Written evidence submitted by Utilita Energy Limited (WIN0053)

Utilita Energy is a British-owned independent energy supplier specialising in delivering an excellent Smart+ Pay As You Go (PAYG) service to over 760,000 customers. It is the eighth largest residential energy supplier in the UK.

Approximately 40 percent of Utilita’s customer base are considered to be financially vulnerable. In addition, over 20% of its customers accessed Utilita’s interest-free financial assistance when they did not have enough money to meet their energy needs in the quarter April-June 2023 alone, which is very high for a non-winter quarter. Utilita’s Smart+ PAYG service is designed with features to help households avoid self-rationing and self-disconnection.
 

What role did the UK grid play in the high domestic prices of winter 2022-23?


We have observed a prolonged, large increase in constraint costs. These costs are incurred when generation output exceeds network capacity, so National Grid pay generators to constrain their output. Ofgem and National Grid should reform the constraints cost system to limit the compensation paid to generators, as this has created a perverse incentive.

The Renewable Energy Foundation (REF) cite numerous instances of windfarms receiving constraint payments in considerable excess of the revenue lost during the constraint occurrence, and in some cases sites that have been repeatedly constrained by a considerable portion of their total output have subsequently made decisions to expand capacity, suggesting the constraint payment is their intended source of income and return on investment. 

 

Restricting constraint costs to just the lost renewable subsidy (typically the number of Renewable Obligation Certificates foregone due to the constraint) would sufficiently compensate the generator to protect their minimum rate of return and cost of capital.  Meanwhile, compelling them to bear the risk on any lost wholesale revenue would correctly incentivise them to site their assets away from constrained areas and transmission bottlenecks.

 

Evidence:

[Taken from FW Call for Input Locational Pricing Assessment.msg]

https://www.ref.org.uk/ref-blog/354-a-decade-of-constraint-payments

https://www.ref.org.uk/ref-blog/371-constraint-payments-to-wind-power-in-2020-and-2021

https://www.ref.org.uk/ref-blog/356-the-western-link-a-new-failure-highlights-the-overbuild-of-scottish-wind-and-raises-new-questions

What more could have been done to prevent price shocks being passed to consumer bills?


Customers experience price shocks when: the level of the price cap set by OFGEM increases by a large amount; an energy supplier with prices well below the cap fails, forcing the customer to move to a new supplier with a higher price.

A less prescriptive cap would have allowed more resilience in the market and given consumers greater choice to seek competitive and stable prices. Critically, the price cap should not attempt to prescribe suppliers’ approach to hedging. Rather than focusing on this area, Ofgem should have paid greater attention to ensuring that suppliers had in place adequate hedging policies and were adhering to them.

The level of the price cap

Energy wholesale markets are complex, with multiple products that allow suppliers to purchase energy for a future date. The cost of this energy for any given future date is constantly fluctuating. The cap handles this by observing future prices over a reference period to determine the wholesale cost to be passed on through the cap. The implication of this is that if an energy supplier purchases energy outside of the reference window (e.g., hedges further in advance than the price cap reference window), the energy supplier will not have a mechanism to recover costs from an unfavourable movement in the wholesale market. The supplier will be engaging in speculative energy trading. This forces rational suppliers to sell at or near the price cap and follow the short-term hedging strategy implied by the cap.

Prior to the energy crises, the price cap observation window was a relatively short 6 months. It has been further reduced to 3 months. This is much shorter than the 2 – 3 years suppliers may have hedged over before the introduction of the cap. Shorter observation windows expose the consumer to volatility in the wholesale energy market whereas longer observation windows smooth out the bumps of short-term fluctuations.

By strongly encouraging suppliers to hedge over a short window, Ofgem created a market that is open to volatility. This goes against OFGEM’s own consumer research which found “participants preferred stability in their bill payments over the possibility of seeing lower prices more quickly” (reference below).

With perfect hindsight, a longer observation window would have kept the level of the cap stable, reducing the shock particularly as prices were relatively low and consistent. This would not address the critical mistake by Ofgem of prescribing a hedging strategy to rational suppliers thus creating a homogenous market built upon Ofgem’s opinion on future volatility. This is a mistake Ofgem has repeated by setting the price cap observation period to 3 months, where they are speculating that energy prices will fall and there will not be any more sudden wholesale increases.

An energy supplier with prices well below the cap fails

When an energy supplier pricing unsustainably below the price cap fails, their customers will be moved to a new supplier. It is likely that the gaining supplier has a sustainable pricing strategy, which is closer to the cap, leading to the customer being charged a higher price by the new supplier. The increase may appear as a shock to the consumer.

