Electricity Supplier Licensing – What does the future hold?

Published on 3rd May, 2019

The spate of electricity supplier failures in 2018 and early 2019 has caused some to argue that the sector is out of control, with consumers over-exposed to the poor business practices of ‘fly by night’ operators who have entered the market without sufficient oversight and surviving businesses left to pick up the pieces through the mutualisation of unpaid debts and the unloved ‘supplier of last resort’ (SoLR) process.

At the other end of the spectrum, some observers take the view that new entry into the electricity supply market has been a positive force for good, since it has significantly increased the level of competition in the sector and that consumers have been ever more ready to take advantage of the new opportunities on offer as demonstrated by switching rates increasing to 19% last year.

No doubt the truth lies somewhere between these two rather extreme positions. At the heart of this debate lies the question of whether, and to what extent, the electricity supply sector is beset by an example of ‘moral hazard’, in which the rules and financial arrangements affecting suppliers create incentives for some parties to behave in a way which harms the interests of others. In this case, the argument is that the process of entering the supply market – not only the licence application procedure but also BSC accession and MRA accreditation – is insufficiently rigorous and allows businesses that lack adequate understanding of the market, and with only limited access to capital, to join the game.

If such firms fall – perhaps because of a failure to invest in customer service, an excessively aggressive pricing strategy or substantial adverse wholesale market movements – then there are limited consequences for the failing firms or their directors because of debt mutualisation and the way the SoLR process works. There are other concerns relating to the fact that current licence application procedures may allow individual directors who may have been through SoLR previously to re-apply later and repeat the same mistakes. Similarly, the frequent use of “off the shelf” supply models which facilitate market entry, perhaps at the expense in-depth business understanding, has been flagged as encouraging ill prepared market entrants..

While these concerns may be real in principle, is such behaviour- assuming it exists – having a material impact on the sector?

Reservations have been expressed by the larger established suppliers – the so-called ‘big 6’ amongst others – that the moral hazard problem risks undermining overall confidence in the sector and that it is simply not fair that some businesses do not play by the ‘normal rules’. This is of course what you would expect to hear from large businesses with strong balance sheets who no doubt see a potential competitive threat from smaller suppliers. In a similar vein, consumer representative organisations like Citizens Advice protest that low income households should not be exposed to the risks posed by ‘cowboy’ companies who may take them for a ride.

But the whole point of mutualisation and SoLR is that they largely protect the domestic householder from loss of both physical supply and money.

This does not mean, however, that the question of distorted incentives in the supply sector can be dismissed. While it is true that recent failures have been at the smaller end of the supply business spectrum, historically some quite large supply businesses have failed and, if the issues of principle set out above are indeed real, then there is no reason why they may not lead to the failure of some sizeable supply businesses in the future – with material adverse financial consequences for all.

Recognising this, the industry regulator Ofgem is conducting a review of the current approach to licensing and regulation of suppliers with the aim of “raising standards around suppliers’ financial resilience and customer service”.

This review covers three areas:

• Conditions for suppliers entering the market;
• Ongoing requirements for current suppliers;
• Arrangements for managing supplier failure and market exit.

Proposals for the supplier licensing arrangements for those entering the market were published in early April, and three options were considered:

Ofgem decided to go for Option 2 which will require applicants to demonstrate more explicitly that they are adequately prepared and resourced to operate in the supply market. Option 1 was rejected on the grounds of the current approach being too ‘laissez faire’, and Option 3 because it would be too intrusive and detrimental to the positive impact of new entry on competition and innovation in the sector.

The chosen Option 2 does not involve setting any specific minimum capital requirements but does involve checking that business plans do not rely on extensive use of customers’ credit balances. Other aspects of the proposed change worth noting are that applicants will have to satisfy a ‘fit and proper’ test and the timing of licence application/approval will coincide more closely with actual market entry on the grounds that the Elexon and MRA processes will provide additional useful information for Ofgem. It remains to be seen whether the new arrangements will differ significantly in terms of how they will apply to the domestic and non-domestic supply sectors.

It is envisaged that Ofgem will issue a final letter on licensing arrangements in June together with an update on current work looking at ongoing supplier requirements and market exit.

EnDCo is a supplier in the I&C market and offers direct and transparent access to the wholesale market. Our business model means that we do not trade ‘for our own book’ and as a result the secured wholesale prices and the retail prices offered are matched, thus removing one of the main business risks faced by suppliers.

For further information, please email me at: les.abbie@endco.co.uk

Les Abbie, CEO, EnDCo