Customers will need to pay an estimated £2.7 billion to cover the costs of 28 energy suppliers failing since June 2021, in addition to the cost of running Bulb Energy. While the supplier failures were caused by substantial increases in wholesale prices, Ofgem’s approach to licensing and monitoring suppliers over previous years increased the risk and cost of them failing, according to the National Audit Office (NAO).
Since 2019 there has been a 78% increase in the bill of a typical customer buying energy at the price cap to £1,971 per year. The wholesale price of gas increased nearly six-fold from February to December 2021 and this has contributed to energy suppliers exiting the market.
Ofgem and the Department for Business, Energy and Industrial Strategy (the Department) have two main processes for maintaining continuity of supply for affected customers when a supplier fails: the supplier of last resort (SOLR) process and the special administration regime (SAR). Under the SOLR process, Ofgem transfers customers from a failed supplier to an existing supplier to maintain their continuity of energy supply. In cases where SOLR is not viable, a SAR is where a temporary special administrator continues running the failed company until it can be sold as a going concern, or the customers can be transferred to other suppliers.
Ofgem ensured that customers whose supplier failed transferred to an alternative provider without interruption to their energy supply. Nearly 2.4 million customers transferred through the SOLR process. Citizens Advice estimates that transferring has cost the average customer £30 more per month for the duration of their original contract because many were moved to a higher tariff. Customers have faced other challenges such as the loss of debt repayment plans, which particularly impacts vulnerable households.
Ofgem currently estimates that the supplier failures will cost £2.7 billion through the SOLR process and to cover the costs of failed suppliers missing payments into government schemes to support renewable generation. The largest component of this cost is for suppliers buying wholesale energy above the level of the price cap for customers from suppliers that had failed. The costs are distributed across all energy bills, rather than just the customers of failed suppliers, equating to around £94 per customer. The cost of energy suppliers exiting the market is very uncertain and could go up or down from Ofgem’s current estimate. The costs of supplier failure are likely to have been offset to some extent by some households having cheaper bills in previous years because new entrants to the market increased competition.
The Department and Ofgem had prepared in advance for the collapse of a large energy supplier, which meant they were prepared to put Bulb Energy into special administration, ensuring there was no immediate impact on its 1.6 million customers. During 2021-22 the government spent £0.9 billion on an administrator to run Bulb Energy and has budgeted an additional £1.0 billion to run it during 2022-23. The overall costs of supporting Bulb Energy will not be known until the government sells it, or it exits special administration by other means.
Ofgem’s approach to licensing and monitoring suppliers increased the risk and cost of them failing. To encourage new entrants to the market and improve customer choice, Ofgem operated what it termed a ‘low bar’ approach to licensing new suppliers. It did not undertake detailed scrutiny of their financial position when they applied for a licence or after they entered the market. Ofgem began tightening rules to improve suppliers’ financial resilience in 2018. In 2019, it introduced new assessments of applicants for a supplier license but did not implement changes to address the risks relating to existing suppliers until 2021.
By 2021 many suppliers lacked the financial resilience to deal with wholesale price increases. A report commissioned by Ofgem following the 2021 supplier exits found that many new suppliers adopted business models that made them heavily exposed to volatility in the energy market. For example, suppliers that failed operated with lower liquidity levels (less access to cash) than their peers.
The Department introduced the energy price cap in 2019 with the aim of ensuring customers pay a fair price for their energy. Ofgem did not consider what impact the price cap might have if there were sustained periods of price increases in the wholesale energy market. Although some modelling was undertaken to understand the price cap’s potential impact on supplier resilience, Ofgem did not stress-test its design in depth. Ofgem also did not consider how the price cap might interact with the SOLR process. The Department has announced plans to extend the price cap but is yet to evaluate its costs and benefits for consumers, or consider alternative forms of price cap.
Ofgem is tightening the rules for suppliers to improve their financial resilience. In December 2021, it set out plans to strengthen the financial resilience of suppliers to ensure that risks are not passed on inappropriately to consumers. Ofgem is also seeking additional resources from HM Treasury, and new powers to enable it to take a more proactive approach to monitoring and responding to issues of financial resilience.
There is a risk that Ofgem’s changes could hinder effective competition. While its ‘low bar’ approach to licensing suppliers meant some were vulnerable to external shocks, it did allow new suppliers to enter the market. Some of these offered more innovative products that supported customers to reduce their energy consumption or use their energy more flexibly. They also created greater competition on the price of bills. Some stakeholders told the NAO that there is a risk that Ofgem’s reforms could prevent the entry of new suppliers in the future.
The NAO recommends that BEIS and Ofgem should establish a process for considering how new interventions in the retail market, like the price cap, would react in a range of scenarios. In addition, Ofgem should define a set of objectives for its regulation of the retail market around price, stability, and innovation, against which it should review and report its performance at least annually.
“Ofgem and BEIS ensured that the vast majority of consumers faced no disruption to their energy supply when their provider failed. However, by allowing so many suppliers with weak finances to enter the market, and by failing to imagine that there could be a long period of volatility in energy prices, Ofgem allowed a market to develop that was vulnerable to large-scale shocks.
“Consumers have borne the brunt of supplier failures at a time when many households are already under significant financial strain having seen their bills go up to record levels. A supplier market must be developed that truly works for consumers.”
Gareth Davies, the head of the NAO