BEIS and Ofgem consider quarterly RO settlement to reduce defaults

The government and Ofgem are considering requiring suppliers to settle their Renewables Obligation (RO) on a quarterly basis in an effort to reduce the amount on which they are able to default.

The proposals come after a series of supplier failures led to the emergence of large shortfalls in the scheme’s buyout fund in recent years that were subsequently spread across the industry.

The RO scheme requires suppliers to purchase a certain number of Renewable Obligation Certificates (ROCs) from accredited generators in proportion to the amount of electricity they supply to customers.

They can alternatively make cash payments in lieu of ROCs, which are recycled back to suppliers based on the number certificates they submitted to meet their obligation, raising their value. About 10 per cent of the overall obligation across the industry is met using these buyout payments.

Obligations are set on an annual basis, with suppliers having 5 months after the end of the period to settle up, either using certificates or buyout payments. Suppliers also have a further 2 months in which to make late payments but must pay interest on their outstanding debts.

In a joint consultation, the Department for Business, Energy and Industrial Strategy (BEIS) and Ofgem noted that these arrangements allow suppliers to default on up to 19 months’ worth of obligation.

They also noted an increase in the number of suppliers failing and defaulting on their obligations, with defaults manifesting as shortfalls in the buyout fund. This trend peaked in 2018/19 when 21 suppliers defaulted on obligations worth £88.1 million – the equivalent of 1.5 per cent of the total obligation for that year.

The scheme includes a mutualisation mechanism whereby unpaid bills are recovered from remaining suppliers in proportion to the size of their obligation and then recycled back to them based on the number of ROCs they presented. This mechanism is only triggered when the shortfall exceeds a threshold, below which it is left unrecovered.

Mutualisation has occurred in all of the past three years, when the threshold was set at a fixed level of £15.4 million for England and Wales, with the sum totalling £173 million. Since 1 April 2021, the threshold has been raised to 1 per cent of the total value of the obligation, equating to £63.7 million for 2021/22.

There are separate but interlinked schemes for Scotland and Northern Ireland, for which their respective devolved governments are responsible and have their own thresholds.

BEIS and Ofgem said the current arrangements are resented by the electricity suppliers required to meet the unfulfilled obligation of their suppliers, whilst generators lose out when the shortfall is insufficient to trigger mutualisation.

They have therefore proposed three main options for addressing these concerns, with the first being to pass legislation to require suppliers to settle their obligation on a more frequent, namely quarterly, basis. This would reduce the maximum period of obligation on which suppliers could default from 19 to 10 months. They said this could be further reduced to 6 months by abolishing the option for late payments and compressing the settlement period to 3 months.

The consultation said this would introduce a new risk that there may be insufficient ROCs available to suppliers to meet their obligation using the certificates during the earlier settlement periods in each year.

To mitigate this risk, BEIS and Ofgem also set out proposals to offer suppliers more flexibility in how they settle their obligations. This could be done by allowing them to exchange buyout payments from the first three quarters of the year for ROCs in the final quarter, or allowing them to submit standby letters of credit to meet their obligations over the first three quarters on the condition that they are substituted for ROCs or buyout payments by the settlement deadline for the final quarter.

Under the second option, changes would be made to the electricity supply license to require suppliers to protect some or all of the amounts at risk of being mutualised. Suppliers would choose from a “menu” of options, with the level of protection depending on the size of obligation they had accrued, or would be likely to accrue, during a specified protection period.

The consultation said this could be done on either a forward or backward-looking basis, with the former requiring suppliers to estimate their supply volumes in advance and the latter being less costly but leaving some of their obligation at risk. Potential protections include a guarantee from their parent company or a third party or funds being held in escrow.

The third option would be to continue under the existing policy on the basis that license amendments to ensure supplier resilience and the new mutualisation threshold have yet to take full effect. The consultation noted that under the new threshold, mutualisation would only have been triggered in 2018/19.

As well as feedback on these options, the consultation also asked for views on an earlier proposal in 2011 to transition to fixed price certificates from 2027 onwards. The deadline for response is 9 November.

Earlier this week, Hub Energy became the third supplier to cease trading in 2021.