Written evidence submitted by RWE (EPM0012)
BEIS Select Committee inquiry into energy pricing and the future of the energy market
RWE response
RWE is the UK’s second largest power producer, producing around 12% of UK electricity and employing around 2,600 people in the UK. RWE is the third largest renewable generator in the UK, with a diverse operational portfolio of renewables including onshore wind, offshore wind, hydro and biomass amounting to over 2.1GW. In addition to its growing renewables portfolio, RWE operates around 7GW of modern and efficient gas-fired capacity in the UK, making us one of the largest providers of firm flexible generation, which is crucial for security of supply.
RWE welcomes the opportunity to comment on the BEIS Select Committee inquiry on energy pricing and the future of the energy market. The focus of the inquiry is on the functioning, performance and regulation of the retail energy market and others will comment in more detail on these aspects of the inquiry.
However, we would highlight that the energy market is an integrated system and the recent supplier failures not only impact on the retail sector, but also have wider and significant implications for power generators which the Select Committee should consider as part of its deliberations on the future design and sustainability of the retail sector.
Supplier default under the Renewables Obligation (RO)
In our recent response to the BEIS consultation on supplier payment default under the Renewables Obligation (RO), we noted that the recent wave of exits from the supply market began occurring when the annual RO settlement obligations arose. This is not a new phenomenon. Rather, the recent crisis has extended and exacerbated a trend we have seen over the last few years.
The annual settlement of the RO creates a material one-off payment for suppliers. It has been our observation that instead of saving the RO money levied on consumers throughout the year until obligations are due, some suppliers have used this as free working capital for wider business activities. When the RO is due, many of these suppliers have failed to meet obligations and defaulted as a result. In the last three Compliance Periods (CP16, CP17 and CP18) over £172mn of annual money was not paid by defaulting suppliers. For CP19 (2020-21), 54 obligations were not met in full resulting in a 100%+ increase in the annual amount not paid, with a RO shortfall of £218mn for CP19 alone. A shortfall is already predicted for CP20 (2021-22) at £119mn. This will trigger mutualisation for the fifth consecutive year, despite the recent raising of the trigger level to ~£64mn earlier in 2021.
For RO generators, the impacts are either lost revenue (where supplier default is below the mutualisation threshold) or (where above the threshold) revenue provided to generators up to 20 months in arrears. The current process creates revenue risks, cashflow uncertainty and ultimately adds a risk premium to generator activity under the scheme.
For consumers, supplier mutualised charges are added to future consumer bills. This means that most consumers (including most vulnerable customers) are effectively paying twice for elements of the RO whereas only some private shareholders and a minority of active switchers are benefitting if they were on a lower tariff as a result of unsustainable pricing by their suppliers.
RWE encourages consumer choice and competition in the energy supply markets, but to protect consumers suppliers must be able to meet their expected liabilities and obligations, including events of high wholesale gas and power prices.
We welcomed Ofgem’s recent consultation on proposals to strengthen the financial stress testing of suppliers and the financial resilience of the sector; time will tell whether this goes far enough. We have been concerned in the past to observe new challenger suppliers entering into the market often with insufficient creditworthiness, financial standing or risk management experience and oversight to protect customers, and the ensuring the effective operation of the energy market, by adequately hedging their power and gas exposures to underwrite the tenor of tariffs that they promote in the consumer markets. As these suppliers are not hedging properly, and therefore short gas and power, it should be of little or no surprise that if wholesale markets increase, they all too easily can become insolvent.
In practice, when wholesale prices fall, these unhedged suppliers have benefitted against the fixed-price tariffs contracted with consumers. When wholesale prices rise, the supplier can simply default and fall into administration – walking away from significant amounts of RO payments that should have been paid, with these costs then being socialised across the more prudent and creditworthy energy suppliers (and their customers) and generators.
Government are considering a legislative requirement for suppliers to settle their RO more frequently (quarterly), compressing settlement arrangements and abolishing the option of late payments. Backed by licence changes which ensure suppliers are collateralised for their RO obligations and some flexibility in the way suppliers settle their obligation, RWE believes this is a step in the right direction.
However, we believe that stronger measures should be implemented to further reduce the risk of large-scale default and impacts of mutualisation, ensuring suppliers are incentivised to be in more robust financial health. These are:
Addressing misinformation on the contribution of renewables to current costs
We have been concerned to hear some of the commentary around the cost of living crisis linking the expected energy price rise to the transition to net zero and, in particular, to green levies and renewables costs. This is patently untrue, and the anticipated price rise can largely be attributed to wholesale energy (mainly gas) price increases and the ‘smeared’ cost of supplier failure through the supplier of last resort process.
Under the two-way Contracts for Difference (CfD) scheme operating in the UK, CfD renewables generators are guaranteed a strike price which means that when the market price is below the strike price, they are paid top-up payments to the strike price for the low-carbon electricity they generate. However, if the market price is above the strike price – as it has been this winter – CfD generators pay the difference between the market price and the strike price to the LCCC which returns it to suppliers. In fact, the LCCC’s latest forecasts anticipate that CfD renewables generators could pay back £770m by the end of the winter.
Prior to the CfD scheme, most renewable projects were supported by the Renewables Obligation Certificate (ROC) scheme. Under this scheme, the projects were exposed to the wholesale power price. At first examination it could be concluded therefore that these projects would have benefitted from the recent higher wholesale prices. However, most projects will have forward hedged their power exposure, providing vital liquidity to the energy suppliers and their forward sales providing some protection to retail customers. Therefore, it is likely that most projects have not benefited from the current high prices.
Unintended Consequences of Interventions
Finally, while we appreciate there is a sense of urgency given the seriousness of the cost of living crisis, careful consideration needs to be given to the implications/unintended consequences of any proposed measures or interventions for the wider energy market and future investment.
It is important that adequate demand and price signals are provided to the gas and power markets to ensure that supply meets demand across all timescales. It is also important that energy suppliers protect customers’ money and meet their payment obligations in a full and timely manner. As such, a well-operating, robust and credit-worthy retail market with appropriate risk management requirements is critical for our energy security.
We would therefore urge thorough consultation with all energy players before any significant policy or regulatory intervention in the operation or functioning of any part of the market.
January 2022