Ofgem

What is Ofgem?

Ofgem is the public body responsible for overseeing the electricity and gas markets. Its primary duty is the protection of current and future consumer interests. ⁸⁵ Ofgem, ‘Our powers and duties’ Ofgem, 19 July 2013, retrieved 1 November 2022, www.ofgem.gov.uk/publications/our-powers-and-duties  It achieves this by ensuring that energy companies comply with existing regulation, including by investigating potential breaches. Ofgem also manages environmental schemes and, initially since April 2017 but expanded in January 2019, sets a unit cap for household electricity and gas prices, the ‘price cap’. It operates primarily in England, Scotland and Wales – in Northern Ireland, the Utility Regulator assumes most of Ofgem’s responsibilities apart from the administration of certain renewable energy schemes.

What does Ofgem do?

Ofgem regulates all aspects of the energy market: generation at power plants, transmission through the National Grid and retail supply to consumers. Some companies operate in both the generation and supply markets while others only produce energy or purchase it to then sell on to consumers.

Generally, all energy companies active in Great Britain must apply to Ofgem for a licence and must fulfil, on an ongoing basis, certain conditions around financial sustainability and treatment of vulnerable customers. ⁸⁶ Ofgem, ‘Supply licence guide: Introduction to the supply licences’, 21 February 2019, retrieved 1 November 2022, www.ofgem.gov.uk/sites/default/files/docs/2019/02/introduction_to_the_supply_licences_0.pdf  Ofgem has a broad set of powers to demand information from energy companies and to punish breaches of licence conditions, with fines of up to 10% of a company’s annual turnover. ⁸⁷ Ofgem, ‘Compliance and enforcement’, Ofgem, (no date) retrieved 1 November 2022, www.ofgem.gov.uk/energy-policy-and-regulation/compliance-and-enforcement

Ofgem also investigates anti-competitive behaviour such as introducing barriers to switching provider or active collusion between companies. Since 2010 it has imposed fines of more than £595m in total for such and similar breaches. ⁸⁸ Ofgem, ‘Total fines and redress payments since 2010’, Ofgem, August 2022, retrieved 1 November 2022, www.ofgem.gov.uk/energy-data-and-research/data-portal/all-available-charts?keyword=penalties&sort=relevance Its remit also requires it to protect future consumers’ interests by making the market cleaner, which it does by administering government schemes and monitoring the compliance of suppliers with government-mandated renewable energy obligations.

How is Ofgem structured?

Ofgem is a statutory non-ministerial government department. ⁸⁹ UK Government, ‘Ofgem’, Gov.uk, (no date) retrieved 1 November 2022, www.gov.uk/government/organisations/ofgem  This means that while it takes overall policy direction from the Department for Business, Energy and Industrial Strategy (BEIS), its sponsoring department, it has some independence from central government in how it implements those policies. Its employees are civil servants and any change to its status must be passed by parliament. Ofgem is funded by a licence fee that it levies on the energy industry.

How has Ofgem evolved over time?

Ofgem was formed through the merger of Office of Electricity Regulation (OFFER) and Office of Gas Supply (Ofgas) under the Utilities Act 2000. ⁹⁰ United Kingdom, Utilities Act 2000, Chapter 1. London: Stationery Office, 2000.  The liberalisation of the domestic gas and electricity markets in 1998 and 1999 respectively meant a regulator was needed to promote competition in these markets due to the tendency of energy markets to become monopolistic. Politicians also worried that markets would not necessarily produce outcomes that were in the public interest regarding issues like protecting vulnerable consumers and producing clean energy.

Regulation of the energy sector was originally envisioned as small and temporary, serving to “hold the fort until competition arrived”. ⁹¹ Littlechild S, Regulation of British Telecommunications’ Profitability: Report to the Secretary of State, February 1983.  However Ofgem has in fact grown in scope and funding since its creation. In 2000 it had an operating budget of £59.6m (in 2022 prices); ⁹² Ofgem, ‘Office of Gas and Electricity Markets Plan and Budget: April 2000 – March 2001’, March 2000, retrieved 1 November 2022, www.ofgem.gov.uk/sites/default/files/docs/2000/03/1751-planmarch.pdf  in 2022, its expenditure had more than doubled, to £129m. ⁹³ Ofgem, ‘Accountability Report: Ofgem Annual Report and Accounts 2021-22’, Ofgem, 11 July 2022, retrieved 1 November 2022, www.ofgem.gov.uk/sites/default/files/2022-07/OFG2169%20Ofgem%20AR%26A%202022_Accountability.pdf  And while its principal duty remains consumer protection, under the Energy Act 2010 Ofgem was instructed to consider whether there are alternatives to competition when pursuing consumer protection. ⁹⁴ United Kingdom. Energy Act 2010, Explanatory Notes. London: Stationery Office; 2010. United Kingdom

