Utility Week

UTILITY WEEK | AUGUST 2022 | 19 Customers The advantage of age The division is perhaps unsurprising when considering that legacy retailers, with the advantage of having been long-established in the market, have better credit ratings than their newer competitors – a fact highlighted by Nera Economic Consulting. Ofgem commissioned Nera to analyse the potential impacts of its proposed inter- ventions and the subsequent report high- lighted the current disparity between large and small suppliers in the costs of capital for insuring credit balances. Nera calculates that the cost of capital for small suppliers is almost 12%, com- pared with just over 1% for their larger counterparts. Despite further calculations that, follow- ing the introduction of the proposals, the costs will be 1.12% for both large and small suppliers, there are still concerns in the sec- tor about the disparity in credit ratings. Amy Marshall, energy expert at PA Con- sulting, wonders whether if the proposed rules had been in place earlier, they would have had an impact on the market entry of newer players. She tells Utility Week: "Thinking back to when some of the suppliers that are now successful and well established entered the market, you have to wonder how they would have thought di‡ erently about their business plans if the amount of funding they would have had to have behind them under the new rules were a requirement. "It is di‰ cult to prove as a counterfactual but the opportunity cost of innovators not entering the market is something we need to guard against." Octopus Energy's director of economics and regulation, however, is more frank in her assessment of where she believes Ofgem's plans will leave competition. "I think it could take us back to having the oligopoly we had in 2015," says Rachel Fletcher. She references the report that resulted from a major review into the root causes of supplier failures and Ofgem's role in them, which was undertaken by " nance consul- tancy Oxera. "We really risk going back to that world. The Oxera report very clearly puts a warn- ing out about the risk of Ofgem swinging the pendulum too far in its work on " nancial resilience and killing o‡ competition and innovation. Just to be really clear, our mes- sage to Ofgem is not to do nothing, our mes- sage to Ofgem is be e‡ ective," she says. In its consultation, Ofgem says that while its new ring-fencing requirement should deter new entrants with insu‰ cient capital and poor business models from entering the market and growing unsustainably, e‰ cient suppliers will receive an appropriate return on capital. "As such, we do not consider this pro- posal will deter e‰ cient new entry or inno- vation, or competition in the market," the regulator added. The alternatives Octopus proposes that rather than ring- fencing credit balances, the regulator should among other things consider ATOL-style insurance. However Ofgem has discounted this from its considered options, stating that while credit insurance may not be avail- able to suppliers or may be prohibitively expensive. So how, at a time of rampant in˜ ation and record energy bills, can Octopus jus- tify its stance against ring-fencing? Fletcher believes in being more outspoken about the " nancial impact on consumers themselves. "Centrica talks about ring-fencing with- out talking about the cost to customers, and Ofgem has been really clear – it will adjust the price cap to accommodate the additional cost of ring-fencing. This is not a zero cost option," she says. Despite their di‡ erences, there is an acknowledgement that all the industry's remaining suppliers have the same goal – to create market stability. Vyas says: "All of our members would agree with the need for " nancial resilience and the priority of making sure people are " t and proper to run companies in this mar- ket. None of our members would dispute the need for that because you want a healthy, functioning market that has a good, strong reputation." Similarly, in response to the di‡ erences between Octopus and Centrica, Marshall's fellow energy expert at PA Consulting, Liz Parminter, tells Utility Week: "If you sub- scribe to our hypothesis, that there needs to be a more systemic review of all of the mar- kets, I suspect that there is some commonal- ity between them. "Because both parties are saying there needs to be some protection for consum- ers or some form of mutualisation. And it's just a question of the di‡ erent types of intervention." The future of hedging strategies Elsewhere, Ofgem has further set out its ini- tial thinking on how failed suppliers' hedges can be passed on to a Supplier of Last Resort (SoLR). Parminter tells Utility Week that the proposals will have bene" ts for the SoLR process because they will provide more transparency. She explains: "I think it's absolutely the right thing to do because it would encourage people to take on those customers. During the SoLR process people bid for those books and they don't always bid in the knowl- edge of what the hedge position is, in my experience. "If those things were transparent and evi- dent, they may be more attractive. I guess the converse of that is that they may have hedges in place themselves already. And they may not want to double-up on that position. So I guess the key thing is to make those things transparent." Marshall adds: "Broadly speaking, I think it's very sensible. And just from a very basic perspective, it makes eminent sense to have the positively valued assets and the nega- tively valued assets together if you're talking essentially about a transfer process which is to protect consumers. "What do I mean by that? We've seen lots of examples and I think it's mainly by acci- dent, rather than design of customer books that don't have a huge amount of value going one way down the SoLR route, and then hedge books with a huge amount of value returning value to shareholders and found- ers, etc. "So from a principle perspective, to reduce the impact on the consumer and to reduce the impact on the supplier of last resort, it makes sense." In its consultation, Ofgem points to the fact that the proposals around " nancial sta- bility are just one component of its wider work to build an energy market that is "fair and works for everyone", and that related work includes changes to the price cap, new measures around " t and proper persons and more rigorous stress testing. In order to achieve true market stabil- ity, there needs to be a holistic approach to reform. As Parminter observes: "There's things that Ofgem needs to do which fall into the short, medium and longer term. In the short term, of course, they have to address the criticisms around the ring-fencing of credit balances and the like, because I think that is part of the problem but not the whole picture. "In that respect it is welcome but there is still need, in our view, for a proper look at it much more systemically. It is a bit of a stick- ing plaster when you start to think about the broader issues around security of supply and wholesale markets – you still do need to address those issues as well." Adam John, senior reporter

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