Ministers, one fears, still haven’t grasped scale of Ofgem’s regulatory failure | Nils Pratley

Ministers, one fears, still haven’t grasped scale of Ofgem’s regulatory failure

Nils Pratley

Business committee right to be sceptical about ability to reform UK energy market in damning report

the Ofgem sign on the regulator's office in central London

“If Dermot Nolan was still in post, we would be calling for his dismissal,” say the MPs on the business select committee, in their report on the energy sector, about the former chief executive of regulator Ofgem. And they would be right to do so. Top billing in the MPs’ report was taken by the need for the government to boost financial support for poorer households when the energy price cap rises again in October, but the other key conclusion was the damning verdict on the pre-crisis performance of Ofgem.

That is not surprising, of course, but it needed to be said with suitable force: “Ofgem has proved incompetent as the regulatory authority of this complex market, thereby costing taxpayers billions of pounds. The scale of failure and the cost exposure to taxpayers is only comparable to the financial crash of 2008.”

So, no, a chief executive of Ofgem of that era could not have survived the catalogue of failures. The regulatory body let thinly capitalised companies operate with inadequate financial controls and didn’t stop to ask if a pro-competition approach was storing up trouble, which duly arrived when wholesale energy prices soared in 2021. Twenty-nine firms have failed so far, with the cost of the mess rebounding on consumers in the form of an extra £94 on bills. The failure of the obscure Avro Energy alone, a loss-making company paying small fortunes to its inexperienced directors, is reckoned to have cost £700m.

You might assume such a colossal failure of oversight would prompt politicians to pause and ask fundamental questions about the entire regulatory architecture of the past 20 years. After all, that is what happened after the financial and banking crash. George Osborne, chancellor at the time, abolished the Financial Services Authority and returned many of its supervisory powers to the Bank of England.

But, no, the political appetite for deep regulatory reform in the retail energy market appears very limited. On the plus side, one might say that is because Jonathan Brearley, who replaced Nolan in February 2020, is doing a better job. He has confessed Ofgem’s shortcomings, consulted like crazy and is trying to revise the regulatory rulebook, particularly around capital and financial stress-tests, at pace. A major package of reforms is under way.

Yet is the whirr of action as it seems? Are these the right reforms? And should we still trust Ofgem to deliver? The MPs are sceptical. “While we support its vision for suppliers to be well capitalised and prudently run, we are concerned that if measures are poorly designed and executed, they will risk further destabilising the market and distorting competition,” says the report.

It’s a fair point. Take the energy cap itself, which one can now say was poorly designed since it created a position in which suppliers subsidised customers, which was never supposed to happen. The design contributed to the chaos when prices changed suddenly – and quarterly revisions to the cap, as now planned, may not overcome the basic flaw.

Indeed, the outside world is asking a more basic question about the cap: should it be replaced by a social tariff that would only protect vulnerable customers? It’s a reasonable idea, but officialdom doesn’t seem interested in exploring it. An unreformed cap is now planned to continue beyond 2023 and, as the report says, “neither the government nor Ofgem has evaluated its costs and benefits or considered alternative forms of price protection”.

Meanwhile, scrutiny of Ofgem’s work remains a work-in-progress since the government still hasn’t published its “strategy and policy statement” that would set ground rules for how the business department and the regulator interact. Given that one major criticism of Ofgem in the past is that it behaved as a political poodle that was too afraid to shout about the holes in the deregulated model, the document matters.

None of which is to deny that Ofgem, under Brearley, is full of good intentions. But the missing piece in the jigsaw is a proper reckoning with the governance failures of the past decade. This report makes a powerful case more scrutiny, more transparency and more analysis. Ministers, one fears, still haven’t grasped the scale of the regulatory failure.