This article was originally published in Energy Spectrum Issue 689 on 4 November 2019.
Whether by accident or design last week’s last payment date for the 2018-19 Renewables Obligation (RO) followed nine days after Ofgem issued its proposals and impact assessment for ongoing monitoring of energy retailers.
Halloween was always going to be a difficult time for some suppliers. Unless it is more careful, Ofgem’s proposals could make next Halloween unnecessarily tougher for them.
Trick or treat
Stresses on suppliers have been apparent in Ofgem’s licensing activity as it issued four final and two provisional orders in the run up to the late payment deadline (see Figure 1). Accounting for around 16% of total electricity sales, the RO has become the critical bill to pay or touchpoint for concern depending on perspective. That suppliers can also hold on to RO money for up to a year and a half before forwarding to Ofgem has further heightened concerns.
Two of the final orders were complied with by Robin Hood Energy and Delta Gas and Power with non-compliant Toto Energy leaving the market. Its customers switched to EDF Energy under a supplier of last resort (SoLR) transfer. The two provisional orders were issued on the last day of October with Ofgem commenting that despite the companies providing assurance in September that RO payments would be made, they had then indicated full payment might not be forthcoming. Nabuh Energy responded stating that it had “made a significant payment towards its RO obligations, [but] there is a balance of monies due to be paid”. It claimed “the delayed payment is not a cause for concern for any of our suppliers or customers and Ofgem has been made aware of the nature of the circumstances which have led to a delay in the balance of the RO payment being made”. As with Robin Hood Energy before it, the company was making a pitch to pay late—although in the end Robin Hood Energy paid up in full before 31 October.
Ofgem launched its Supplier Licensing Review in November 2018, having first promised action a couple of years ago. The Review has resulted in new requirements for new suppliers entering the market since July this year. They have effectively upped the management and capital credentials entrants need to demonstrate.
Ofgem is now proposing regulations for suppliers for their ongoing operations and potential market exits. They embody three overarching themes:
- Promoting more responsible risk management
- Encouraging more responsible governance and increasing accountability
- Improving market oversight
Key among the proposals are a requirement for suppliers to have arrangements in place to cover at least 50% of the value of their customer credit balances, a requirement to maintain “living wills” that identify and plan for risks to their customers and the wider market if they fail, an obligation for companies to be open and transparent with the regulator and establishing assessments of suppliers’ capabilities when they cross customer number thresholds.
The latter two proposals have the most scope to improve supplier performance. A requirement for suppliers to be more open and cooperative should reduce communication barriers when a company is in financial difficulty, as well as producing a swifter resolution of compliance issues. It should also dovetail with a fit and proper persons test if executives wish to continue careers in the sector.
Checkpoints, determined by customer numbers, should be used to ensure the proportionality of the other remedies, with more detailed tests for large companies. The regulator intends to assess supplier capability and impose new conditions if milestones are not met. The thresholds would be at 50,000, 150,000 and 250,000 customers and a point to be determined between 500,000 and 800,000. Ofgem has also proposed for suppliers to undergo additional assessment if they indicate signs of financial difficulty. This is the right thing to do: bigger suppliers leaving have the potential to run up bigger debts, so it is most important that the fall-out from such exits is limited.
Credit balance protection is to be achieved via a “menu” of options, including parent guarantees, third party guarantees, and insurance schemes, with the regulator open to alternative suggestions. The exact way in which credit balances will be returned to customers will be discussed in Ofgem’s next phase of work. Should the regulator decide on its preferred option of 50% of credit balance insurance, it will allow three to six months for suppliers to implement it, citing a cost case of £34mn. The impact assessment justifies this choice on the basis that half the market will secure credit insurance at a cost of 0.5% of the annual balance to be insured and the other half of the market—larger companies predominantly—will use other means. The premium figure “was provided to Ofgem by a well-known high-street bank as an indication of what these costs could be”.
Insurance is a big part of the business retail market in terms of underwriting the risk of customer default. It is a very graded and segmented market. We suspect a new market to insure customer credit balances will take a while to settle down and while it does it will be the least-well capitalised companies that pay most, if they can get cover at all. A proposal for such a significant change to the terms of trade needs to be much better justified than one rule of thumb figure.
