Background
Wholesale gas prices in the UK remain at unprecedented highs, trading at more than three and a half times the level where they were at the start of 2021. The wholesale markets also have experienced continued volatility, with month-ahead gas prices at the UK’s National Balancing Point hitting a new record high of 450p per therm,1 before dipping to a two-month low at the end of December 2021.
Record wholesale gas prices have created a difficult operating environment for energy suppliers. A total of 28 energy suppliers ceased to trade in the UK in the past year, with more than 20 of those 28 becoming insolvent since August 2021.2
The energy supply company special administration regime
The majority of energy suppliers that ceased trading in 2021 have been subject to Ofgem’s Supplier of Last Resort (SoLR) regime, whereby Ofgem revokes the supplier’s licence and appoints an alternative supplier to take over the customers of the failing energy supplier in order to ensure continuity of energy supply.
However, in response to Bulb’s insolvency, in November 2021, Ofgem and the Secretary of State turned to the previously unused energy supply company special administration (the Special Administration) regime, under the Energy Act 2004 (as modified by the Energy Act 2011). Special Administration is intended to be a backstop to the SoLR regime in situations where it is not feasible for Ofgem to appoint an SoLR – in particular, where a larger supplier becomes financially distressed and there is a risk of financial failure creating a systemic risk which spreads across the market.
Ofgem and/or the Secretary of State may apply to the court for a special administration order and appoint a special administrator to an energy supply company. The special administrator is required to manage the energy supplier in order to achieve the objectives set out in the Energy Act 2011, namely: (i) to continue to supply gas at the lowest cost which it is reasonably practicable to incur; and (ii) to secure the rescue of the supplier as a going concern and, where that is not possible, to transfer the supplier as a going concern to another company or companies.3 In light of those objectives, the special administrator also must consider consumers’ interests in addition to those of the company’s creditors.
Unlike under the SoLR regime, the Secretary of State may provide financial support, guarantees, or indemnities to an energy supplier in Special Administration to enable the administrator to finance the company’s activities. The Secretary of State has broad powers to define the terms and conditions of any such support. If the company in Special Administration is unable to repay some or all of the financial assistance provided by the government, the Secretary of State has the power to modify gas or electricity licences to allow for the recovery of the amount of any shortfall by increasing charges from industry participants through the licence mechanism.4
Another point of difference between the SoLR framework and the Special Administration process is that, while Ofgem can direct a new supplier to take on an exiting supplier’s customers under the SoLR regime, transfers of customers to a new supplier under a Special Administration requires the transferee’s consent. In the ordinary course of business, suppliers would tend to welcome taking on new customers, but in an unsettled market with difficult economics, it may prove more difficult for a supplier in Special Administration to find willing transferees.
New measures to boost financial resilience
As noted in our previous client alert, Ofgem has introduced a number of measures in recent years aimed at protecting consumers in the event of a supplier’s failure. These include tighter standards for new entrants to the energy supply market and increased reporting and auditing obligations under suppliers’ licence conditions.
However, in response to the scale of recent failures, Ofgem has gone “further and faster” in strengthening its regulatory approach in order to improve the financial resilience of the energy retail market, and has published a suite of documents detailing its proposed actions in December 2021.5
Some of the immediate actions in Ofgem’s “Building Energy Market Resilience” package include:
- Refining and enhancing the information collected from suppliers and other parties relevant to supplier and retail market resilience and, where necessary, expanding the scope of reporting from suppliers;
- Launching a new financial stress testing process in January 2022 to assess whether suppliers are sufficiently robust to withstand a range of scenarios (e.g., price volatility, differing levels of customer bad debt, significant acquisitions or loss of customers) through their capital cover or risk management;
- Launching a self-assessment exercise in early 2022 to be undertaken by suppliers’ boards. Suppliers will be expected to demonstrate that their management control framework is sufficiently robust, including by reference to their governance, policies, processes, controls, and management information used to manage and monitor commercial risks;
- Engaging with suppliers to explore protections around customer credit balances, such as clearer guidance around ring-fencing, pending the development of a regulatory framework for supplier financial resilience; and
- Reviewing whether further guidance or regulatory change is needed on “fit and proper” requirements, and potentially wider measures associated with board accountability and governance.
In addition to the above, Ofgem is currently seeking views from stakeholders on the following measures:
- Introduction of several temporary measures to enable domestic suppliers to manage the risks to consumers from continued wholesale market volatility;6
- Introduction of new supply licence conditions to allow Ofgem to conduct assessments of gas and electricity suppliers when they reach 50,000 and 200,000 customers, and ahead of any significant planned commercial and personnel changes;7
- Potential changes to the price cap methodology, with potential interventions being introduced from April 2022 if necessary, and an amended price cap methodology in place by October 2022;8
- A proposal to amend the default tariff cap, to take account of proposals being made under Uniform Network Code Modification 687,9 which will modify the way in which SoLR levy costs are recovered from gas customers;10 and
- A proposal to modify gas and electricity licence conditions to allow third-party financing of SoLRs levies in order to smooth the impact of SoLR levy payments on consumer bills in 2022/2023.11
The above consultations will close in mid-January 2022.
Final thoughts
Energy suppliers should continue to be mindful of their existing reporting and auditing obligations to Ofgem. In addition, suppliers should take time to properly digest the various immediate and short-term actions proposed by Ofgem, and ensure that they understand the various obligations to be undertaken and their potential impact on the business.
Those trading with energy suppliers also should continue to closely watch their counterparties’ positions, particularly from a credit and exposure perspective. They should be ready to exercise their contractual rights and remedies (after ensuring that these are as robust as possible), including triggering events of default, and should even be prepared to issue close-out notices.
Our Energy & Natural Resources Group and our Restructuring & Insolvency team have extensive experience in advising energy suppliers on transactional, regulatory, and contentious matters, including advising on supply licence conditions and matters involving the entrance and exit of supply businesses. If you would like to discuss any of the issues in this article, please get in touch.
- Trading Economics, UK Natural Gas data, tradingeconomics.com/natural-gas.
- Ofgem, Building energy market resilience (15 December 2021), ofgem.gov.uk/energy-market-resilience.
- Energy Act 2011, section 95.
- Energy Act 2011, sections 98 and 99.
- Supra 2.
- Ofgem, Consultation, Statutory consultation on potential short-term interventions to address risks to consumers from market volatility (15 December 2021), ofgem.gov.uk/market-volatility.
- Ofgem, Consultation, Statutory consultation on strengthening milestone assessments and additional reporting requirements (15 December 2021), ofgem.gov.uk/milestone-assessments.
- Ofgem, Call for input, Adapting the price cap methodology for resilience in volatile markets (15 December 2021), ofgem.gov.uk/price-cap.
- Joint Office of Gas Transporters, Uniform Network Code Modification 0687V, Creation of new charge to recover Last Resort Supply Payments, gasgovernance.co.uk.
- Ofgem, Consultation, Price Cap – Consultation on reflecting change to gas SoLR levy costs in the default tariff cap (15 December 2021), ofgem.gov.uk/tariff-cap.
- Ofgem, Consultation, Statutory consultation on modifications regarding Last Resort Supply Payment Claims for electricity supply, gas supply, electricity distribution and gas transportation licence conditions (30 December 2021), ofgem.gov.uk/statutory-consultation.
Client Alert 2022-011
