What does the Ofgem Review mean for retail?
The government has finally published its long-awaited review of Ofgem. But was it worth the wait and will it signal a new dawn for energy retail as many had hoped?
By Dorjee Wangmo, junior reporter
What does the Ofgem Review mean for retail?
The government has finally published its long-awaited review of Ofgem. But was it worth the wait and will it signal a new dawn for energy retail as many had hoped?
By Dorjee Wangmo, junior reporter
In the 16 months between the government launching its official review of Ofgem and its drawn-out conclusion, regulation of the energy retail market stood out as the primary area where many in the sector wanted to see drastic change.
The clamour for a shakeup was typified by Energy UK’s no-holds-barred submission to the review, which labelled the energy regulator as “too big and bureaucratic” to regulate the market. It specifically called for consumer protection and competitive market roles to be shifted to the CMA, while letting Ofgem focus on infrastructure regulation.
Writing for Utility Week, the former chief of the Office for Electricity Regulation Stephen Littlechild went so far as to suggest that Ofgem could be relived of all its regulatory powers over the energy retail market.
Calls for such dramatic action were – somewhat inevitably – largely ignored by the Department for Energy Security and Net Zero (DESNZ) in its final report. It led to an immediate backlash from Energy UK chief executive Dhara Vyas who slammed the review as falling short of the radical reform that she deemed necessary.
But was the review really a damp squib or will any of its 38 action points make a substantial difference to the customer-facing side of the sector?
Optical disillusion
Energy UK’s headstrong rebuttal of the final Ofgem Review was driven as much by the narrative constructed around its publication as the actual contents of the report. The message from DESNZ’s communications team was clear: we’re cracking down on retailers.
Instead of stripping back Ofgem’s authority over the retail sector, the energy regulator has been emboldened with new powers to block companies from paying out bonusses to their senior executives. The regulator will also be given stronger powers which will allow it to enforce consumer law directly, negating the need to go through the courts when companies breach certain licence conditions.
While both measures are applicable to the entire energy lanscape, one retail source said, “it’s obviously targeting suppliers”. Another former Ofgem executive agrees that the bonus ban “is more likely to be used in the supplier market” as they have a more direct relationship with their customers, meaning higher chances of breaching customer protection duties.
The energy retail source adds that the ban is based on little more than trying to appease voters: “They’ve seen how well the bonus ban in the water sector has gone down with the public and they’ve thought ‘you know what, let’s do the same here’. With all due respect, we’re not the water sector and we shouldn’t be treated like we’ve wronged the public in some way.”
Another former regulator says the bonus ban doesn’t make sense and expresses doubts over its ability to encourage good behaviour. “It’s absolute politics, nothing to do with economics,” they say. “Firstly, it’s incredibly difficult to use pay as a meaningful incentive mechanism for good behaviour. And because Ofgem is really slow in investigating things, the risk is that by the time the enforcement comes in the chief executive responsible for actions will no longer be working at the company.”
Secondly, the former regulator claims that the added uncertainty around bonus pay will inevitably lead to higher fixed salaries for retailer bosses, rendering the bonus ban pointless at best, and counterproductive at worst.
They add: “That’s bad for financial stability. It means if you have a down year, and your fixed pay base is high, as a company you can’t cut costs. Whereas having a big variable pay is good for financial stability as when the business isn’t doing well, the bonus pay can be lowered or even scrapped. Bonus pay is an automatic economic stabiliser and shouldn’t be banned.”
Light touch regulation
Beneath the headlines about bonus bans and tougher enforcement, the review’s other action points do suggest a more progressive change of approach – at least in some areas of the retail market.
In particular, industry insiders point to DESNZ’s idea to create a General Authorisation Regime (GAR), which would offer Ofgem the opportunity to adopt “lighter-touch regulation for low-risk activities”. The GAR will allow Ofgem to set specific conditions that retailers would need to meet when entering the market, negating the need to hold a full traditional licence. While DESNZ has not specified what kind of activities would be considered as low risk, Dan Norton, commercial director at Ohme, thinks it could offer benefits to flexibility service providers (FSPs) and load controllers.
Norton – a former Ofgem director – explains: “The GAR process would allow a risk-based approach that we [FSPs] want but currently don’t have.”
Norton sees this as a positive change and a significant shift from Ofgem’s existing plans to regulate load controllers and FSPs with a trimmed down version of the current 623-page electricity supply licence. “The relationship between an FSP and their customers is very different to a licensed supplier," he says. "The licensed supplier has rightly got lots of duties around making sure that the customer doesn't come to any sort of substantial harm.
“But a lot of those processes aren't really relevant for FSPs because if for whatever reason our service fails or isn't delivered, the customer still gets electricity, the car still gets charged, there's no risk to life or wellbeing from the services that FSPs are providing.”
“The General Authorisation Regime process would allow a risk-based approach that we flexibility service providers want but currently don’t have.”
