Just as the holiday season got going, BEIS and OFGEM published a much needed and new consultation on the need for market change to enable consumers to benefit from a smart, low carbon energy system. In English- how to structure energy retail markets going forward? (https://www.gov.uk/government/consultations/flexible-and-responsive-energy-retail-markets)
Having got back from holiday this week, I read the consultation and was left feeling slightly deflated but with some hope.
There is much in the document which rings true and many of the real and current challenges with the retail market are presented. There are snippets of ambition to make fundamental change to the market structure, but still too much based on core assumptions underpinning existing market design rather than what will work for the future. Whilst I will leave others to form their own conclusions on the consultation and respond accordingly, I’d like to throw in some personal thoughts on areas which I don’t think yet get the focus in the consultation that they deserve.
1) A solution to the practical challenge of protecting the vulnerable whilst delivering greater choice and innovation
No one disagrees with the necessity to protect vulnerable consumers in society, who deserve the confidence that they are being charged a fair price for the energy that they consume and are being treated well by their supplier.
Going forward however, if the ambition is genuinely to allow consumers choice and businesses to innovate, protecting the vulnerable is going to become increasingly hard. Why? Because there will not be a ‘standard’ comparable energy supplier model. Consumers may buy their energy with their electric vehicle as part of a package. They may buy a ‘warm home’ allowing a supplier to optimise their energy costs through remote management of smart appliances, in home generation and heating. They may buy and manage their energy collaboratively through a community energy scheme. The options are endless, but what is unlikely to be easy is a direct comparison between different options on the ‘energy only’ bit.
Whilst the innovation and choice will be great for engaged consumers- many, like now, will just want the ability to turn the lights on and heat their home in the knowledge that they can do so reliably and for a fair price.
For the Regulator to be able to deal with all these scenarios, at some point, there needs to be simplification and standardisation to enable like for like comparison. There is an argument for saying a ‘nationalised standard cost’ (which could alternatively be called a price cap) is adopted for energy consumed. All the current complexity of pricing and the associated cashflow risks could be taken away from the supplier, who could then focus on the innovative parts of their business model.
So would that still be a retail market? Absolutely, just not as we know it. In reality, as price caps and business failures have shown, margins from pure energy retail are now almost non sustainable. Businesses are chomping at the bit to develop their models without the constraints currently imposed by regulation and perhaps would be willing to accept a standard margin on energy supply as a starting point (which of course, could be improved through efficient and technically advanced business models). Not so far from the concept of the price cap and much closer to the competitive water market.
Real value, differentiation and innovation will accelerate if many of the constraints of the current system, both regulatory and operational are lifted. Going forward, commercial value is unlikely to come from pure supply, we’re past that. Businesses will be focused on creating differentiated models of which supply is one element.
A backstop model or more likely a commercial model, focused on the vulnerable and fuel poor, or those who do not want to engage in more complex propositions should be part of the answer, potentially linked to local authorities own activities in this area. The vulnerable would likely get better outcomes then in the current world.
The consultation rightly identifies the existing Universal Service Obligation (ie suppliers have to be able to supply any consumer who asks) as a barrier to this new world. The ability for suppliers to offer products and services to a segmented subset of consumers is critical to success in new markets.
There are some big radical ideas needed to really solve this market conundrum. The ambition is outlined in the consultation, but it feels like within a constrained envelope.
2) Fairer allocation of commercial risk
The consultation is pretty much silent on the word ‘risk’. This is despite the current supplier licencing review being almost entirely focused on strengthening risk management by suppliers. The existing ‘supplier hub’ model effectively creates a central focus for all commercial risk. Existing suppliers as a product of their licences currently bear commodity risk, metering risk, government cost recovery risk and costs associated with the failure of other suppliers, as well as more standard operational risks that would be expected of a consumer facing business. Managing this risk landscape is hugely complex, commercially and operationally and takes disproportionate amounts of management time and effort, even in the current ‘simple’ retail model. If we are genuinely going to encourage new business models and innovation, there needs to be a greater focus on allocation of risks between different parties. Sharing, more proportionate allocation, or even removal of risks that cannot be directly controlled by suppliers would be hugely liberating for the market.
3) Timescales, method and priority
There is no mention in the consultation (other than its closing date) that gives any indication of timescales for delivery or relative priority against all the other current ongoing initiatives. The need for change is here today and we’re seeing businesses new and old struggling in the current regime. New innovative businesses need the shackles removing quickly if they are to survive. Delivering new market structures, we all know, will not be quick. But there needs to be an urgency and agility applied to making change happen that we have not seen before if we are to maintain the forward momentum that is currently happening.
This consultation is welcome and is worthy of broad market engagement. It demonstrates a serious recognition from BEIS and OFGEM that real change is required. We just need to ensure that it happens as quickly as possible and is suitably ambitious and radical. It would be a market failure if we simply end up with a fudge to the current model.