Energy supply market – stable door finally closed?
This latest activity from Ofgem introduces the first set of changes resulting from its Supplier Licensing Review launched in June 2018. This decision document is therefore essential reading for aspiring new market entrants, but also important to existing market participants and consumers who have a vested interest in the health of the energy retail supply market.
What’s the issue?
The context is a period of instability in energy retail supply, especially the domestic market, which has come to a head in recent times with the collapse of a number of energy suppliers, including Extra Energy, Iresa Energy, Our Power and, most recently, Brilliant Energy.
This comes at a time when industry regulator Ofgem has been striving for greater competition in the retail supply market, with a policy focus on increased customer switching and greater customer choice, which has encouraged new market entrants. In parallel, Ofgem has been grappling with perceived complexity in the market and poor customer service, alongside a desire to foster innovation against the backdrop of a low carbon transition.
The fact is that it has been relatively easy to enter the market as a licensed supplier – made easier by the availability of “off the shelf’ market-ready shell companies. Furthermore, armed with a competitive tariff offering, the customer switching sites make it relatively simple for a new entrant to build a large customer base very quickly – although these customers will inherently be regular switchers, and brand loyalty will be hard earned.
A large customer base in turn brings a heavy financial exposure, not only to the wholesale power markets – which are difficult to weather at times of market volatility when low fixed price tariffs give low margins and a limited ability to hedge through forward trading – but also through commitments to the Renewables Obligation and other government schemes. It also brings a heavy regulated burden, with standard licence requirement placing onerous requirements around customer protection especially for vulnerable customers.
As one of the legal advisers involved in several of the recent supplier failures, we have seen first-hand Ofgem’s approach when a supplier finds itself in difficulty. Often, financial distress and poor customer service are linked, although sometimes this is more perception than reality. Furthermore, suppliers investing in their businesses to meet their legal and regulatory obligations rightly complain there is no level playing field when those not complying are allowed to compete.
However, Ofgem has arguably been over-zealous in imposing restrictions on a struggling supplier’s operations through a provisional enforcement order, in the name of addressing customer detriment, but with the perhaps inevitable consequence of forcing that supplier into insolvency with all the consequences that entails.
Supplier failures have wide-ranging impacts, and not just for business creditors and shareholders. Citizens Advice estimates that over 800,000 customers have been affected by the failure of 10 suppliers in the 12 months to January 2019.
With a focus on protecting the customer, Ofgem’s “safety net” process involves the appointment of a supplier of last resort (SoLR), required to take over the failed supplier’s meter points.
Crucially, this comes with a mechanism whereby the incoming supplier takes on customer credit balances and can apply for its costs in doing so to be wholly or partly funded by all consumers via network charges. Separately, supplier defaults under the Renewables Obligations are mutualised across all other suppliers.
There are few other industries where the costs of failure are socialised in this way, and the impact ultimately finds its way to the consumer in higher prices.
How is Ofgem responding?
Ofgem’s Supplier Licensing Review has looked at three areas: the conditions for suppliers entering the market; ongoing requirements including monitoring and engagement; and arrangements for managing supplier failure and market exit.
This latest decision document covers just the first of these.
New entry criteria
Applicants for a supply licence will need to meet new requirements from June 2019. Notably, alongside new “fit and proper” disclosure requirements, applicants must be able to demonstrate to Ofgem that they have planned their financial and operational resources for market entry and are prepared to meet the costs they will face – although Ofgem is not imposing any minimum capital requirements on new entrants. Applicants must also provide a “statement of intent” regarding licence compliance especially around customer service.
Ofgem has also decided that the timing of the licensing process be shifted close to actual market entry rather than, as now, ahead of entry testing processes. Otherwise, in the case of “off the shelf” companies, Ofgem’s scrutiny would focus on the managed service provider and not the eventual market participant.
These new rules will require changes to the statutory instruments (SIs) which were made in 2010 and govern the process for applying for licences under the Gas Act 1986 and Electricity Act 1989 ¹. In fact, Ofgem proposes to revoke these SIs and replace them with new versions, and alongside its April final proposals Ofgem also published a consultation on those new SIs, together with a new accompanying guidance document.
Significantly, the new “fit and proper” disclosure requirements will apply to applications for all types of licence, not just gas and electricity supply. The effect is to broaden the disclosure requirements, currently covering just unspent criminal convictions and director disqualifications, to capture individuals with “significant managerial responsibility or influence”, and to cover additional disclosure including involvement in prior SoLR events, compliance and enforcement history and actions by other regulators or competition law infringements.
Subject to conclusion of the SI consultation (on which responses are sought by 13 May), the new entry criteria regime is expected to be in place from June 2019.
Ofgem’s attention will now turn to the other areas of its Supplier Licensing Review, namely on-going requirements and market exit, which will arguably be of more interest to existing suppliers. A summary of responses on these topics from the November 2018 consultation will be published by Ofgem in a working paper in May 2019, followed by a stakeholder workshop in June 2019.
The direction of travel here will likely include new rules on customer credit balances, and changes to the SoLR process. When combined with the new entry criteria, these new market interventions are now taking shape. Broadly speaking, Ofgem appears to have the support of the existing market participants, although many will argue that these changes have come too late.
Furthermore, only time will tell whether Ofgem has achieved the fine balancing act of raising the bar high enough to reduce the disruption risk of supplier failure, but not so far that innovation and competition is hindered just at the time when it is most needed. A key barometer of success will be whether Ofgem needs to resort quite so often in future to waiving its ultimate big sick: the enforcement order.
¹ The Gas (Applications for Licences and Extensions and Restrictions of Licences) Regulations 2010 and The Electricity (Applications for Licences, Modifications of an Area and Extensions and Restrictions of Licences) Regulations 2010