Ofgem announces price cap review

A review into the price cap has been announced by Ofgem following the unprecedented rise in wholesale energy costs.

In a letter to the industry on Friday (29 October), the regulator’s chief executive Jonathan Brearley outlined a series of measures Ofgem is undertaking in response to the continuing pressures being faced by retailers.

Among the key announcements was a consultation on the price cap methodology, plans to facilitate faster payments to suppliers of last resort (SoLR), as well as a pause on all new applications for supply licences for at least six months.

The price cap methodology includes several mechanisms to allow suppliers to recover uncertain costs based on what was considered reasonable at the time.

For example, there is a wholesale additional risk allowance which is an additional 1% of direct fuel cost in the efficient benchmark to help suppliers manage the uncertainty around risk, unmodelled volatility in demand and methodological uncertainty.

Ofgem said it expects to consult next month on whether the existing mechanisms should be adjusted in light of the increased costs and risks facing suppliers. The regulator added it expects to publish a decision in February, in time to implement any potential changes before the next price cap period beginning on 1 April.

The regulator will also shortly publish a letter setting out the steps it is proposing to take to expedite the process for SoLRs making a Last Resort Supply Payment claim. These steps, it said, will facilitate faster payment to retailers taking on the role of SoLR, and so enable the process to continue to protect customers.

Brearley said Ofgem must plan on the basis that shocks like the recent rise in gas prices could happen again and as such it intends to respond by “raising the bar” of what it expects from suppliers with regards to financial risk management.

Going forward, Ofgem will conduct more regular assessments of supplier finances, including audits, and apply increased scrutiny. It will set a “firmer expectation” on the capital investment that all suppliers should have in place, reflecting the higher risks the market is now seeing.

It will also take a “more robust approach” to assessing suppliers’ operational capacity, pricing and hedging strategies and planned investment as they reach the 50,000 and 200,000 domestic customer milestones.

Suppliers will be expected to regularly demonstrate compliance with the requirement that individuals with significant managerial responsibility or influence in the business are fit and proper to occupy their role.

“In assessing compliance, we will consider the capacity of individuals to manage market risks and uncertainties, and will take into account whether they have held positions of responsibility or influence in companies that have exited (or the parent/holding companies), leaving behind significant mutualisation costs, and in particular, instances of mismanagement which failed to protect the interests of energy consumers,” the letter added.

Furthermore, as a “vital step” to restoring stability in the sector, Ofgem will, subject to review, temporarily pause assessment of applications for new supply licences by extending the reasonable period of assessment, initially to a period of six months.

The letter additionally highlighted how the recent turmoil in the energy market has necessitated a reprioritisation of resources within the regulator.

“As a result we are deprioritising certain workstreams. We will publish these, and any resulting changes to outputs or timelines, on our website in the near future. And we intend to set out our draft forward work programme for 2022/23 as usual by end of December 2021,” it said.

Audrey Gallacher, deputy chief executive of Energy UK, welcomed the letter.

“We look forward to continued constructive and collaborative engagement with Ofgem and other stakeholders as this work is taken forward. We need to ensure we have a robust, resilient, and competitive retail market, where suppliers have the confidence and ability to invest and innovate to support customers and deliver the smarter, more flexible low carbon system required to achieve net zero,” she said.

Michael Lewis, chief executive of Eon UK, said: “We’ve got to take a cold, hard look at the energy market to understand what went wrong and to make sure we can stop this happening again.

“Customers are already facing steep rises in bills because of the sudden jump in wholesale energy costs, made worse by the added costs from the failure of more than a dozen energy companies.

“Today’s update from Ofgem is a welcome step in the right direction and I applaud the speed of their response. This is a positive move towards making sure only responsible companies can play a part in our energy future and in insulating customers from picking up the tab of bad businesses.”

Suppliers facing customer bans

Elsewhere in the sector, code administrator Elexon has suspended, subject to approval by Ofgem, Simply Your Energy and Maxen Power Supply from registering new electricity meters after their failure to sufficiently reduce their credit cover percentage.

Meanwhile, Omni Energy, which was also barred from registering new meters earlier this week, will be expelled from the Balancing and Settlement Code if Elexon’s decision is approved by Ofgem.