Power Failure – Legal Aspects of the Energy Crisis

24 Aug 2022

To say that there are mixed fortunes in the UK energy supply market would be an understatement. Whilst BP, Shell and Centrica have reported record profits, in the last 18 months the lights have gone out at 31 energy supply companies (comprising nearly half of all suppliers) who have entered insolvency. The reason for this marked contrast is that smaller suppliers, and for that matter larger suppliers who have failed to hedge significantly, lack the capital reserves to bear the cost of soaring oil and gas prices. Most of these costs cannot be passed on to customers due to the Ofgem imposed price cap. As such, energy suppliers now find themselves trading at a loss. What are the legal options for suppliers in such a position?

Quitting is not an Option

The energy industry is highly regulated to protect consumer interests and ensure that they receive an uninterrupted supply of energy. For these purposes, sections 160-164 of the Energy Act 2004, as well as the terms of the standard supply licenses, restrict the insolvency procedures available for energy suppliers and require consent from the court and Ofgem for a supplier to enter a voluntary winding up.

Accordingly, unlike regular unregulated businesses who can elect to cease trading, simply quitting is not an option for energy suppliers. Energy is deemed an essential service so suppliers cannot be permitted to simply walk away and leave their customers in the dark. For this reason energy suppliers are locked into supplying energy until they can convince Ofgem that they are insolvent and should have their licences revoked.

The SoLR Process

If an energy supplier believes it is insolvent, the first port of call is to commence the Supplier of Last Resort (SoLR) process with Ofgem. The SoLR regime is designed to ensure the continuity of supply for consumers by transferring them to an alternative supplier.

As soon as a supplier believes they are insolvent, they are obliged to inform Ofgem. Ofgem then approach various potential SoLR’s, generally the ‘Big Six’ energy companies, and either ask, or if there are no volunteers, direct them to take on the failed supplier’s customers. In selecting a SoLR, Ofgem consider whether the potential SoLR can honour the customers’ credit balances and whether it has the energy capacity to take on the new customers without compromising its ability to supply its existing customers. Once a SoLR is appointed, Ofgem revoke the failed supplier’s licenses, after which the supplier is no longer a regulated company and can begin regular insolvency processes.

Energy Special Administration

If Ofgem decides that it is unfeasible to appoint a SoLR, it turns to the energy supply company special administration regime, set out in sections 93-102 of the Energy Act 2011. This contingency was designed for what the government labelled a ‘low probability, but high impact event’, namely the failure of a large supplier. Such a ‘low probability’ event transpired in November 2021 when Bulb Energy, a supplier of 1.7m customers, failed and the special administration regime was deployed for the first time.

Unlike a regular administration, whose objective is to rescue the company or protect creditors, a special administration’s primary objective is to protect customers and ensure they receive a continuous, cheap supply of energy until the supplier can be sold or rescued. Suppliers in special administration can also secure government funding to enable them to continue supplying, in Bulb’s case a tidy £2.2b government bailout.

Conclusion

The current energy market regulatory framework has favoured the Big Six, who have seen the price cap freeze out smaller suppliers and have then picked up those customers as SoLR’s. However, the way in which the government respond to the energy crisis, with annual household energy bills predicted to rise above £3600, will affect the balance of power in the market. Raise the price cap further to provide small suppliers with breathing space and you make heating homes even more prohibitively expensive than it already is. Leave the price cap where it is, consumers are protected but many of the suppliers that have survived until now, nearly half of whom are already thought to be balance sheet insolvent, appear destined to fail.

As inflation continues to rise, the crisis in Ukraine deepens, and we hurtle towards what looks like the winter of discontent for small energy suppliers, it has never been more important for energy suppliers to remain aware of the unique insolvency regime in place and the choices they might unfortunately face.

Asserson’s Business and Dispute Resolution teams have been advising energy suppliers through many of the above issues. If you have any questions and for further information, please be in touch at Sammy.Liebert@Asserson.co.uk.