The energy regulator has promised to enact tougher stress tests for energy suppliers to prove they have the financial strength to weather a surge in energy market prices – with consequences for suppliers which fail.
Ofgem’s chief executive, Jonathan Brearley, said regulation would need to “go much further” to assess whether suppliers are able to survive unpredictable energy market shocks, after the collapse of more than 20 suppliers in the last 12 weeks.
The energy regulator boss was forced to defend its record in a House of Lords hearing after historic energy market highs sank a string of providers, including Bulb Energy, which will require a taxpayer bailout of up to £1.7bn to keep supplying its 1.7 million customers through the winter.
“We do need a retail sector that is able to handle shocks like this in the future,” he said. “In my mind that means making sure we have a very sharp focus on capital adequacy, but also the rules in place as to what you do when someone breaches those rules.”
Brearley warned that suppliers must plan for record market prices “to be around in the coming months”, and brace for “a very, very different way of regulating the retail sector” in the future.
The “new reality” after the energy crisis will require “fit and proper” tests, he added, to determine whether suppliers have taken on too much risk, and whether they have enough capital to manage this risk if energy markets rocket.
“What is evident from the last few months is that those stress tests need to be very wide. We’ve seen a fivefold increase in the price of gas. This is certainly not something we’ve seen before in the market,” Brearley said.
Many challenger companies buy energy from the wholesale markets just three to six months in advance, which left them exposed to record energy markets prices after a rapid surge earlier this year.
By contrast, established energy suppliers and those with strong financial backing have been more resilient to the energy shock because they sourced more of the power needed for the coming winter last year, when market prices were weak.
Brearley told the committee that each company can decide how much it wants to hedge, and how much risk it wants to take, but “the rule has to be that if you take risk you have to have the capital available” to manage a wide range of market scenarios.
About 90 of the highest energy price events of the last 10 years have taken place in the last few months, so energy suppliers “need to be ready for that in the future”, he added.
“I don’t see that this is going to be a bubble that goes away and then we will carry on as we were before. I think we are going to be in a different kind of reality. That will mean having rules in place which say ‘you choose what you do, but you have to underpin that choice’,” he said.
The regulator is planning to put in place new regulation to strengthen the resilience of the market in February next year, including changes to the energy price cap, which could mean that it is allowed to rise and fall more quickly to reflect sudden changes in the energy market.
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The regulation review is likely to reignite criticism of the regulator for allowing a deluge of small, unstable energy suppliers to enter the market in an attempt to boost customer switching to improve market competition.
Dozens more energy suppliers are expected to go bust in the coming months, according to market analysts, which could reduce the number of suppliers in the market from a peak of 70 to fewer than 10 by next spring.
“Competition is important; it drives customer value, it drives innovation,” Brearley said. “But we need a broader way to look at the retail sector in the future and to make sure that we go get to a sustainable place.”