Dan Norton, commercial director, Ohme
Two-tier concerns
While welcomed from an FSP perspective, the implementation of the GAR has raised concerns that it could create a “two speed” system in the retail market, with those on the GAR granted quicker access to customers because they will not be hampered by the rigours of being on a supply licence.
Deborah Harvey, a partner at Freeths, points out that the GAR risks exacerbating a retail system that she deems to already be tiered. “We already have a sort of a two-tier system in the sense that at the moment we've got the licensed supply regime and all the other access-to-market routes that sit with that,” Harvey says.
She is referring to the small supply exemption rule introduced in 2001, which allows suppliers providing 5MW or less to serve customers without needing a supplier licence. In other cases, small suppliers with fewer than 20,000 customers, are also exempt from delivering Energy Company Obligation scheme while requiring a full supply licence.
There are other ways as well. Harvey points out that Ofgem currently has a Licence Lite, which allows a new supplier to partner with an existing supplier and serve customers without needing to comply with the full supply licence. According to Ofgem, “a Licence Lite direction relieves the applicant of their obligation to be a direct party to a number of industry codes”. These codes include the Balancing and Settlement Code (BSC) and Connection and Use of System Code, among others.
Harvey also highlights a third route, the white label option, currently used in the market as an example of two-tiered system. Under this option, a licensed supplier lends its licence to another, unlicensed, supplier, who then serves customer under its own brand. For example, Sainsbury’s Energy that uses Eon’s licence.
“All of these kinds of alternatives to a supply licence were devised in sort of a high-level way some time ago and are opaque in places,” she says. As a result, the Licence Lite option has rarely been used. To avoid a repeat, for the GAR to be successful, Harvey hopes to see definitive rules on when and how the regime can be used.
While scant on details, the review suggests that Ofgem would implement the GAR for emerging areas, potentially replacing existing licences with the GAR over time.
DESNZ adds that it has drawn the GAR from the financial services sector where the regime is used as “provisional licences”. The Financial Conduct Authority (FCA) issues provisional GAR licences to get firms up and running while working towards full authorisation.
In the financial services sector, the GAR is often used to bring in companies en masse into the regulatory regime. For example, when customer credit firms were regulated, thousands of firms registered under the regime. A point of comparison could see thousands of heat networks registering under GAR regulation, one regulation expert suggested.
However, Thomas Forman, partner in the energy and climate change team at law firm CMS, says the Ofgem review doesn’t make it clear whether the GAR in the energy sector will be “a flexible alternative to a full licence or as parallel regime sitting beside the full licence”.
“A further question is how modifications to the rules around the GAR itself will work in practice? Will modifications to GAR conditions follow the current consultation and appeal route?” he adds.
“We already have a sort of a two-tier system in the sense that at the moment we’ve got the licensed supply regime and all the other access-to-market routes that sit with that.”
Deborah Harvey, partner, Freeths
We’re gonna need a bigger sandbox
A lack of innovation in the energy retail sector has long been bemoaned. Ofgem already set out to address this earlier this year when it proposed a refresh of its performance indicators. The regulator has proposed that measuring innovation in the retail sector should be one of its new performance indicators, expressing a desire for new entrants with innovative business models enter the energy retail market.
To realise this ambition, DESNZ has enhanced Ofgem’s power to make targeted exemptions for existing licensees for a short period of time to drive innovation in the market.
The review adds that Ofgem’s current regulatory framework “can unduly limit an innovator’s ability to bring new products and services to the market”. To tackle the problem, Ofgem will be able to suspend enforcement actions against a company for licence breaches for a set period while they are in the process of trialling a new product.
A former executive at Ofgem has, however, raised concerns about how effective the rule change will be, suggesting that it will run into the same pitfalls as the Energy Regulation Sandbox. “When I was at Ofgem, the criticism around sandboxing from suppliers as a whole was that the conditions you must meet in order to access that sandbox were restrictive, making it not really worthwhile as a route to market,” they add. “It comes down to Ofgem’s lack of ability to take risk. It’s risky to give [licence] derogations to individual players as it could risks an uneven playing field.”
Shraiya Thapa, senior knowledge management lawyer at Freeths, disagrees and thinks this is a positive change. She says the current sandboxing was “designed in a world where there were only very few suppliers and generators and other traditional players”.
“We always say things move faster than the regulation, and this [sandboxing] is so far out of date that it needs to be looked again with a fresh perspective,” Thapa says.
Following the review, she expects “Ofgem to extend the scope and scale of the players eligible for sandboxing”.
The devil will, however, be in the detail, Thapa says, and only then will we know if the Ofgem Review was really worth the wait.
“We always say things move faster than the regulation, and this [sandboxing] is so far out of date that it needs to be looked again with a fresh perspective.”
Shraiya Thapa, senior knowledge management lawyer, Freeths
