Supply licence modifications to ensure control over key assets

Obligations for suppliers to have control over key economic and operational assets needed to run their businesses, including energy hedges, are to be enshrined into electricity and gas supply licences, Ofgem has confirmed.

The regulator said the modifications will minimise the cost of supplier failures and ensure suppliers of last resort (SoLRs) and special administrators are not impeded from taking over their operations.

The requirements are already contained within the accompanying guidance for the Operational Capability Principle and the Financial Responsibility Principle, which was updated by Ofgem in May.

Both principles were added to the gas and electricity supply licences in early 2021 as part of the Ofgem’s Supply Licencing Review.

The Operational Capability Principle requires suppliers to have robust internal capabilities, systems and processes to enable them to serve their customers efficiently and effectively.

The updated guidance clarified that Ofgem expects companies to either have direct ownership or legally enforceable rights over the material assets required to run their businesses. The regulator said these assets could include premises, facilities, staff, equipment, IT systems, brand names and hedging contracts.

Meanwhile, the Financial Responsibility Principle is an overarching obligation on suppliers to act in a financial responsible manner. The principle requires supplier to have adequate financial arrangements in place for costs that are at risk of being mutualised in the event of their failure. It also requires companies to take appropriate actions to minimise these costs.

The updated guidance confirmed that if a supplier uses an asset to meet its obligations under the Financial Responsibility Principle, the company must either own this asset or have sufficient control over the asset to be able to rely upon it legally. It said suppliers should not liquidate, sell or dispose of such an asset if doing so increases the risk and amount of mutualised costs.

In its decision letter in May, Ofgem gave the specific example of hedging positions: “We wish to avoid a situation where suppliers’ hedges are held by a third-party, and the supplier is not in control of its own hedging strategy. When hedges are valuable, this can incentivise the hedge’s holder to liquidate hedges, leaving the supplier unhedged and increasing the risk of supplier failure.

“Therefore, if hedges are owned, managed or controlled by a third-party, the supplier must have back-to-back agreements with the third-party which prevent the third-party from actioning contractual levers to liquidate positions the supplier relies on without the supplier’s consent and when this increases the risk of cost mutualisation.”

Ofgem proposed in a consultation in June to enshrine the updated guidance directly into gas and electricity supply licences.

In one of a series of decision documents published alongside its announcement of the new price cap level from October, Ofgem confirmed on Friday (26 August) that it is proceeding with the proposed licence changes.

“Given the potential adverse consequences of failure to have sufficient control over material assets, we consider that it is prudent, and supports our principal objective to protect the interests of consumers, to place the obligation to do so directly into the licence,” Ofgem stated.

“This ensures suppliers are clear that there is a direct obligation to comply with these requirements and highlights to suppliers the enforcement action Ofgem can take in the event of a failure to do so.”

The regulator said the changes will take effect 56 days after the publication of its decision.

Direct debits

Ofgem additionally confirmed its decision following a separate consultation to strengthen the licence condition requiring suppliers to set direct debits at an appropriate level.

The regulator said the current licence condition only requires suppliers to “take all reasonable steps” to ensure direct debits are based on the best and most current information available, unless the terms and conditions of the contract provide otherwise. It said the current drafting of the condition allows suppliers to accrue excessive customer credit balances.

Ofgem has therefore decided to remove these qualifiers, meaning suppliers will have an absolute obligation to set direct debits based on the best and most current information available “in all cases”.

“We continue to believe that suppliers should not be able to use their terms and conditions or an all reasonable steps test to effectively derogate themselves from the requirement to set fixed direct debits based on the best and most current available information,” the regulator explained.

“We remain of the view that strengthening the existing requirements will help reduce the scope for excessive customer credit balance accrual,” it added. “This will in turn help tackle the poor business practices that excessive customer credit balance accrual helps to facilitate.

“Recent market failures and the poor practices concerning the use of customer credit balances that they have exposed serve to further support the need for a strengthening of the rules in this area.”

Ofgem continued: “For clarity and in response to the concerns raised by suppliers, basing the amount of the fixed direct debit payment on the best and most current information available does not mean that suppliers need to automatically reset customers’ fixed direct debits every time they receive a new piece of information.

“For example, we do not anticipate a supplier needing to reset a direct debit where a new meter reading reports a minimal change in consumption compared to previous readings now, and the modification we are making will not change this.

“Instead, new information should feed into a broader picture of an individual customer’s consumption, circumstances and preferences and suppliers should reassess a customer’s fixed direct debit when they receive information that is likely to have a material impact on the direct debit amount.”

Market Stabilisation Charge and ban on acquisition-only tariffs

Furthermore, Ofgem confirmed its decision to proceed with proposed extensions of both the Market Stabilisation Charge and the ban on acquisition only-tariffs until 31 March 2023.

The temporary measures, which were approved by Ofgem in February and came into effect in mid-April, are intended to ensure that prudently hedged suppliers are not penalised by being undercut by rivals if wholesale prices fall sharply.

Suppliers are required to pay the Market Stabilisation Charge to the losing company when they acquire a new customer, but only if wholesale prices fall significantly below the level assumed in the price cap. The ban on acquisition-only tariffs bars suppliers from luring in new customers by offering them exclusive cheaper tariffs that are not available to their existing customer base.

In May, Ofgem altered the parameters for the Market Stability Charge to make it stronger and more easily triggered, and in June, the regulator proposed to extend both measures, which were otherwise due to expire at the end of September.

Confirming its decision to extend the measures, Ofgem said the issues they are intended to address are “likely to be greater in terms of potential supplier and consumer impacts, throughout the extension period, than they were when the original decision was taken.”

The regulator has quantified these impacts using the measure of “value at risk”, representing the estimated value of energy purchased in advanced to serve all domestic customers on standard variable tariffs minus the value that energy would have if prices fell back to typical historic levels.

In the consultation document published in June, Ofgem estimated the value at risk as of the beginning of July at £12.6 billion (£636 per customer) and forecast this to peak at £16.4 billion (£812 per customers) at the beginning of October.

Although the July figures have been revised down slightly, the regulator now expects the value risk to peak at £30.9 billion (£1,467 per customer) in January 2023.

Latest estimates for value at risk

Although it has not yet been triggered, Ofgem said the Market Stabilisation Charge has been providing suppliers with the confidence to hedge appropriately: “Without it, suppliers would have had a strong incentive to provide a lower level of hedging cover and, with the current very high price background, suppliers could be facing financial stress and consumers could be facing further costly and disruptive market exits.

“It is therefore too narrow to look at the benefits of the Market Stabilisation Charge solely on the basis of the benefits once it is triggered by a substantial fall in prices.”

Ofgem said it believes the charge may have already benefitted customers but more than £1 billion.

The regulator noted concerns over the dampening of competition but argued that “the current hiatus is due to the state of wholesale energy markets and the Market Stabilisation Charge is unlikely to prevent competition so much as reduce savings for switchers over a few months while hedge positions unwind.

“We judge that the importance of having a viable supply sector to do the competing outweighs the transitional reduction in competition that the Market Stabilisation Charge entails.”

Although it did not ask about this in the consultation, Ofgem said almost all of the responding suppliers indicated that the Market Stabilisation Charge should be extended beyond the new end date in March 2023. It said most of these suppliers suggested this would need to be done by November 2022 when suppliers who hedge according to the price cap will start buying energy for April 2023.

The regulator said it has no power to further extend the charge other than through a licence modification. It therefore asked stakeholders whether some kind of regulatory response to the issue will still be needed after March 2023, and if so, what measures would be appropriate.