When energy regulator Ofgem introduced the UK consumer energy price cap, its stated aim was to encourage competition in the consumer energy market and stop the Big Six energy companies that dominated the market from overcharging consumers who didn’t regularly shop around.
A worthy goal, indeed. And for a while it succeeded. Many smaller energy companies flooded the market and consumers paid a “fair price for energy”, as more and more consumers shopped around annually, avoiding the so-called loyalty penalty that is higher annual prices for consumers who didn’t switch suppliers regularly.
The total number of domestic suppliers multiplied from 12 in December 2010 to 23 in May 2022, with a peak in mid-2018 of 70 suppliers fighting for customers. By September 2021, the new entrants held around 40% of the market share.
But then from mid-2021 to spring 2022, the wholesale market price that suppliers paid for gas and electricity rose rapidly to unprecedented levels. As a result, 29 energy suppliers failed, affecting nearly four million households in the UK between July 2021 and May 2022.
Given that Ofgem operates the Supplier of Last Resort (SoLR) process, no households faced a disruption to their supply, but the mass failure of so many energy suppliers suddenly caused confusion and consternation among consumers and advisers. It also raises questions about the whole regulatory structure and insolvency process in the energy sector.
In its report Energy pricing and the future of the energy market published in July 2022, the Business, Energy and Industrial Strategy Committee said that the SoLR process “has been stretched to its capacity”. Ofgem’s latest estimate of the total costs of supplier failures was £2.7bn.
“Customers ultimately pay the costs of supplier failure. Under insolvency law, administrators have a statutory duty to recoup whatever costs they can for creditors of failed companies and not for customers. Rachel Fletcher, Director of Regulation and Economics, Octopus Energy, told us that this creates a ‘massive imbalance’,” the BEIS report said.
The National Audit Office (NAO) also condemned Ofgem in a report published in June into the energy supplier market saying the regulator hadn’t done enough to ensure the sector was resilient to external shocks. “By allowing many suppliers to enter the market and operate with weak financial resilience, and by failing to imagine a scenario in which there could be sustained volatility in energy prices, it allowed a market to develop that was vulnerable to large-scale shocks and where the risk largely rested with consumers, who would pick up the costs in the event of failure,” the report said.
PwC Restructuring and Insolvency Partner Issy Gross says that although many things contributed to the numerous energy supplier failures over the past 18 months and no two situations have been the same, common threads had emerged.
“A common theme across a number of providers was their risk management processes, specifically around energy price hedging policies and practices, and the choice of hedging counterparty. Some of the companies that failed early did not hedge at all and some that failed later did so because they couldn’t effectively access hedging markets going forward, leading to significant liquidity challenges,” Gross says.
Typically, larger established market players will have built in hedges to manage the risk of fluctuating wholesale prices, but many new market entrants tended not to have hedges in place because, until recently, the market had been relatively benign.
Gross also believes contagion risk between counterparties also factored in some of the failures. “In one instance, the supplier failures caused significant credit losses for one of the shippers, which is a key counterparty that sits in the middle of hedging transactions. The subsequent failure of that shipper then caused further knock-on failures in some of the smaller energy suppliers, as their hedging contracts and ability to hedge disappeared.
“Understanding key counterparty risks, not just through your traditional supply chain – for example, who provides your data system and who are they then reliant on – will be critical to protect business going forward,” Gross adds. Current market dynamics and the issues caused by inflationary pressures and staffing shortages mean that companies need to ensure that anything critical to their business is financially resilient and yet they often don’t think beyond the traditional supply chain, Gross warns.
Due to the critical nature of energy suppliers to UK infrastructure, the administration process for energy suppliers is different from a non-regulated company going bust. Once an SoLR is identified and set up, Ofgem revokes the failed energy company’s gas and electricity supply licences and once the company is no longer a regulated company, it can be placed into an ordinary administration or any other insolvency process.
The rules in place for insolvency practitioners and the energy regulator have created tensions between the two. Once appointed as an ‘office holder’ in a formal insolvency process, insolvency practitioners’ (IP) duty is to maximise returns to the company’s whole body of creditors. Their primary duty is to the creditors of the insolvent company.
Yet the BEIS report illustrates how some IPs, complying with their duties, were “making demands” of customers of failed suppliers for payment. When a supplier fails, customers lose the debt protections set out in the supplier licence, because administrations have no obligation to abide by these rules.
“Citizens Advice told us it had received reports of administrators mistreating customers in debt by making large demands for payment at short notice, and that existing repayment plans with the failed supplier were being ‘torn up’. In May 2022, 43% of contacts to Citizens Advice about supplier failures related to administrators pursuing debt, compared with 10% of cases in November 2021,” the BEIS report says.
A blog post written by insolvency practitioners’ trade body R3 at the time said: “Previous criticisms of office holders’ approach to collecting debts have ignored the statutory and regulatory framework in place that they must adhere to. Failure to adhere to these duties … would lead to regulatory penalties for an insolvency practitioner, potentially including the loss of their licence to practise.”
Nick Middleton, Senior Associate in the Banking and Finance team at Burges Salmon, says: “Making sure those systems align and making sure information can pass between SoLRs and IPs properly has been quite difficult.”
The difficulty has been that consumers, especially vulnerable ones, probably don’t understand the complex process of administration. One solution put forward by National Energy Action is that when a customer is transferred to an SoLR, their debt to the failed company is also transferred, so the customer in debt would still be protected by the supplier licence conditions.
Ofgem told the BEIS committee that requirements introduced in January 2021 in the terms and conditions of customers’ energy contracts ensure that “debt recovery practices will be executed in line with the supplier licensing conditions”. But this safeguard does not apply to customers in debt who signed contracts with the failed supplier before the January 2021 requirement was introduced.
In June Ofgem recommended a raft of changes, including the requirement for energy suppliers “to protect their customers’ money, so that it isn’t lost if they go out of business, adding costs to already high bills and causing a huge amount of stress and worry for customers”.
Regulation of the UK energy sector is complex and needs an immediate overhaul, which is what Ofgem and the government plan to do, but many would argue not fast enough. The most urgent step is for government and Ofgem to revise the SoLR process to address the problems over the past year and redress the imbalance of risk between customers and suppliers.
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