Today (11 November 2020) Ofgem has confirmed that there will be mutualisation of the 2019-20 Renewables Obligation. On Monday, in our 'Energy Spectrum' Perspective, we explained to customer’s why this was important and likely and what it means for the energy industry. Find out more about a free trial to Energy Spectrum here.
This article was originally published on 9 November 2020.
In this week’s Energy Perspective, we take a look at the 2019-20 year of the Renewables Obligation (RO), as the deadline passes for suppliers to pay their contributions. Once again, we are seeing the prospect of mutualisation from unpaid costs spread across those suppliers that remain in the electricity market.
Ofgem issued an update late on Friday (6 November) on payments made for what remains the primary support scheme for renewable power production by value, despite its staged closure to new generation capacity from 2015 - 2019.
Like many energy policy schemes the RO is funded from consumer bills with suppliers responsible for collecting money and remitting to Ofgem on an annual basis. RO costs have grown to around 15% of consumer spend. Ensuring the generators’ share of that money gets through to them from suppliers has become a challenge in recent years in a retail market which has witnessed a stream of exits.
Ce n’est pas la mer à boire
The Renewables Obligation was designed two decades ago as market based around the sale of Renewables Obligation Certificates (Rocs) by generators to suppliers. A buy out fee was put in place to cap costs in a market designed to be structurally short so it would attract investment. However, as we quickly learned, it had no protection for generators in the event of a supplier failure. That failure occurred barely seven months after the RO started in November 2002 after TXU Europe fell into administration. Amongst its debts was a near £23mn exposure to the RO, seemingly small now but the company had a 15% share of the power market when it exited. The shortfall translated to ~£4.1/Roc or about 8% of total value (see Figure 1). While much of the debt was subsequently recovered by TXU’s administrators, it sent a dislocating signal at a time when the government was desperate to stimulate investment in the sector after the wholesale power price crash that had taken down TXU in the first place.
Mutualisation was the result. Introduced from 2005 (supported by our analysis), it provides for the recovery of unpaid RO costs above a threshold level from one year in the future. Payments are made in stages and pro-rated by volume market share of the remaining suppliers. At the time with the mutualisation threshold set to the equivalent of £15mn, it was seen as a better solution than alternatives such as collateralisation or shortening the payment periods. Risks were seen to be concentrated on smaller suppliers failing and it was thought unfeasible that market participants should pick up the costs of a larger failure given the wider disturbance such an event would likely cause. For more than a decade the mechanism went unrequired until the close out of the RO for 2017-18 in October 2018.
L’habit ne fait pas le moine
Suppliers must settle their ROs at the latest by 31 October following the year ending 31 March in which their supplies of electricity were made. For 2019-20 the RO has a cost of the order of £6.4bn, or approximately 15% of a £40bn total spend on electricity. With one pound in every six taken in by suppliers attaching to the RO, 31 October has emerged in recent years as the up or under moment in the retail market, as some companies scramble to pay their dues. Herein lies the challenge of the RO. Suppliers will typically charge on a per unit basis sold for it throughout each target year. They can then hold on to it for a maximum of seven months after that. Officially the last date for them to “redeem” the Rocs they have purchased with Ofgem is 1 September, but they have a further two months before it is absolutely necessary to pay the buy out fee. Interest is charged for the late payment period and it is a legitimate commercial strategy for suppliers to wait until the end to pay: it may well be cheaper for them to do so compared to other forms of finance. It is an option that has been used by many suppliers over the years, for example, Ofgem’s latest annual RO report (for 2018-19) recorded some £740mn of buy-out payments and £110mn of late payments.
Il ne faut rien laisser au hasard
After a decade of lying on the shelf, mutualisation became a big issue in the Roc and retail markets in autumn 2018. While there had been earlier failures of suppliers (in autumn 2008 and 2016), there was insufficient call to trigger mutualisation. But the failure of IRESA in summer 2018 became the first of what turned out to be a string of exits involving the likes of Spark Energy and Extra Energy (see Figure 2). There were many learning points for the RO from these exits, notably:
- The RO debt would often be the trigger for supplier failures causing concerns about retail market stability to peak at this time of year.
