The Renewables Obligation – The Annual Mutualisation War Dance

Published on 13th October, 2020

For anyone involved in the electricity industry, the vexed issue of Renewables Obligation mutualisation rears its head every year at around this time and has been particularly noticeable in the last two or three years. So, why is this happening?

The Renewables Obligation (RO) imposes a requirement on electricity suppliers to purchase a certain percentage of their supplies from renewable sources of generation. Suppliers can meet their obligation by purchasing Renewables Obligation Certificates (ROCs) from eligible generators and presenting their ROCs to the regulator, Ofgem.

Alternatively, if suppliers do not have enough ROCs then they can pay into the so-called buy-out fund. The buy -out fund is used to cover scheme administration costs and any surplus is redistributed to suppliers in proportion to the quantity of ROCs originally presented. If there is a shortfall in the buy-out fund due to failure of suppliers to meet their obligations, the deficit is covered by a mutualisation process in which all suppliers share the financial pain.

The mechanics of how the RO works are the root cause of why RO mutualisation has been a source of considerable angst in recent years. Suppliers collect ROCs or payments from customers during each scheme year running from 1st April to 31st March. The regulator collects ROCs and/or funds from suppliers on or before August 31st – noting that late payment is allowed with all buy-out funds having to be paid by 31st October (including late payment interest charges).

RO payments to suppliers are therefore in effect a source of additional cash which builds up from April onwards and does not have to be paid until end-October in the following year at the latest.

It is not surprising therefore that when supplier businesses come under financial pressure, the RO cash which accumulates over the year is used to support normal supplier operations. In recent years, there has been a significant increase in the number of new market entrants in the supplier role and it seems reasonable to assume that, in assessing their cash requirements, many of these companies have seen RO money as a ready source of funds to help keep the business running.

Of course, the principles of prudent cash management dictate that companies should hold this money in readiness for when it has to be paid to Ofgem. Unfortunately, it seems that in many cases inadequate management of financial risks and/or over-optimistic assessments of the costs of doing business in the regulated electricity supply market has left companies overexposed and short of cash at times of stress.

A stream of smaller new entrant suppliers has gone bust in the last 3 years and millions of pounds that should have been reserved for buy-out payments have disappeared into the ether.

As a result, Ofgem finds itself in a difficult position. The principle of light touch regulation has guided the way electricity companies have been regulated since privatisation. However, the rate of supply business failure in recent years has ramped up the pressure for Ofgem to know more about suppliers’ plans when they enter the market, and about the way existing suppliers are running their businesses. This led to the Supply Business Review as part of which Ofgem has tightened the criteria for market entry and the adoption of principles to guide the way existing suppliers behave.

The corona virus pandemic and concern about its impact on suppliers’ finances has provided another reason for Ofgem to take an interest in matters previously regarded as commercially sensitive.

With the late payment deadline looming at the end of October, this year Ofgem took regulatory intrusion to another level by writing to all 24 suppliers who had not met their obligation to pay the RO by the end of August insisting that they provide “robust assurances” that all RO debts would be paid by 31st October. In addition, they threatened to include any business not providing such assurances on a public “black list” in advance of the deadline actually being reached. It was by no means clear what a “robust assurance” was. Moreover, the strong tone of these demands sat awkwardly with the fact that suppliers are perfectly entitled to withhold payment until the end of October and the threat of enforcement action against businesses which had not actually broken any rules seemed like overkill.

Determined to exercise its limited power to the extent it could against any companies not complying with its demands, Ofgem duly published its promised “black list” on October 2nd. Seven companies were “named & shamed” – one of which (Tonik Energy) has gone bust at the time of writing. Ofgem also stated that it thought it was likely that all companies on the list would fail to make their RO payments by 31st October and that they might then be subject to a process of having their licences revoked.

Looking at these events dispassionately, it seems fair to conclude that the actions of the regulator may have mitigated the buy-out payment problem – but only to the extent of any suppliers who might have been considering the cash flow benefits of stringing out their RO payments beyond the compliance deadline, will probably have been deterred from taking that course of action. It’s hard to know how many of the “shamed” – or even others who may have provided robust assurances – fall into this category.

The reality is that each of the 24 suppliers will fall into one of two simple categories – those who remain viable and will meet their obligations by 31st October and those who are in effect insolvent and will fail to meet their obligations.

As ever under the current regulations, the buy-out shortfall remains a problem and the ability of the regulator to deal with it meaningfully is limited.

It is possible that the more general conditions developed as part of the Supplier Business Review will mitigate the problem over the longer term by weeding out the weaker new entrants and correcting inappropriate business practices by existing suppliers.

A more direct way to solve the problem would be to make the RO buy-out payments like a tax comparable to VAT or Climate Change Levy which has to be paid monthly or quarterly to HMRC – although it is clear that this approach would be unlikely to find favour from our political leaders due to the sudden clarity it would bring to the cost of subsidising the renewable sector.

EnDCo provides independent and transparent access to the wholesale electricity market for independent generators and consumers. Our services include helping our customers to optimise their financial position taking account of their assets and market opportunities.

For further information, please email me at:

Les Abbie, CEO, EnDCo