In an attempt to increase competition (and therefore lower retail energy prices) in the retail consumer energy market, multiple new supplier entrants have been licensed by Ofgem. These tend to be smaller providers representing disruptive competition to the larger, established players. Like the larger providers, the smaller supply companies use hedging and forward trading to mitigate against price fluctuations and consumer revenue. In the period since November of 2020 wholesale energy prices have almost doubled as a result of a number of factors including marked COVID-driven decrease in demand from office and other large premises coupled with the divergence of liquefied natural gas supplies to South East Asia. This has disproportionately impacted the smaller suppliers who are less able to absorb the increased costs, and consequent impact on hedging, of this price shock when compared with the “big six.”
Insolvencies in the energy supply industry fall under a special administration regime known as the Energy Supply Company Administration. This special administration regime (which applies by virtue of both the Insolvency Act 1986 and the Energy Act 2011) is intended to provide for the uninterrupted supply of energy to consumers by means of a “Supplier of Last Resort” alternative to the appointment of an “Energy Administrator.” Essentially, this means that Ofgem attempts to replace a failing supplier with an alternative supplier rather than place the failing supplier into “Energy Supply Company Administration.”
Since the beginning of January 2021, at least three energy supply companies have run into distress including Green Network Energy which, according to Ofgem, is the largest energy supply company to date to have gone through the Supplier of Last Resort process.
Whilst the intention of the Supplier of Last Resort process is to ensure that customers receive a continuous supply of energy, the issue that arises is that the process is one that must be completed within a short timeframe. The nature of the Supplier of Last Resort process favours the big six providers which may lead to further consolidation in the consumer energy industry, and a consequential reduction in competition, presenting Ofgem with a conundrum.
The Energy Supply Company Special Administration Regime
What is a special administration regime?
There are a number of special administration regimes in England and Wales which amend the general administration process set out in the Insolvency Act 1986. These special administration regimes were introduced in respect of industries where there are wider public interests, or in which statutory functions of a public nature are carried out, such as, the supply of gas and electricity, or the ownership and operation of electricity transmission, or distribution networks or gas pipelines, or indeed the supply of water.
These regimes, including the regime introduced for energy supply companies, tend to follow the form set out in the Insolvency Act 1986, but the nature of the industry means that it is appropriate to have modified objectives and accompanying powers to achieve those objectives.
The current energy market
Energy supply companies often purchase a proportion of their energy supplies ahead of time using forward trading and hedging arrangements. Such arrangements are quite normal and are intended to ensure that energy supply companies can meet their energy supply obligations, but also afford them a degree of protection against energy prices which are inherently volatile. When and how an energy supply company enters into hedging provisions are likely to impact on whether it flourishes or struggles, especially in the face of a more volatile market.
From November last year and continuing into this year, wholesale energy prices (gas and electricity) in the UK experienced significant volatility and rose to a record high, doubling in value within a short timeframe. The reasons for this are varied but a price war resulted in the diversion of liquefied natural gas supplies to Asia at the expense of Europe and the UK. In addition, other factors such as climate factors (prolonged cold spell in both Europe and Asia), and a shortage of gas and renewable energy have contributed to this sharp rise, leaving many UK energy supply companies exposed to increased wholesale costs which they are unable to pass to consumers. This, together with the ever increasing cost and burden of environmental and social schemes, has left a significant number of energy suppliers facing financial distress. The coronavirus pandemic has only compounded the issues faced by supply companies. With lockdown and the closure of offices and industrial activity, the demand for energy has plummeted, and whilst working from home has increased domestic use of energy, this is not enough to offset the loss.
Whilst the Office of Gas and Electricity Markets (“Ofgem”), the UK energy regulator, has recently announced that it will raise the price cap for default domestic energy deals which will go some way to alleviating the pressure on supply companies and allow them to recover some of their increased costs from customers, this will not entirely resolve the issues as many energy supply companies are operating on thin profit margins.
Energy Supply Company Administration
The Energy Act 2004 (as it applies by virtue of the Energy Act 2011) introduced the “Energy Supply Company Administration” which is a special insolvency regime specifically created for companies that supply gas and electricity in England and Wales pursuant to specific supply licences granted by Ofgem. In addition to creating a special administration regime for energy supply companies, there are also restrictions on the use of insolvency processes that would ordinarily be available under the Insolvency Act 1986, such as the ordinary out-of-court administration.
Under the Energy Act 2004, a failing energy supply company is under an obligation to notify Ofgem that it is unable to pay its debts as they fall due1.
According to Ofgem’s published guidance, their preference for a failing supply company will be for a private trade sale of that supply company. However, in circumstances where a trade sale is not achievable, Ofgem has the power to revoke the company’s supply licence with 24 hours’ notice and exercise its powers to: (i) appoint a ‘Supplier of Last Resort’, or, if this is not feasible; (ii) to seek the Secretary of State’s consent to apply to court for an Energy Supply Company Administration order.
Ofgem will not seek to appoint an “Energy Administrator” under the Energy Supply Company Administration order where it considers the ‘Supplier of Last Resort’ process would be achievable. In practice, the Energy Supply Company Administration order is not often used and is envisaged to be used for large energy supply companies only.
Under the ‘Supplier of Last Resort’ process Ofgem asks suppliers to notify Ofgem of their willingness to be considered as a Supplier of Last Resort together with the terms on which they would undertake such a role although Ofgem does have the power to direct a gas or electricity supply company to take over responsibility for supplying energy to a failed supplier company’s customers. Once Ofgem has assessed the various suppliers as against certain published criteria and nominated a ‘Supplier of Last Resort’, the failing supply company’s gas and electricity supply licences will be revoked. Upon revocation of its licences, the supply company is no longer a regulated company,2 and the supply company can be placed into an ordinary administration or any other insolvency process.
Ofgem’s principal objective is to protect the interests of customers and, in the event of a supplier failure, to ensure that customers receive a continuity of supply of gas and electricity. The Supplier of Last Resort process and modified administration regime equips Ofgem with the powers to achieve that objective.
Since the beginning of January 2021, at least three energy supply companies have been placed into administration, including Green Network Energy, which, according to Ofgem, is the largest energy supply company to date to have gone through the ‘Supplier of Last Resort’ process and ultimately be placed into administration. Green Network Energy supplied gas and electricity to approximately 360,000 customers before it ceased trading on 30 January 2021.
As noted above, Ofgem’s main duty is to protect the interests of existing and future consumers. A key part of Ofgem’s strategy in this regard is to enable competition in an effort to drive prices down. One consequence of this approach in recent years has been the entry into the market of numerous small to medium-sized energy supply companies in an effort to increase competition and provide an alternative to the Big Six energy companies.
However, as we look forward, these supply companies find themselves battling to survive in a market where they need to cope with a low oil-price scenario, wholesale energy price volatility, lower demand, increasing environmental and social obligations and the need to shore up revenue and manage debt obligations, to keep trading as a going concern. Where it proves too difficult for energy supply companies to continue to trade as a going concern under such circumstances, directors of those companies will need to seek specialist legal advice to consider what (if any) restructuring options are available and whether to commence the ‘Supplier of Last Resort’ process under the modified administration regime.
The ’Supplier of Last Resort’ process plays into the hands of the biggest energy supply companies who have the existing infrastructure to take on additional customer obligations without jeopardising the supply to their existing customer base. Interestingly the Supplier of Last Resort process may result in the large suppliers consolidating their position in the marketplace, ultimately reducing competition and presenting Ofgem with a conundrum.