Building energy market resilience

Reports, plans and updates
Publication date
Industry sector
Supply and Retail Market

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The unprecedented rise in global energy prices has put severe strain on energy markets and energy consumers around the world. Since the gas crisis started, Ofgem has worked at pace to protect consumers as gas prices rose more than five-fold in a year. Ofgem has ensured that over 4 million customers of failed suppliers have stayed on supply, protecting domestic customers’ credit balances and ensuring that they are paying energy prices in line with the price cap level. We have worked with suppliers to ensure that they have complied with their licence obligations, including providing support to their most vulnerable consumers.

However, the rise in gas prices on the UK market has had a huge impact on the British energy market. In particular, we have seen 28 supplier failures to date in 2021 with consequential costs for consumers. It is clear, as highlighted by the recent Citizen’s Advice report, that many suppliers in the market were not as robust as they should have been and certainly not enough to withstand an economic shock of this magnitude. Equally, the methodology of the price cap makes it harder for suppliers to adapt in a market that has these high levels of volatility. Therefore, building on the rules we have in place, we are working at pace to strengthen the resilience of the sector. It is vitally important to note that the volatility in the gas market is not over, and we are continuing to see significant shifts in the market, particularly for Summer 2022. Suppliers will need to ensure that they are continuing to manage risks to avoid further financial distress and potential insolvencies.

On 29 October, I set out our approach to dealing with the current energy price volatility (Rising wholesale energy prices and implications for the regulatory framework | Ofgem). We are now putting that approach into action, with measures and consultations focused on: strengthening suppliers’ financial resilience so that they can cope with these high and more volatile energy prices, and potential adjustments to the price cap methodology so that it can continue to protect consumers at times of high price volatility without creating unsustainable risks for suppliers. The details are set out in six documents Ofgem are publishing today:

  • An action plan on retail financial resilience
  • A supporting statutory consultation on strengthening milestone assessments and additional reporting requirements
  • a call for views on potential adaptations to the price cap methodology for resilience in volatile markets
  • supporting statutory consultation on potential short-term interventions to address risks to consumers from market volatility
  • And two decision letters regarding the time period for assessment of supply licence applications and tacit authorisation; and revocation of dormant supply licences

Our aim is a competitive and innovative retail market, where consumers have secure energy supplies at fair prices, and have confidence in efficient, competitive suppliers; and where suppliers are resilient to market shocks and can earn reasonable profits commensurate with the risks that they are taking.

Looking ahead, working with stakeholders, we will consider what longer-term reforms from Ofgem are needed to ensure the sector can protect consumer interests through the transition to net zero, and what the appropriate measures of success should be.

Equally, Ofgem will ensure that we learn the lessons from the impact that gas prices have had on the British energy market, and will adapt our regulatory and organisational approach in response.  

Stronger Financial Regulation

Energy supply is a competitive market in which suppliers can fail, but the combination of recent exceptional energy prices and some poor business and risk management practices, has resulted in a large number of suppliers exiting the market, leaving high costs to be recovered from energy consumers.

Ofgem has been strengthening its approach in this area, for example introducing tighter standards for new entrants. The number of new entrants from 35 during 2016-18, to 8 in 2019 and 2 in 2020. And we established a new Financial Responsibility licence condition earlier this year, and had started enforcement proceedings against two suppliers. However, our regime was not fully developed and our regulatory action was overtaken by the speed of change in energy markets.

We are now going further and faster.

Our proposed Action Plan to boost financial resilience in the sector is set out in the accompanying document, and includes:

  • the launch of financial stress testing for suppliers from January;
  • requiring supplier Boards to undertake self-assessments of their management control frameworks and provide assurance to Ofgem;
  • strengthening existing controls on “fit and proper” requirements;
  • tightening rules around the protection of credit balances and renewables levies; and
  • consulting on new financial licence requirements in Spring 2022.

We are temporarily extending the period for assessment of new supplier licences to nine months, and consulting on strengthening our ability to ensure appropriate standards, including fit and proper persons tests, apply to all those seeking to operate in the market. We are also consulting on being able to require suppliers to pause expansion until we are satisfied that they are financially resilient before they grow beyond certain milestones.

As we strengthen our regulatory approach, we will also consider whether to ask government for additional powers to ensure that we can take rapid and appropriate action when suppliers are unable to meet the tough new requirements we are establishing.

Our intent is not to discourage well-financed new entrants, new business models, innovation or risk taking, but to reduce potential harm to energy consumers, in particular, to ensure that if suppliers do fail, the resulting costs to consumers are minimal, even in instances of high or volatile energy prices.

These proposed reforms will strengthen risk management in the sector, protecting the interests of consumers, providing greater certainty for investors and strengthening the resilience of the sector. Our aim is to bring in these reforms as soon as reasonably practicable.

Adapting the price cap methodology for volatile markets

As part of our drive to improve the resilience of the energy retail market, we are considering whether to adapt the price cap methodology to ensure the price cap is better able to handle energy market volatility, whilst retaining its benefits for consumers.

The price cap has delivered significant price protection to consumers and driven suppliers to become more efficient, with an expected benefit to consumers of roughly £1bn per annum since its introduction. The current price cap methodology, whilst protecting consumers from volatility, exposes suppliers to risks that are harder to manage at times of high energy price volatility. There is a risk that, if not tackled, this could lead to higher costs for consumers.

The accompanying paper sets out potential adaptations that we believe would reduce the risks facing suppliers whilst retaining the benefits of the price cap for consumers. We are keen to get stakeholder responses: to understand whether change is justified, what matters most to consumers, what is feasible for suppliers, and whether there are any additional options that we should consider. This is not a formal consultation, but we are keen to quickly gather views before consulting on a preferred option early next year.

If we decide to proceed with adjustments to the price cap methodology, we aim to get changes in place in time for next winter. But this could leave the market exposed ahead of that. To enable suppliers to better manage market volatility on behalf of consumers, we are consulting now to gather stakeholder views on potential temporary interventions that could, if needed, be implemented by April. Ofgem is only considering these measures due to the severe price volatility we are seeing in energy markets. There will be a very high bar to intervention, and Ofgem will only proceed if we are satisfied any intervention is in the interests of consumers.

Moving forward

Our priority has been, and remains, to act in the best interests of energy consumers. We are committing ourselves to develop our capabilities as a regulator in order to ensure a more resilient retail sector going forward, able to withstand potential continued energy price volatility, and provide a firm foundation for the energy market transformation as we transition to net zero and a more decentralised, data enabled energy sector.

We will continue to work closely with stakeholders in delivering these changes in the interests of consumers, and welcome views on the proposed actions and potential interventions to establish a more resilient energy retail sector.

 

Jonathan Brearley

Chief Executive