Ofgem should re-consider the suitability and ethos of the cap and they must urgently examine if a less prescriptive mechanism can be introduced to safeguard customers.

https://www.ofgem.gov.uk/publications/consumer-attitudes-towards-price-cap-changes


How should energy companies respond if customers cannot pay their bills and what actions should they not have recourse to?

 

When an energy bill is not paid for, the debt is shared across all bill payers via a provision in the price cap. This debt will arise both from people who are struggling to make ends meet and those who are able to pay but decide not to.

Energy suppliers have a responsibility to keep this debt as low as possible. In some cases, this can be done by utilising soft measures such as energy efficiency advice and signposting to charities and support groups. These measures will be of limited support for households where there is an insurmountable deficit in their budget and they are in need of extra help and support, nor are they likely to encourage a change in behaviour from someone who may choose not to pay their bills. Since February we’ve been solely reliant on these measures and have since a 50% increase in our debt book.

It is imperative that support is given to those who need it so that they can keep their homes at a healthy temperature and use vital equipment and appliances. This should not be done implicitly by forcing struggling households to accrue debt. Where debt is accrued in bad faith, it is not fair that hard working, honest bill payers must help fund people who are able but unwilling to pay.

Suppliers must be mandated to use stronger initiatives including:

There should be an immediate ban on all types of legacy meter installations. They lock a household into one method of payment and where that method is pre-payment, the household will suffer in silence with limited options to receive support. In the case of legacy prepay meters in particular, the lack of data and visibility means the supplier will not know whether the customer is in difficulty, and will also not be able to provide help and support remotely.

Evidence:

[Utilita Energy - Countdown to Cold Urgent Intervention Required - June 2023.pdf]

https://app.powerbi.com/groups/f3a1d95e-c3d2-49a2-8325-d0aa7cac2beb/reports/d581fc06-704a-460d-be70-ba3ba6dfae5f/ReportSection?experience=power-bi

 

Has Ofgem got its priorities right in addressing customer protection?
 

No. Ofgem has an obligation to incentivise license holders to improve their efficiency; set the cap at a level that enables holders of supply licences to compete effectively for domestic supply contracts; maintain incentives for domestic customers to switch to different domestic supply contracts and; ensure that holders of supply licences who operate efficiently are able to finance activities authorised by the licence.

The price cap is constructed by taking the lower quartile for each cost across suppliers to create an idealised model of an efficient supplier. In reality this means as many as 75% of suppliers’ costs will not be adequately reflected in the price cap. This gives a false sense of protection by keeping prices artificially low in the short term at the expense of further costs long term from supplier failures, bad debt, discouraging investment and lack of innovation. The cap is not set at a sustainable level, leaving Ofgem’s initiatives unfinanced and many of these initiatives are aimed at customers who Ofgem deems to be vulnerable. This leaves a large hole in Ofgem’s customer protection with an uncompetitive, homogenous energy market.

We are in the midst of another crisis, at least partly created by Ofgem, demonstrating that they only focus on the very short-term impacts of the customer protection rather than the longer-term view. We’ve seen a consistent increase in our debt book since the moratorium on installing prepay meters in February.  The increase is now around 50% and has been growing steadily, a dramatic change in the pre-February picture of a situation that was getting under control. OFGEM have not proposed how to prevent customers going into debt or who will fund the debt that cannot be collected.
 

How effective is the Government's approach towards supporting the sector and delivering a functioning energy market?

 

Is the legislative framework on pricing controls suitable for protecting consumers?


We believe that the current framework for retail pricing uses price caps, not controls. A control implies checks are in place to ensure suppliers take steps to deliver value for money, provides for collection of allowed revenue, and protects the price controlled (usually monopoly) entity.

The current price cap is constructed by taking the lower quartile for each cost across suppliers. This means 75% of suppliers fixed costs will not be reflected in the price cap. This creates a non-existent, notional supplier who operates at an unobtainable efficiency level, but that suppliers must outperform to make a profit.

As we have already said it is a critical mistake by Ofgem of prescribing a hedging strategy to rational suppliers thus creating a homogenous market built upon Ofgem’s opinion on future volatility. This is a mistake Ofgem have repeated by setting the price cap observation period to 3 months where they are speculating that energy prices will fall and there will not be any more sudden wholesale increases.

The cap does not protect against wholesale costs.

August 2023