Under the same act, Ofgem was instructed to view reducing emissions and securing stability of energy supply as part of its remit. Partially in response, Ofgem changed its price control models in 2013 to place a greater emphasis on innovation-led investment over simply lowering prices. ⁹⁵ Ofgem, ’RIIO - a new way to regulate energy networks’, Ofgem, 4 October 2010, accessed 3 November 2022, www.ofgem.gov.uk/sites/default/files/docs/2010/10/re-wiringbritainfs.pdf  More recently, Ofgem has begun to develop a new framework of consumer interests that includes decarbonisation alongside lower prices. ⁹⁶ Ofgem, ‘Net Zero Britain: developing an energy system fit for the future’, Ofgem, 8 July 2022, retrieved 1 November 2022, www.ofgem.gov.uk/sites/default/files/2022-07/Net%20Zero%20Britain%20Publication%202022%20FINAL.pdf

What is the state of competition in the energy market?

Evidence on the true degree of competition in the energy market is mixed, both in the wholesale energy generation and retail supply markets. In 2019, more than two thirds of all energy was produced by the largest six companies; ⁹⁷ Department for Business, Energy and Industrial Strategy, ‘Competition in UK electricity markets’, (no date) retrieved 1 November 2022, https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/920563/Competition_in_UK_Electricity_Markets.pdf   the retail supply market is even more concentrated. The so-called ‘Big Six’ suppliers emerged from the 15 former regional monopolies by 2002 and held 99% of the retail market in 2008. ⁹⁸ Ofgem, ‘Energy Supply Probe: Initial Findings Report’, Ofgem, 6 October 2008, retrieved 1 November 2022, www.ofgem.gov.uk/sites/default/files/docs/2008/10/energy-supply-probe---initial-findings-report.pdf, pp. 27-28.  The number of companies active in the market has grown steadily since then – from 12 to 70 between 2010 and 2018 – but what are now the Big Five, following the merger between E.ON and npower in 2019, still hold around four fifths of the market. _{⁹⁹ Ofgem, ‘Electricity supply market shares by company’, July 2022, retrieved 1 November 2022, www.ofgem.gov.uk/energy-data-and-research/data-portal/all-available-charts?keyword=suppliers&sort=relevance}

The number of households switching suppliers did increase from 2014 to 2019, ¹⁰⁰ Ofgem, ‘State of the energy market report 2019’, Ofgem, November 2019, retrieved 1 November 2022, www.ofgem.gov.uk/sites/default/files/docs/2019/11/20191030_state_of_energy_market_revised.pdf  but Ofgem found in 2017 that many customers, especially the most vulnerable, still didn’t know how to do so. After a major review in 2016, the Competition and Markets Authority estimated that “in total, domestic customers of the Big Six energy companies were paying an average of £1.4bn a year more than they would in a truly competitive market”. ¹⁰¹ Competition and Markets Authority, ‘Energy market investigation final report’, 24 June 2016, retrieved 1 November 2022, https://assets.publishing.service.gov.uk/media/5773de34e5274a0da3000113/final-report-energy-market-investigation.pdf

These findings prompted the creation of price caps in 2017 for pre-payment customers and its expansion to default tariff customers in 2019, as these two consumer groups are the least likely to switch. The price cap is a maximum price that energy companies are allowed to charge for each kilowatt hour (kWh) of gas and electricity and is designed to only increase if the actual costs of supplying energy increase. Ofgem is responsible for setting it and for compliance.

Recently, small improvements in the concentration of retail supply have been reversed following the collapse of multiple small energy suppliers. ¹⁰² Ofgem, ‘Number of active domestic suppliers by fuel type’, Ofgem, October 2022, retrieved 1 November 2022, www.ofgem.gov.uk/energy-data-and-research/data-portal/retail-market-indicators Ofgem faced criticism for allowing under-financed suppliers to enter the market in the pursuit of more competition. These companies took advantage of low wholesale energy prices but failed to buy energy in advance at locked-in prices to hedge their market exposure. This meant they were extremely vulnerable to rising wholesale energy prices and, when prices did rise from 2019 onwards, they collapsed.  