Chamber of horrors
Other areas are also discussed but without firm proposals. For example, the regulator has warned that it will treat trade sales shortly before market exit “very seriously” as they reduce the competitiveness of SoLR events and may not lead to the best outcomes for customers. It may go as far as disallowing such trade sales on a case-by-case basis. Presumably Ofgem is thinking about examples such as in January 2019, when it issued E with a provisional order requiring it stop transferring former Economy Energy customers. Economy Energy had agreed the sale of around 30,000 customers to E in December 2018 before the former exited the market. The regulator subsequently revoked the order in February 2019 after receiving a report from E demonstrating its compliance. Solarplicity’s sale of some of its customers to Toto Energy shortly before going in to a SoLR is another example. Ironically both sets of customers from these suppliers have ended up with EDF Energy through two separate SoLR processes.
There is also the question of whether the companies that take on customers through SoLR obtain anything much for their trouble. Ofgem’s summary letters on the SoLRs show trends over time to fewer bidders, more mandated bids and generally higher prices for consumers. Some winning suppliers have had considerable difficulties with the data they have secured on their onboarded customers making it extremely difficult to assess closing and opening balances.
These difficulties have then been compounded for some unfortunate customers by heavy-handed demands from administrators looking to collect the departed companies’ debts. This issue has been well highlighted by Citizens Advice and is followed through with Ofgem’s proposal for a requirement for suppliers to include reference in their contract terms and conditions to activities related to debt recovery. It is hoped that in the instance of a supplier exiting the market, debt collectors take into account customers’ ability to pay and are not “aggressive” in their debt collection.
All Souls Day
Before intervening with new rules and obligations we need to remember what the purpose of change is. The overall objective should be to keep the detriment to consumers to a minimum while maintaining the integrity of the market by preventing disorderly exits, particularly of larger suppliers.
The detriment can be immediate through, for example, harsh treatment by debt collectors—Ofgem’s language shows just how limited its powers are here—and also through customers having to make good the industry debts the failed suppliers have left behind. Here, it is the size of the failed suppliers that is key. We have been heading for mutualisation of the 2018-19 RO since the supplier exits that triggered 2017-18 mutualisation. Four suppliers—Economy Energy, Extra Energy, Spark and Iresa—were responsible for 97% of the buyout fund shortfall in 2017-18 (see Figure 2). They also accounted for 73% of our forecast of the 2018-19 RO shortfall. The RO shortfalls from the suppliers that have failed in 2018-19 to date would not be sufficient to trigger mutualisation in their own right.
As for their other debts, various administrators’ reports show the larger the company, the more they leave behind. These reports also reveal the grim inevitability of the SoLRs that have come after companies have sought and failed to recapitalise. They also highlight some consistent themes for the larger supplier failures:
- The default price cap was expected to squeeze margins and up working capital requirements for suppliers. It directly contributed to Spark losing its long-term trading arrangement and having to pay on the day for its energy.
- 2018’s volatile wholesale market generally upped the working capital requirements for suppliers in their energy trading.
- Awareness that companies may be facing a shortfall in their ROs upped other costs for doing business.
- Struggles with billing and customer services, sometimes caused by fast growth, damaging the reputation and limiting cash in to the business.
The first theme is a good reminder of the unintended consequences of intervention. We think there is a risk from these proposals of making it more expensive and tougher for the smallest suppliers to do business, when their exits are not those that have to date caused the most detriment. The impact assessment is based on averaged costs of SoLRs and needs to be refined to consider better the cost per customer by size of failed supplier.
The proposals suggest to us that Ofgem thinks the current regime is too loose and it could now be overcompensating in the other direction especially on credit arrangements. Things do need tightening up, but Ofgem’s proposals need to be better tailored to the size of supplier. In the round we suggest a more measured approach is needed looking towards the long-term steady state that the regulator wants to see.
The minutes of the September meeting of Ofgem’s board—the Gas and Electricity Markets Authority—"noted concerns that the [Supplier Licensing Review] proposals could be seen as setting the bar too high for entry to the market.” The concerns were not specified but “the board was advised that procedures could be amended if needed”. We think those concerns are right. Better to “treat” the proposals to a bit more thought than risk an unintended “trick” on the smallest participants in the retail market.
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