Ofgem pledges action on ‘moral hazard’ of energy retail

Ofgem wants suppliers to ringfence customer credit balances and renewables obligation (RO) payments to try and fix what it calls a “moral hazard” in the energy sector.

The regulator had previously consulted on requiring energy suppliers to automatically refund any surplus credit balances every year as part of a regulatory clampdown on unsustainable business practices.

Its chief executive Jonathan Brearley said one of the “root causes” of the failure of many suppliers which exited the market as a result of the gas crisis was related to the way they managed the money paid to them by customers.

He added: “…some suppliers have been using these balances to prop up their finances, enabling them to follow more risky business models with reduced financial resilience and higher likelihood of failure.

“If that supplier becomes insolvent, the cost of replacing those balances has to be picked up by other suppliers and ultimately all energy consumers.”

In an open letter Ofgem’s director of enforcement and emerging issues, Cathryn Scott,  said the regulator does not consider its previous proposals “go far enough to address the problems we are seeing today”.

Instead Ofgem is considering a new principle that suppliers should not use customer credit balances for working capital at all. Such a move would replace current guidance under the Financial Responsibility Principle that suppliers should not be “overly reliant” on credit balances for working capital.

In addition, Scott said Ofgem is also considering banning tariffs which require more than a month’s payment from customers upfront, as well as plans to strengthen its requirements for more accurate billing by direct debit.

To ensure suppliers comply with a prohibition on using credit balances for working capital, Ofgem is proposing that retailers hold them (or an equivalent amount) in insolvency-remote vehicles.

Its preferred option is for suppliers to protect an amount equal to gross credit balances net of unbilled consumption as this will ensure the methodology would reflect the amount at risk of mutualisation.

Ofgem further explained that it does not consider that netting this amount off with debit balances will provide an effective solution to this risk given that only credit balances are mutualised whilst debit balances are for the creditors of the failed supplier.

“However, we acknowledge there are different views across the market on this point and we welcome engagement on this, and how other solutions could create an effective solution to this problem,” the letter added.

Ofgem said that on balance it currently favours calculating an amount to be protected each month or each quarter.

RO payments

The open letter also confirms Ofgem is exploring the introduction of licence conditions that oblige suppliers to protect or ringfence the payments they receive from customers in respect of their RO.

In terms of the scope of the protection of RO payments, the regulator is considering whether all payments should be protected from the start of the obligation period, or whether there should be a sliding scale whereby the obligation increases over time.

“We are engaging with suppliers to understand how they interact with the ROC market in order to develop a suitable forecast methodology, to explore practical questions around timing and calculation, and to ensure that these measures do not negatively interact with the incentives of the scheme,” Ofgem added.

Ofgem is considering a range of ringfencing mechanisms such as escrow accounts, trust accounts, letters of credit and third party guarantees or surety.

The regulator said to the extent that any of its proposals result in the need to re-capitalise efficiently run suppliers, it is open to allowing a “suitable transition period” which aligns with any necessary reform to the price cap.

While the letter is not intended to be a formal consultation, Ofgem will consider any representations as it works towards a statutory consultation.

“Draconian”

One industry source told Utility Week they had major concerns about Ofgem’s proposals.

They said: “My very cynical view is Ofgem are running scared and feel they have to do something because so many retailers have gone bust.

“And in an attempt to placate the media, politicians, they are coming out with some quite draconian measures on credit balances, and to a lesser extent the RO.”

The source added that it feels as if Ofgem is trying to encourage suppliers to improve their financial resilience “through the back door” by removing the safety net of customer credit balances.

They added: “On one level, I kind of get that, but they’re doing that for all retailers, including retailers that are well capitalised that are not using credit balances to go in with unsustainably low prices.

“In an attempt to rectify wrongs, they’re reaching for a blunt instrument that would apply to everybody. And that will have really drastic consequences for competition.”

Elsewhere, Brearley has revealed there are concerns some suppliers may have been increasing direct debit payments by more than is necessary, or directing customers to tariffs that may not be in their best interest.

“We have also seen troubling stories about the way some vulnerable customers are being treated when they fall into difficulties,” he said.

Brearley said “now more than ever” suppliers need to stick to licence requirements on how they work with customers in financial distress.

As well as the proposed changes to the way credit balances are treated, Ofgem is commissioning a series of Market Compliance Reviews from suppliers to ensure they are fulfilling the licence conditions they require to operate.

The reviews will include more strict supervision of how direct debits are handled, how much they are holding in customer credit balances, and ensuring companies are held to “higher standards for overall performance on customer service and protecting vulnerable customers”.

“This work will allow Ofgem to determine if companies are fulfilling their licence conditions and to work with them to rectify deficiencies. Where they fail to do so, we will not hesitate to take swift action to enforce compliance, including issuing substantial fines,” Brearley added.