Regulation could have reduced market failure: Ofgem

Fewer energy suppliers would have failed in recent months had more stringent financial controls been introduced earlier, Ofgem chief executive Jonathan Brearley said on 24 May as the UK energy regulator draws up plans to boost market resilience.

The Ofgem boss apologised as he told a House of Commons panel on business, energy and industrial strategy that "had financial controls been in place sooner, we would have likely seen fewer suppliers exit the market".

In a separate letter published on 25 May, Ofgem laid out three areas of reform to address "the economic model that allowed low-capitalised companies to enter the market", based on an independent review conducted by UK-based research firm Oxera into the root causes of recent supplier failures published earlier this month.

The regulator plans to first introduce a ringfencing of customer credit balances and renewable levies, preventing them from being used as working capital and reducing the risk that this money will be lost if a supplier fails.

The report concludes that most of the failed suppliers "were overreliant on customer credit balances to finance their operations". The reliance of failed suppliers Green Supplier and Utility Point on customer credit balances peaked at about 90pc of total assets in 2020, according to the report.

The regulator last month said it was considering banning suppliers from using customer credit balances for working capital and would consult on the matter "later in the spring".

Ofgem is also considering changes to the supplier of last resort (SOLR) levy component of the UK's retail energy price cap, with the regulator consulting on a scheme that would allow SOLRs to take out third-party financing for the costs incurred in taking on customers of failed energy suppliers and to pass on the charges to retail consumers over multi-year periods.

About 93pc of the SOLR levy claims of £1.8bn to be recovered in April-September this year stemmed from energy firms rehedging customers from companies that went out of business.

Tougher financial regulation

Ofgem will also introduce "a much tougher approach to financial regulation to ensure that companies have the right governance, risk management and appropriate finances behind them".

Oxera argued that Ofgem's approach was "reactive rather than proactive" and that Ofgem could have required "a higher degree of assurance from directors of a supplier in relation to its business model, how its cash flow position has evolved and how risks are managed (including hedging policies)".

Green Supplier, which failed in September 2021, had none of its customer demand hedged for winter 2021-22 in July 2021.

The regulator consulted on plans to strengthen financial risk controls for new gas and electricity supply license applicants in February and introduced new rules to increase its scrutiny of significant planned commercial developments of gas and power suppliers.

New price cap methodology

The regulator in future will update the UK's energy price cap each quarter rather than every six months, starting in October.

Ofgem's use of a deliberately "tough" price cap "may have left some suppliers with insufficient headroom to deal with shocks" as prices soared, while it acted as an effective ceiling "preventing suppliers from being able to fully recover wholesale costs", Oxera said. And the previous six-month review exposed suppliers to such a gap for a significant period of time, it said.

The standard dual-fuel price cap for a direct debit customer could rise to £2,800 from 1 October from £1,971 this summer, Brearley said, although this is not yet fixed, as Ofgem is only halfway through its time period for the price cap's assessment.

By Auguste Breteau