‘Maths doesn’t add up’ on credit balance plan

Energy retailers have told Utility Week that Ofgem’s plans to make them refund customer credit balances will do nothing to address the affordability issue and simply heaps further pressure on suppliers at the worst possible time.

Earlier in the year Ofgem consulted on proposals to limit the amount of customers’ credit balance suppliers can hold, which the regulator says could be as much as £1.4 billion in total, or £65 per household on average being returned.

This money comes from customers who pay by direct debit, the monthly amount being calculated from their estimated annual consumption. They typically build up a credit balance during the summer when their energy use is lower and then draw down on this credit during winter.

Ofgem is concerned that some suppliers may use customers’ surplus credit balances to fund otherwise unsustainable and “risky strategies, particularly unsustainably lowpriced tariffs, which they would otherwise not be able to offer”.

The “auto-refund” proposal would require suppliers to refund any credit balances above zero each year on the anniversary of when their direct debit domestic customers started their contract. It would stop surplus credit balances growing year on year but would not stop suppliers building up surplus credit balances during the year.

To address this risk, Ofgem is also proposing to introduce a credit balance threshold for all domestic suppliers. This would require balances retailers collect above the threshold to be protected. This could be done through an escrow account or a guarantee from a third party or parent company with a minimum credit rating of investment grade.

Ofgem says the threshold would encourage suppliers not to collect surplus credit balances by making them pay to protect any credit balances they hold above the threshold limit.

The recent spate of collapses has thrown the spotlight on this issue and whether the current practice of mutualisation of these credit balances across the sector remains feasible, as larger suppliers, like Avro Energy, go out of business.

These new proposals would also reduce the amount of credit balances held when a supplier fails, reducing the cost to the market, says Ofgem, and to the consumers who ultimately assume the additional costs.

Currently, when an energy supplier goes into administration and is unable to remain in business via a trade or sale of assets, Ofgem’s Supplier of Last Resort (SoLR) process is used. The regulator then steps in and appoints a new supplier for the failed company’s customers. This process seeks to select an SoLR who will honour domestic customers’ credit balances. On some occasions, following Ofgem’s consent, credit balance costs can be recouped by the SoLR via an industry levy where costs are mutualised or met by all suppliers.

RO problems

Ofgem previously proposed that suppliers should protect 50 per cent of the failed supplier’s credit balances and Renewables Obligation (RO) payments. These proposals concern credit balances only. The regulator is now exploring the RO jointly with BEIS, and will separately publish a consultation exploring the full range of options for addressing RO mutualisation, including increasing the frequency of RO compliance and potential licence changes to require suppliers to protect or demonstrate their ability to pay the RO.

Some suppliers have been lobbying hard for changes that would reduce liability of mutualisation across the sector, but it would be a hammer blow to some smaller firms who use credit to hedge future supplies. It is therefore not surprising that opinions are split on Ofgem’s proposals – though not always along size-of-company lines.

The consultation began in March and closed in May. Ofgem has said that it will issue a statutory consultation in the autumn. In the meantime, according to retailers, Ofgem has contacted all suppliers to gather more information, including how much of customers’ credit is held by companies, and the administration costs that the new proposals might cost.

Retailers say that the proposed changes will particularly affect those suppliers who have entered the market in the past 5-8 years who have actively advertised for customers to sign up and pay by direct debit, and pay for that in advance. “They’ve built their business based on that. The larger suppliers with legacy customers wouldn’t have designed their business to rely on direct debit so much,” said one of those interviewed.

Others point out that the current system process already limits the degree of mutualisation.

“Quite often, suppliers offer to cover all of the credit balance themselves to increase their chances of getting those customers. It’s usually the RO cash collected from customers that is mutualised rather than the credit balances.”

There has been concern that with so many suppliers going out of business the SoLR process would not hold up, and that Ofgem would not be able to get suppliers to take on these customers. But so far this has not materialised and larger energy companies have stepped in to take customers of all nine failed suppliers. Meanwhile, it has been reported that Ofgem has appointed City consultant Teneo to be on standby to act as special administrator in case other suppliers need to be rescued and there is no retailer prepared to step in.

Discouraging investment

Both those for and against the proposals put forward arguments that reforms to credit balances would make it harder for companies to be profitable and would therefore discourage investment.

Said one retailer: “The current credit balance mutualisation proposals will not address affordability issues. Instead, they will add cost to suppliers and consequently add cost in energy bills. Auto refunds or threshold mechanisms do not help customers reduce energy bills.” He described the proposal as a “headline grabber”, and felt that it was another example of Ofgem’s approach of treating the symptom not the cause. Demanding prepayment is not an unusual approach either for goods and services in other sectors, such as insurance.

Others, though, have been far more vocal in their support. At the time the proposal was announced, Green Energy CEO Doug Stewart told Utility Week: “Perhaps this is the moment that we see a realignment between the energy industry, the customer and the regulator – one that is based on sound finance, trust and transparency. Put it another way, would you shop at Tesco if they said you had to pay £200 today to be allowed in store next week? Well done Ofgem for making the move.”

However, acknowledging the concerns of those others who say that customers prefer to build up credit in the summer to pay for heftier costs in the winter and could find themselves in debt, he added: “Great care should be taken to ensure that customers who have a credit refund are not further exposed to building up a debt because the refund was made at a point in time before any increased winter usage and future payment levels are not adjusted to take that into account.”

A further potential downside is that it could expose retailers to greater debt. If customers’ bills are based on estimates rather than meter readings (it costs suppliers to send round meter readers if the customer has not yet had a smart meter installed), suppliers will be forced to refund on an estimate. Then customers could leave having had estimated credits returned but in fact be in debt. This would leave retailers very little scope for recovering the money – and no incentive either for customers to install smart meters.

“The maths doesn’t add up. There’s not enough free cash in the industry, and it’s not being spread across the supply chain.”

He added: “Of itself, this won’t push the market, but it runs a big risk in the context of everything else. And it’s a lot of money, without any evidence of benefit to consumers, and a guarantee of no bene‡ t to investors.”

One thing, however, that everyone can agree on is the sentiment expressed by one interviewer: “If some suppliers are asked to return large credit positions and they’re using this to fund their business then this could well lead to more failures.

“We’ve always supported competition in the market, which has already delivered for customers in terms of improved service, price competition and other innovation. But this must be responsible competition from a mix of suppliers that are able to build sustainable businesses and don’t use customer credit balances to fund a business.

“It’s okay for consumers not to pay their bills on time, but it’s not okay for the supplier not to pay them on time? That’s the message.”

Again, the issue of what was equitable came to the fore: “If you’re asking me to give credit balances back, I should enforce debit balances. You cannot have it both ways.

“If you’re going to work on that basis, honestly the margins would need to go up. Even if you were getting outside funding, who’s going to give you that when you’re making 1 or 1.5 per cent. That could swing easily into minus with one little move, which is the problem.”

This is an extract from a Utility Week sentiment report in association with Gentrack investigating the need for a new approach to balancing fair costs within a competitive but sustainable energy retail market. Download it for free here