In this alert, we consider the impact of rising wholesale gas prices on energy suppliers and discuss some of the actions that suppliers and their counterparties should be considering in the face of a difficult trading environment.

This alert follows on from our previous client alert in which we considered (1) Ofgem’s supplier of last resort (SoLR) regime, which was introduced as a safety net to protect consumers from the effects of energy suppliers’ insolvency, and (2) Ofgem’s proposals in relation to the second stage of its Supplier Licensing Review. Ofgem has since introduced a number of modifications to the licence conditions for gas and electricity suppliers in order to further minimise the likelihood and impact of disorderly supplier failure, which we discuss in further detail below.

Background

Wholesale gas prices in the UK have experienced significant volatility of late and have risen to a record high, doubling in value over the last six months. A number of factors have contributed to the sharp rise, including increased global demand due to a cold winter and continued industrial output rebound, and lower-than-expected power generation from renewables. In addition, a fire at National Grid’s IFA interconnector site in Sellindge last week has resulted in a loss of 2GW of interconnection capacity between the UK and France until March 2022, and has further tightened supply and increased pressure on natural gas prices1

In response to rising wholesale gas costs, Ofgem announced last month that it will be increasing the energy price cap for customers on default or standard variable tariffs with their supplier from 1 October 2021,2 and another tariff increase is widely expected when Ofgem carries out its next review in February 2022. Note that unlike retail prices, there is no cap for wholesale gas prices. On that basis, suppliers, who are subject to increased prices, are unable to pass down increased costs to their customers.

A range of potential measures is being considered, including a ‘bad bank’ system, to take on unprofitable customers or the government underwriting debt for the large suppliers. However, as at the time of writing, it appears that a full-scale bailout for struggling energy firms has been ruled out.

Surging wholesale prices have also placed pressure on energy suppliers, in particular smaller suppliers who, due to having insufficient hedging strategies or weaker balance sheets, are likely to be more exposed to changes in market prices than their larger counterparts. Indeed, just this month, four energy suppliers (PfP Energy, Moneyplus Energy,3 Utility Point, and People’s Energy4) have ceased trading, and there are concerns that more suppliers could fail in the next few weeks.

Impact on smaller energy suppliers

Energy suppliers have increased reporting obligations under their licence conditions and are required to have in place a number of measures which are aimed at protecting consumers in the event of the supplier’s failure.

In particular, energy suppliers are now required to be more proactive and direct in their communications with Ofgem, and must alert it to any changes that may affect their operations and any changes in ownership or in persons with significant managerial responsibility of the business. Energy suppliers also are required to produce and maintain a Customer Supply Continuity Plan (CSCP), which sets out the supplier’s strategy for safeguarding the continuity of supply for its customers in the event of its exit from the market. Ofgem may also require suppliers to undertake an independent audit when it has specific concerns as to the supplier’s financial health or customer service capabilities.

Ofgem has also made changes to arrangements for the exit of suppliers from the market if their business were to fail. Both outgoing and incoming suppliers are now required to notify Ofgem where they are planning to undertake a book sale or purchase. The notification requirement will take effect before entering into a binding agreement for a book sale or purchase, and there are restrictions on the nature of the commercial terms that can be reached in such deals. These measures have been put in place to enable Ofgem to maintain balance and minimise systemic risk borne by individual suppliers.

It is reasonably foreseeable that, as a result of the current situation, the government will be forced to introduce stricter measures and rules for those seeking to become suppliers, as well as stricter regulation of hedging strategies and balance sheets and liquidity requirements.

Market access arrangements

Volatile wholesale prices may also impact suppliers’ abilities to meet their obligations under their market access, forward trading, and hedging arrangements. Energy suppliers should review the terms of their market access arrangements carefully and consider whether any terms thereunder have been breached. If there is a breach, suppliers should consider whether the breach can be remedied or whether a waiver should be sought from their counterparty.

Similarly, access providers should review their market access arrangements and identify any provisions that may be available where they have concerns about the status of a supplier counterparty (for example, representations and warranties, events of default), as well as provisions that would be triggered if their counterparty fails to perform (for example, termination rights, right of set-off). Access providers also may wish to revisit relevant limits in such arrangements in order to manage the size of any outstanding orders and positions in a situation where their supplier counterpart ceases to trade.

Final thoughts

With wholesale gas prices set to rise further throughout the coming winter months, energy suppliers – particularly smaller suppliers – should be mindful of their increased reporting obligations to Ofgem and of the need to have in place and to maintain a CSCP setting out their strategy for safeguarding the continuity of their customers, if they were to exit the market.