Between January 2021 and February 2022 – so before the further price pressures caused by the war in Ukraine – 31 companies failed. ¹⁰³ Byrom S, ‘Which energy suppliers have gone bust in 2022’, The Energy Shop, 7 July 2022, retrieved 1 November 2022, www.theenergyshop.com/guides/which-energy-suppliers-have-gone-bust  These failures cost consumers £2.7bn as the negative balances of failed energy companies were recouped through additional charges on all consumers’ bills. ¹⁰⁴ Lawson A, ’Failing energy firms will cost UK consumers £2.7bn, says watchdog’, The Guardian, 22 June 2022, retrieved 1 November, www.theguardian.com/money/2022/jun/22/failing-energy-suppliers-cost-uk-consumers-2-billion-pounds-watchdog  Citizens Advice, ¹⁰⁵ Citizens Advice, ‘Catalogue of errors at Ofgem leaves consumers with multi-billion-pound bill’, press release, 9 December 2021, retrieved 1 November 2022, www.citizensadvice.org.uk/about-us/about-us1/media/press-releases/catalogue-of-errors-at-ofgem-leaves-consumers-with-multi-billion-pound-bill/  the National Audit Office ¹⁰⁶ Comptroller and Auditor General, The energy supplier market, 14 June 2022, Session 2022-23, HC 68, National Audit Office, 2022.  and the BEIS select committee ¹⁰⁷ House of Commons Business, Energy and Industrial Strategy Committee, Energy pricing and the future of the energy market: Third Report of Session 2022–23, HC 236, The Stationery Office, 2022.  all criticised Ofgem for not providing adequate oversight of new entrants, and the regulator’s own independent review found its scrutiny of financial resilience had not been sufficiently rigorous. ¹⁰⁸ Oxera, ‘Review of Ofgem’s regulation of the energy supply market’, Oxera, 3 May 2022, retrieved 1 November 2022, www.ofgem.gov.uk/sites/default/files/2022-05/Review%20of%20Ofgems%20regulation%20of%20the%20energy%20supply%20market_May%202022.pdf

How does Ofgem encourage the net zero transition?

While net zero is not currently an explicit statutory requirement, advancing decarbonisation is part of Ofgem’s strategic framework and described as an “enduring priority”. ¹⁰⁹ Ofgem, ‘2022/23 Ofgem Forward Work Programme’, Ofgem, 30 March 2022 retrieved 24 November 2022, www.ofgem.gov.uk/publications/202223-ofgem-forward-work-programme#Who%20we%20are%20and%20 http://www.nationalgrid.com/stories/energy-explained/how-much-uks-energy-renewable  It delivers renewable energy schemes worth more than £9bn a year. ¹¹⁰ Ofgem, ‘2022/23 Ofgem Forward Work Programme’, Ofgem, 30 March 2022 retrieved 24 November 2022, www.ofgem.gov.uk/publications/202223-ofgem-forward-work-programme#Who%20we%20are%20and%20http://www.nationalgrid.com/stories/energy-explained/how-much-uks-energy-renewable

However, Ofgem must balance this responsibility alongside its other duties, such as consumer protection through low prices. This is principally done through price controls, in which Ofgem must weigh up the degree of investment to allow energy companies against the extra costs this will mean for consumers in the short term. In 2022, a House of Lords Industry and Regulators Committee report warned that price controls “have the potential to stifle investment” necessary for decarbonisation. ¹¹¹ House of Lords Business, Industry and Regulators Committee, The net zero transformation: delivery, regulation and the consumer: 1st Report of Session 2021–22, HL Paper 162, The Stationery Office, 2022.

Partly in response to the difficulties of balancing the separate responsibilities of its remit, Ofgem agreed with BEIS in April 2022 to create a new body – the Future Systems Operator (FSO) – to operate the UK’s national gas transmission network and to provide expert advice to Ofgem and the government on managing the transition to net zero. ¹¹² BEIS, ‘Energy Security Bill factsheet: Future System Operator’, 6 September 2022, retrieved 24 November 2022, www.gov.uk/government/publications/energy-security-bill-factsheets/energy-security-bill-factsheet-future-system-operator.