The gravity of the default tariff cap and the impact of the SOLR process

With wholesale gas and electricity prices continuing to reach new records, successive supplier exits during September 2021 and a new level for the default tariff cap (£1,277 for a typical dual fuel direct debit customer) for Winter 2021-22, the GB energy market remains on edge for fresh volatility and further consolidation.

While – less than two weeks ago – Cornwall Insight modelling indicated a default tariff cap level of £1,455 for Summer 2022 and £1,416 for Winter 2022-23, the increase in wholesale prices in the intervening period has pushed our indicative forecast for the two periods to approximately £1,660. Although there is a long way to go, and a lot of uncertainty to resolve, before there is certainty on these figures we note that the implied Summer 2022 cap level would be an increase of approximately 30% on the record level seen for Winter 2021-22.

Despite the record levels seen in the wholesale market which are contributing to the forecast increases in the default tariff cap, additional costs resulting from the succession of supplier exits risk contributing to even higher costs – these being charges under the Supplier of Last Resort (SOLR) scheme and the need to recover costs to industry support schemes for which the former suppliers were liable. Although the price cap methodology is structured to accommodate both outcomes, the extent to which they will be relied upon means that the impact on consumers could be felt into 2023. 

Under the SOLR scheme, those suppliers taking on customers of the exited companies can make a claim to Ofgem under the Last Resort Supplier Payment (LRSP), which is a means by which the acquiring SOLR supplier can claim any additional costs above those it expects to recover from the transferred customers – which includes any outstanding credit balances. Due to the way in which the LRSP is recovered, the costs of this are met by electricity and gas distribution network companies – who in turn recover them through their industry charges on consumers. Therefore, supplier exits via SOLR can lead to higher costs for all consumers.

Given that the latest round of supplier exits occurred only last month, details of the relevant Administrator’s proposals – which would normally be expected to contain details of credit balances and other financial liabilities – have not yet been published. However, we note that use of the SOLR process since January 2018 has resulted in eight claims totalling approximately £56mn, with a number of acquiring suppliers using the scheme to recover a contribution towards customer credit balances, as well as other costs.

Therefore, with supplier exits since the start of August already into double figures, the prospect of further claims – and additional costs for all consumers, not just domestic ones – is apparent although when these costs will reach bills is unclear. A claim must first be made by the acquiring supplier for review and consultation by Ofgem, who must then take a view on whether to accept this – a process which can take well over 12 months from an SOLR being appointed. As such, the effects may not be seen until the Winter 2022-23 price cap.

Additional costs must also be met due to the failed suppliers not having paid their charges from mandatory industry schemes, namely the low carbon generation support mechanisms of the Renewables Obligation (RO) and Feed in Tariff (FiT). This process, referred to as mutualisation, sees the remaining suppliers pick up the compliance costs of their failed counterparts – this having been triggered for the RO for the three years since 2017-18. It is also expected to be triggered for 2020-21, although the potential for it to be triggered for 2021-22 is unclear given recently introduced reforms to the process.

There has been a total of approximately £188mn unpaid by suppliers under the RO across the 2017-18, 2018-19 and 2019-20 compliance periods, with this again recovered through customer bills. As with the LRSP, the timing of any potential recovery from the recent supplier exits is unclear, although these could start to have an impact as soon as spring-summer 2022. Again, this cost recovery would not be limited to domestic customers, but to domestic and non-domestic alike.

As such, although our estimates of the cap for Summer 2022 and Winter 2022-23 exclude such effects given the extent of the uncertainty surrounding them, it is apparent that these costs will ultimately be borne by the industry as a whole and by customers in particular. While they have historically been comparatively small amounts in terms of their impacts on bills, the extent and frequency of the supplier exits risks pushing the normal approach of cost recovery into uncharted territory and having unknown impacts on an already stressed retail supply sector.

For example, Shell Energy Retail Limited announced this week that its gross profit for the year 31 December 2020 was £83.9m, down from £106.9m in 2019 and its operating loss was £83.6m, up from £26.7m in 2019. In a statement, the company said that the increase in operating loss was “principally driven by adverse market conditions” and that it has “continued to observe unsustainable, below-cost pricing across the market”.

The explosion of choice and innovation seen in the sector in the last decade by challenger suppliers has been fundamentally altered in a matter of months, and while all eyes will inevitably be on this winter the need for an enduring solution to ensure that the gains experienced by almost three decades of competition are not lost.

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