- Administrators would routinely be left debts for policy schemes, of which the RO was the largest but by no means the only one.
- Exiting suppliers would probably leave RO debts for two years, the one just completed and the one in which they failed.
In this context, pressure has been increasing on Ofgem as scheme administrator to keep the scheme as whole as possible and provide timely updates. In doing the latter role Ofgem has to balance very carefully a general duty to inform with the specific commercial sensitivities of individual suppliers, leading us to last Friday’s update (see Figure 3).
This was the latest of three updates from the regulator on the 2019-20 RO. It confirmed that Ofgem had redistributed £581.7mn of buy out payments to those redeeming Rocs, being the £588.5mn receipts less scheme administration costs. Ofgem stated that the redistributed amount was equivalent to £5.02/Roc. It added further that “there was a combined shortfall of £105,555,614.21 in the England & Wales, Scotland and Northern Ireland buy-out funds. This was due to 33 suppliers not meeting their total obligations by the above deadlines. These suppliers consequently owe late payments”. While £105mn is a substantial figure and looks comparable to that from 2017-18, the regulator had already stated earlier in the month a lower total amount it was concerned enough about the receipt of to propose final orders for. On 2 October Ofgem reported that seven suppliers had “not provided [it] with adequate assurances that they will make their Renewables Obligations payments by the late payment deadline”. The regulator referred to the companies by their licence names: Co-Operative Energy Limited, Flow Energy Limited; MA Energy Limited; Nabuh Energy Limited; Robin Hood Energy Limited; Symbio Energy Limited; and Tonik Energy Limited. It said it was consulting on final orders under the supply licence to compel payment by 31 October. Subsequently on 30 October Ofgem issued three final orders totalling around £15mn to Nabuh Energy, Robin Hood Energy and Symbio Energy and as of 6 November they were outstanding, while Tonik having left the market means its £9mn or so outstanding payment will need to be recovered by the company’s administrator.
Mieux vaut tard que jamais
If no more payments are forthcoming, the total amount of RO shortfall payments from these four companies is nominally pushing £25mn, in excess of the mutualisation threshold of £16.9mn alone. Hopefully the remaining monies can be repaid without further disruption on the supply side, as our latest estimate based on confirmed supplier exits is for a buy out fee shortfall being touching distance of the mutualisation threshold for 2019-20 (see Figure 4), and is too close to call whether there has been sufficient default to trigger mutualisation.
If mutualisation is to apply, it will be for the third year in a row, meaning that other suppliers will be picking up the costs of exited rivals over the period 2019 to 2023. While there is uncertainty about the total amount, it seems that we will not see a shortfall close to the levels of 2017-18 and 2018-19. But the legacy of any defaulted payments will endure. At the same time on Friday, Ofgem stated that it had redistributed a first of four quarterly mutualisation payments, covering £24mn, for 2018-19 and we are now in a world where exiting suppliers are defaulting not just on their own RO payments but also on mutualisation payments for the defaults of others.
The coming weeks will see more clarity. Figure 4 shows the exits of suppliers with 2018-19 obligations spread over time, with Gnergy, which attracted a final order this time a year ago, finally leaving the market in March this year. In the round, and despite COVID 19, the total missed buy out payments look like being an order of magnitude lower for 2019-20 than 2018-19.
Domestic suppliers have also indicated that the furlough scheme has been helpful for many customers in paying their bills. Non-investment rated suppliers have had the network company loan schemes available to them this year to help manage their cashflows. The rates of interest on these loans are nearer commercial levels and require repayment by the end of March for network bills deferred from the summer quarter. The latest information is that £65.1mn of funding had been drawn down by suppliers through these loan schemes at 8 October.
The coming period will confirm whether mutualisation will be required for the RO for a third consecutive year with it looking a very finely balanced outcome.