Public energy company: outline business case

3 Strategic Case

3.1 Purpose

The purpose of the Strategic Case is to provide the strategic justification for the Project, including outlining the background and associated objectives of the Project, as well as assessing stakeholders, opportunities and risks.

This section is set out in the following key headings:

• Project background – a history of the Project and its development;
• Project updates from SOC to date – a summary of project developments following SOC completion to OBC commencement;
• Drivers for change and opportunities – a summary of some of the key issues in the current market and the opportunities this could present for the Public Energy Company;
• Stakeholders – outlines key stakeholders, the stakeholder events held and the key outputs of those events;
• Market information (including opportunities and risks) - details information about the current market, including new entrants and recent supplier exits; and
• Prioritisation of approach – a consideration of areas the Public Energy Company will need to carefully balance to ensure its success.

3.2 Project background

Following the announcement by the First Minister of the intention to set up a Public Energy Company, a SOC was prepared to consider its development. The purpose of the SOC was to present the case for change for Scottish Government to establish a Public Energy Company, it was published in March 2018 and was developed in line with HM Treasury business case model and guidelines^[3].

The SOC was prepared to explore the initial options and determine the purpose and feasibility of establishing a Public Energy Company.

The SOC concluded that it is possible to establish a Public Energy Company which could achieve the objectives stated of delivering competitively priced energy to help alleviate fuel poverty in Scotland. Whilst it did conclude that it is possible, the SOC also documented a number of challenges and risks involved in the Project. One of the key challenges noted was the highly competitive nature of the energy market in Scotland and the notably low profit margins (see section 2.1 for further details of the issues highlighted by the SOC). Due to State Aid restrictions, the Public Energy Company would not be able to rely on subsidies and therefore must be able to run as a commercially operated entity in order to be feasible.

This OBC explores the different options available to explore and further investigate the plausibility of the Project. During the SOC, the four delivery arrangement options considered were:

1) Do nothing

The Project is not pursued and the Public Energy Company is not established.

2) Existing socially minded supplier

The Public Energy Company would utilise an existing socially minded supplier to act as the Public Energy Company into the future. Existing ownership and governance arrangements would need to be reviewed to ensure appropriate control. Per the SOC, there are existing socially minded suppliers in the market who are focused on promoting their social values as a way of engendering trust amongst costumers and encouraging them to switch their energy supply. There suppliers may typically be owned by a Local Authority or housing provider (e.g. Robin Hood Energy).

3) Government owned company

Creation of a new limited company (by shares or guarantee). It would be owned by interested public sector investors and governed by the Companies Act. An example of a relevant entity would be Scottish Water. The public sector investors would appoint the Chairman and Board of Directors to ensure its policy objectives and interests were reflected in the Company Strategy and Business Plan. The Board would oversee the Executive Management Team.

4) Federal model

Creation of an incorporated "Topco" company with joint venture subsidiaries operated by individual Local Authorities. The subsidiaries would White Label the supply of electricity and gas from the Public Energy Company and bring a locally branded supply to the market. The products would be consistent across the Local Authorities. It would be up to individual Local Authorities whether they participated in the vehicle. The top company would be controlled by a Board. Governance arrangements would need to be agreed for the regional subsidiaries, including delegated remit. Funding would be through initial public sector investors (as shareholders) with the potential for third party funding (including through trading profits).

There have been some changes to the options being explored, from SOC stage to date, the reasons for these changes are explained at Section 3.3. The delivery arrangement options which the OBC considers are:

Table 8 – Delivery options

	Delivery option	Description
1	Fully Licensed public sector owned supplier	The public sector owners of the Public Energy Company establishes a Fully Licensed, publicly owned gas and electricity supplier.
2	White Label Supply	This option involves contracting with an existing fully licensed energy supplier, to provide Public Energy Company branded gas and electricity to customers. This partner is chosen in line with criteria determined as part of a formal tender process.
3	Counterfactual: Do nothing	This will provide a baseline and help to highlight the impact of the current situation on fuel poverty.

