Changes to wholesale costs raise investability concerns

Energy UK has raised concerns about proposals set out within Ofgem’s update on its ongoing wholesale cost review.

The trade association has written to the regulator’s price cap team, warning that current proposals “reflect a fundamental departure from previous wholesale cost reviews, and, if pursued, raise serious concerns about the investability of the sector”.

It comes in response to Ofgem’s update issued in early October in which the regulator outlined its proposed framework for adjusting the price cap where “a change in the costs facing suppliers is material and systematic, considering the market as a whole” and where “the type of specific systematic errors for which we would adjust the cap would need to be unforeseen, clear, material, and necessitate changes”.

While Energy UK is in support of Ofgem making adjustments to the cap where appropriate, it claims that the proposed “tools and mechanisms for adjustments” are not “proportionate to the task”.

It adds: “Ofgem’s proposed framework is based on attempting to judge a distinction between ‘external events’ and ‘commercial actions’.

“Ofgem states it will ‘most likely’ seek evidence of a common perceived ‘external event’ to justify a wholesale cost adjustment. Though, the document does not rule out an adjustment being made on the basis of an outcome involving commercial action.

“Such a distinction rarely exists, as commercial decisions are normally made with reference to external events (for example, anticipated weather or demand patterns). What such an approach appears likely to amount to is a backwards rationalisation.”

It adds: “Ofgem is examining outturn financial results for differences to its forecast allowance and then attempting to ‘match’ those differences to some external events.”

Energy UK’s response warns that this approach is “clearly a slippery slope, as Ofgem will constantly be under pressure to repeat the exercise as results vary from forecasts, providing allowances where outturn costs are above the allowance, and claw-backs where they are below”.

The trade body adds that this will effectively create a “rolling ‘float and true-up’” mechanism which will create “uncertainty, undermine incentives, and ultimately result in consumer detriment as a result of a less efficient, less investable, market”.

Instead, Energy UK urges Ofgem to “set out, specifically and up front, what risks the price cap, in combination with external events has created, along with a hypothesis as to how this may have resulted in under- or over-compensation for a notionally efficient supplier”.

“Where there is no clear hypothesis, no adjustment should be made, as originally intended, outturn costs will differ from the price cap allowance in any given period for both the market as a whole, and for any given supplier, but over time, this should even out,” the letter adds.

Any changes to wholesale cost allowances will be implemented in April 2024 at the earliest if deemed necessary by Ofgem.

When it launched a review of wholesale cost allowances earlier this year, the regulator stated that any changes would take effect from the January 2024 price cap announcement.

However, Ofgem has now delayed its consultation on the cost allowances. In its update last month the regulator said it had decided to reschedule the consultation to “ensure that the analysis and calculations used to consider whether an adjustment is appropriate, are robust”.

Ofgem’s review is designed to assess whether the allowances led to either a benefit or costs for suppliers as prices fell in 2023. If appropriate, the allowances will be adjusted to ensure that any previous gains are recovered and passed back to customers.