consulting on potential changes to the price cap (page 15), the regulator has already stated the cap does not currently reflect an efficient supplier’s costs. Is this all coming too little too late? All of the costs left behind will eventually feed into the price cap, not only likely causing negative press for Ofgem, but also meaning that in the immediacy suppliers cannot recover their costs. This Nutwood is not an exhaustive list of every cost that may get left behind when a supplier exits the market but begins to show that the final bill for this rapid market consolidation could be very significant.

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