3.3 Issues highlighted by the Strategic Outline Case

The work performed in the SOC highlighted items for resolution in order for the Public Energy Company to be a success:

• The preferred delivery option needs to be identified. This option must be deliverable by the end of the current parliament, March 2021, therefore the option chosen must be able to fit this timeline;
• It needs to be possible for the Public Energy Company to be self-financing in the longer term (recognising that up-front costs will be incurred and will need to be recouped through trading activity);
• There is little margin on the sale of electricity, and whilst margins are slightly higher on gas, it needs to be proven that the Public Energy Company can provide energy at competitive prices and remain self-financing;
• In a largely disengaged market, the Public Energy Company must be able to encourage customers to switch suppliers, it was noted that a public sector initiative could help in terms of improving consumer trusts to encourage switching;
• Whilst the Public Energy Company must be able to achieve competitive pricing from the outset, it must be able to maintain this over the long term to retain customers;
• Based on the delivery option chosen, it may be necessary to obtain a gas and electricity supply licence. White Labelling would not require this licence as the third-party supplier would hold this and be responsible for meeting regulatory requirements; and
• The Public Energy Company would need to ensure it is aware of and compliant with all laws and regulations. Legal advice will be required to ensure this.

3.4 Project updates from SOC to commencement of OBC

From the SOC to the OBC there have been a number of developments to the potential delivery arrangement options believed to be achievable within the given timescale. The Scottish Government are of the opinion that the timelines for establishing a Public Energy Company by the end of the current Parliament (March 2021) does not provide sufficient time for the procurement and establishment of a Fully Licensed Scottish Public Energy Company.

Additionally, there has been a general acknowledgement of the view that Fully Licensed Supply has greater set-up and ongoing funding arrangements and carries a higher financial and potentially reputation risk than White Label Supply. This has resulted in the shift from exploration of this delivery arrangement from the outset, to considering the potential for the expansion to this type of model from 2023 onwards. However, this delivery arrangement option is described and considered in full in the Economic Case section of this report.

From the SOC stage to the OBC stage, the decision was made to discount the option of pairing with an existing socially minded supplier, this option is therefore not being explored explicitly as part of the OBC. The reason for this was to ensure the Public Energy Company was established in partnership with Local Authorities to maximise the benefits to local communities. It was noted however, that should White Labelling be chosen as the preferred delivery option then the selection process of an appropriate White Label Supplier could, and indeed should, include socially minded suppliers, whilst also ensuring the partner entity is chosen via a competitive procurement process to ensure fairness and transparency.

3.5 Steering Group

It was determined that a Steering Group should be formed who meet throughout the OBC process, providing oversight of the Project. It was highlighted early on that it is considered important to have both COSLA and Local Authority representation on the Steering Group, given the desire for the Project to be a collaboration with Local Authorities. The Steering Group met for the first time on 3 December 2018. The meeting covered the background of the Project to date, as well as setting out the role of the Steering Group, past and planned stakeholder events and a timeline to completion of the OBC.

The role of the Steering Group was to oversee the development of the OBC as well as providing challenge and support as required. A key part of this role was to ensure that any opportunities and risks identified throughout are properly addressed.

3.6 Parliamentary Inquiry

In June 2018 the Economy, Energy and Fair Work Committee launched an inquiry into publicly owned energy companies, its aim was to seek views on the potential role and remit of a publicly owned energy company to help the growth of local and community projects. There were two evidence sessions investigating the perception of the potential role of a Public Energy Company and preferred governance arrangements.

On 14 December 2018, the Committee wrote to the Minister for Energy, Connectivity and Islands with their findings. The letter identified a number of issues and opportunities highlighted by the responses and summarised what it believes to be the key points for consideration of the Project going forward:

• The Committee believes that the Public Energy Company should be an independent body who is accountable to the Parliament;
• It will be important to ensure good governance, policy expertise, cross-party buy in and long-term ownership plans;
• The Public Energy Company should have a clear mission statement, in line with its objectives to provide cheaper energy and the alleviation of fuel poverty. The key objectives of the company should be documented and fit the smart criteria;
• The Public Energy Company should not cut across or undermine any of the 36 current, main energy policies in place; and
• The Public Energy Company should align with Scottish Government's Energy Strategy.

