An analyst has insisted nothing should be “off the table” in efforts to prevent sharp spikes in energy and water charges due to the knock-on effects of lower demand during the coronavirus pandemic.
Martin Young at Investec suggested potential options included deferring regulatory revenues from one period to another or using the public purse to cover policy costs.
Speaking to Utility Week, Young noted that a substantial proportion of expenditure in the energy and water sectors is insulated from short-term fluctuations in demand, instead being driven by long-term needs as well as policy and regulation.
These fixed costs either need to be recovered from suppliers for energy and non-domestic water or directly from consumers for domestic water. But as a large chunk is recouped through unit charges, a reduction in volumes can therefore lead to a shortfall.
If the charges are set over a shorter timescale, the reduction in volumes can be promptly offset by increasing the unit charges. In these instances, the main effect will be to transfer the cost burden between different suppliers and consumers depending on how the lockdown has affected their usage.
However, for those that are set further in advance, such as transmission and distribution charges for energy networks, the shortfalls may persist beyond the current crisis. The charges may instead spike once demand has returned to more normal levels, meaning the increase would be spread more evenly across consumers and suppliers.
In the case of the latter, Young said these spikes could emerge just as Britain is trying to recover from the economic impacts of the lockdown. He said drastic action is needed to prevent this from happening: “There are so many different things that could now be thrown on the table that anything and everything is possible in my mind.”
For example, network revenues could be deferred from the current regulatory period to RIIO2 to “ease the burden” on suppliers. This would allow the shortfall to be spread across a number of years, flattening the charges.
Young said it would be a mistake for energy networks to oppose such a move given the “perceived generosity of returns” during the current settlement period. He said this measure would be less suitable for water companies, which have just begun a new price control and achieved varying levels of financial success in the previous one.
An alternative solution would be to pay policy costs from general taxation – a change which has already been urged by others, on the grounds that the current arrangements are regressive.
“It’s incredibly important at this juncture that these – a number of them have done quite a lot to restore legitimacy in the eyes of the consumers – act in an appropriate manner”, added Young.
“The companies now have to think very carefully about their actions… The energy and water sectors, given their incredibly important role in life, very much need to be looking at this as a long-term game.”
Without action, Young said there is a real risk of more suppliers going bust. He said another option would be to provide loans to suppliers to enable them to pay their charges, although this raises the question: “How do you distinguish between a company that was in a perilous financial situation before the coronavirus, and one that is now in a perilous situation with the advent of coronavirus?”
When asked whether Ofgem’s Supplier of Last Resort is sufficiently robust to handle more s failures, Young said yes, but only if they are small and few in number: “If it’s a bigger supplier going bust, then you’ve got a problem.”
At this point, there could be a “domino effect” as unpaid bills are spread across the remaining suppliers, resulting in yet more failures.