Ofgem allowed challengers to launch bearing minimal risk, report finds
Ofgem was so keen to encourage competition in the energy retail market that it gave new entrants a “free bet” — enabling them to join with minimal risk and to exit with almost no downside, a report commissioned by the regulator has found.
Instead of checking or monitoring new suppliers for their financial resilience, Ofgem left it to the market without fully understanding the consequence for consumers, the study by consultancy Oxera said.
“Ofgem’s approach to regulating the market created the opportunity for suppliers to enter the market and grow to a considerable scale while committing minimal levels of their own equity capital,” the report said.
“By pursuing a high-risk/high-reward business model, the suppliers would benefit from any upside, while being able to exit without any downside.”
This approach — combined with rising wholesale gas prices — helped trigger the collapse of 30 suppliers in the past year, representing 10 per cent of the market and causing distress to their 4mn customers.
Consumers are paying the price through a £68-a-year increase to already fast rising energy bills to pay for the cost of bailing out the failed companies.
Many of these failed suppliers shared similar characteristics such as negative equity balances, over-reliance on customer credit balances to finance operations and counting on spot daily prices rather than “hedged” gas that has been bought in advance.
Customer credit balances accounted for 80 per cent of Avro’s total assets in 2020 and 90 per cent of the assets of both Utility Point and Green Supplier. All three have collapsed.
The protection from the consequences of risk-taking may have led to incentives to pursue riskier business models than if suppliers had greater levels of “skin in the game”, the report said.
Although most customers of collapsed suppliers have been transferred to other providers, Bulb, the largest, has been taken over by the government at an expected cost of £2.2bn, making it the biggest state bailout since Royal Bank of Scotland in 2008. Co-founder Hayden Wood is still being paid £250,000 a year to run the business while around £2mn is being paid on bonuses to retain key staff. Wood and co-founder Amit Gudka each extracted more than £4mn from the lossmaking company in 2018.
The owners of liquidated companies may also benefit from the sale of assets once creditors are paid off in insolvency proceedings, the report warned, although the loophole has since been closed through a temporary 12-month tax law.
Stakeholders are concerned that “the cost of failure is mutualised and borne by bill payers, while any residual asset value at the point of failure could accrue to the shareholders of the failed firm”, the report said.
It also identified concerns with how the energy price cap — introduced in 2018 to protect consumers — had been implemented.
The six-month gap between each calculation of the price cap meant that at times of rising wholesale costs providers could be left to cover the difference between the prices they could charge consumers and the higher cost of buying energy. This “may have left suppliers with insufficient headroom to deal with shocks”, the report argued.
Ofgem said it accepted the findings and recommendations, including the need for tougher checks on companies as well as protecting customer credit balances and increasing the financial requirements for companies starting up, saying “many . . . were already being implemented”.
“The board will ensure all recommendations are carried out to further strengthen the regulatory regime,” it added.