Ofgem - Innovation in the Energy Retail Market

On October 2^nd, Ofgem opened a consultation on innovation in the energy retail market, specifically looking at ways to reform the licencing regime to facilitate market entry. This comes after the 2021 energy crisis brutally exposed the structural failure of the market and the need for fundamental changes. Indeed, as 31 suppliers went bankrupt and the Government was forced to intervene through the £37bn Energy Price Guarantee scheme, whose costs will ultimately fall on taxpayers, it became evident that the market in its current form was not able to deliver for consumers.

In a report published last year, Stonehaven aimed to shed light on the structural issues behind this crisis and proposed a vision for transformative market changes that would unlock the innovation needed to meet ever-evolving consumers’ needs and reach net zero.

First, unlike other markets where players can differentiate on a wide range of factors such as costs, quality and service delivery, competition in the energy retail market is almost exclusively driven by costs. This is partly because energy is an undifferentiated product, but also because the introduction of the price cap in 2017 reinforced the emphasis of both consumers and suppliers on costs. This cost-centric approach led suppliers to adopt risky business models, gambling on prices in the short-term spot markets and ultimately going bust when wholesale prices rose. This approach also stifled innovation by limiting market entry. Indeed, the commercial environment is structured in such a way that companies are unable to add value and develop new services.

Second, the energy system is overly centralised and complex: in order to supply energy, players must receive a licence delivered by Ofgem setting out the conditions they must meet and the industry codes they must respect, such as the universal service obligations. If the licencing regime was initially designed to protect consumers from any suppliers’ malpractices, it distorted new entry into the retail market, which further hindered innovation. Players with innovative business models, such as an electric vehicle manufacturer who would like to make an offer to consumers by supplying electricity to charge their vehicle, are currently unable to enter the market as they cannot align themselves with the stringent requirements set out in the licencing conditions.

We therefore welcome Ofgem’s initiative to launch a consultation on innovation in the energy retail market, specifically looking at ways to reform the licencing regime to facilitate market entry. We particularly welcome the consideration of adding derogation powers to SLC22.3, which implements the universal service obligation to enable specialist suppliers that provide tailored, personalised services to meet the needs of specific customers. Indeed, in our report we highlighted that removing this type of regulatory bottlenecks is needed to facilitate market entry for these smaller, more niche players. As consumers’ energy bills shift from 60% gas and 40% electricity to 100% electricity, there will be growing demand for these assets. Players must be able to adapt and enter the market to meet this specific demand through targeted offers and services, which cannot happen under the current regime.

However, even if this consultation is a step in the right direction, it remains much too timid, and we encourage Ofgem to take on a more structural approach, such as the complete removal of licence obligations for these players. Not everyone will want to engage in the market and the current licencing regime should still protect those who decide not. That being said, the outcomes suppliers for these end uses are expected to deliver should be based on their contract with the consumer and not licence based. In this instance, the Consumer Protection Law is adequate to protect consumers from any form of abuse or negligence on the part of the supplier.