Ofgem is consulting on how to better address supplier payment default under the Renewables Obligation (RO) scheme.
It follows an increasing number of electricity suppliers exiting the retail market - with over 20 going bust since 2018 - and defaulting on their obligation under the RO, with this manifesting as shortfalls in the buyout fund.
A mutualisation mechanism is triggered once this exceeds a threshold. While this was recently increased to make it harder for mutualisation to be triggered, it didn’t address the underlying causes of payment default.
Ofgem said some stakeholders had defined the cause as the ability for suppliers to accrue significant levels of obligation without any specific measures in place to ensure their obligations are settled in the event of default.
It has therefore prepared a consultation jointly with the Department for Business, Energy and Industrial Strategy (BEIS). Three options are being considered for lowering the risk and extent of payment default, the first of these being a legislative requirement for suppliers to settle their RO more frequently to lower the amount they are able to default on.
Currently, suppliers accrue an obligation over each 12-month obligation period and are then given 5 months to settle it with Renewables Obligation Certificates (ROCs) or alternative cash payments. A further 2 months are available for permitted late payments, although these attract interest charges.
In 2020, 10 suppliers missed the late payment deadline, with final orders later given to three suppliers who failed to make their payments.
The scheme’s lengthy settlement arrangements are designed to lower the likelihood of volatility in the ROC market caused by seasonality and intermittency in the supply of ROCs, however they also enable suppliers to default on up to 19 months’ worth of obligation.
In the consultation, Ofgem is considering a quarterly arrangement, although it is also considering the case for compressed settlement timeframes, i.e. shorter than the existing 7 months settlement period that follows each obligation year.
Quarterly settlement would reduce the maximum amount of obligation suppliers could default on from 19 months to ten. If the option for late payments was removed and the settlement period compressed from 5 months to 3 months, the amount of obligation that a supplier could default on could be further reduced to 6 months.
However, compressed timeframes would introduce a new risk that there may be insufficient ROCs available to suppliers, particularly at the early settlement deadlines, to settle their obligation with ROCs. To mitigate this risk, Ofgem is proposing ‘exchangeable’ cash payments or a standby letter of credit ahead of final settlement with ROCs or cash, which it said would give suppliers more flexibility.
Its second option is a licence-based requirement for suppliers to protect their accruing obligation against the risk of default. This would see suppliers given the choice of which protection measure to put in place, for instance parent company guarantee, letter of 5 credit, escrow accounts, ROCs or cash.
If a supplier exited the market and failed to put additional protections in place when required to do so, any existing measures would be put towards settling the supplier’s obligation.
However, Ofgem noted that it is not yet clear whether suppliers who would be unable to meet this requirement with ROCs or cash would be exposed to additional costs attributable to the specific protection measures, e.g. arrangement fees.
It also noted that approaches that restrict suppliers’ access to their revenues, either as a result of more frequent settlement or because they are required to protect a portion of their accruing obligation for extended periods, will increase their operating costs.
Lastly, its third option is to continue with existing policy. This would allow the amendment to mutualisation arrangements as well as changes introduced by Ofgem to the electricity supply licence conditions which aim to increase supplier standards of financial resilience to come into effect.
If the change to the mutualisation threshold has already been in effect, over the past three years - each of which saw mutualisation triggered - mutualisation would only have occurred for 2018/19. On the other occasions the shortfall would have been insufficient to trigger mutualisation.
There remains a case for maintaining the status quo and continuing with existing policy, Ofgem said, given the costs and benefits of taking further action to address supplier payment default, as well as the risks that some of the options presented pose to the ROC market.
The consultation can be viewed in full here, and is to close on 9 November 2021.