The Committee also noted a number of areas which it would like to see addressed going forward:

• How the Public Energy Company plans to build a customer base, what analysis has been done on this, and how it will take into account Ofgem's price cap on default tariffs;
• The detail of the White Label approach options;
• The parameters of what a Public Energy Company can achieve within state aid rules;
• Whether the intention is for the company to be municipal in character (in the manner of Robin Hood Energy for example) or working more at the state level (e.g. Equinor); and
• The status of the body regarding its independence from Scottish Government and accountability to the Parliament.

3.7 Drivers for change and opportunities

There are difficulties in the Scottish energy market which Scottish Government would like to improve via the creation of the Public Energy Company. The Scottish Government's key driver in the short term for considering the Project is to support the wider agenda on tackling fuel poverty.

3.7.1 Draft Fuel Poverty Strategy for Scotland

A key objective of Scottish Government is to help alleviate fuel poverty in Scotland. The Scottish Government issued a Draft Fuel Poverty Strategy in June 2018 which discusses how eradicating fuel poverty is crucial to achieving a fairer, socially just and sustainable Scotland. The strategy also outlines a number of actions to be taken to achieving this, including 'establish a public energy company to contribute to tackling fuel poverty and supporting economic development.'.

The Scottish Government's current definition of fuel poverty was defined in the Scottish Fuel Poverty Statement (FPS) published in 2002 as, "A household is in fuel poverty if it would be required to spend more than 10% of its income (including Housing Benefit or Income Support for Mortgage Interest) on all household fuel use.". However, this is proposed to be updated to "Households should be able to afford the heating and electricity needed for a decent quality of life. Once a household has paid for its housing, it is in fuel poverty if it needs more than 10% of its remaining income to pay for its energy needs, and if this then leaves the household in poverty." Under this definition an estimated 613,000 Scottish consumers are currently in fuel poverty, which equates to 24.9% of households^[4].

The statistics on fuel poverty in Scotland highlight the issue and the opportunities for improvement. The creation of a Public Energy Company could allow Scottish Government to influence and control unit and standing charge pricing for consumers, however the extent to which this can be controlled will also be dependent on the delivery option chosen.

Helping to alleviate fuel poverty is about reducing prices but is also about educating consumers on energy usage to help them reduce their consumption levels. The Draft Fuel Poverty Strategy sets out how fuel poverty and energy efficiency are linked and therefore, simplistically, by using less energy, those facing fuel poverty can help to reduce their energy bills. Education of consumers can encourage the use of less energy as well as encourage switching which can result in cheaper unit costs and therefore cheaper bills. The Public Energy Company will look to use a combination of these factors to help reduce the fuel poverty levels in Scotland.

The Public Energy Company must consider how tariffs will be set and the number of tariffs available, as well as the criteria the customers must fit to benefit from each. For example, the definition of 'fuel poverty' will be crucial if there is a tariff specifically aiming to help these customers. Means testing may also be required to ensure those on this tariff are the target market. This means testing would require resource to complete, it will be important to ensure, in the case of White Labelling, that the White Label Supplier will provide this service and absorb these costs within the revenues generated from the partnership payments.

3.7.2 Energy Strategy

As published in the 'Scottish Energy Strategy: The future of energy in Scotland'^[5] (December 2017) (energy strategy), there is a 2050 Vision for Energy in Scotland. The vision is to create a 'flourishing, competitive local and national energy sector, delivering secure, affordable, clean energy for Scotland's households, communities and businesses.

The energy strategy identified six key priorities as follows:

Table 9 – key priorities

	Priority	Description
1	Consumer engagement and protection	"We will work hard to protect consumers from excessive or avoidable costs and promote the benefits of smarter domestic energy applications and systems."
2	Energy efficiency	"We will continue to take direct and supporting actions to improve the use and management of energy in Scotland's homes, buildings, industrial processes and manufacturing."
3	System security and flexibility	"Scotland should have the capacity, the connections, the flexibility and resilience necessary to maintain secure and reliable supplies of energy to all of our homes and businesses as our energy transition takes place."
4	Innovative local energy systems	"We will empower our communities by supporting the development of innovative and integrated local energy systems and networks."
5	Renewable and low carbon solutions	"We will continue to champion and explore the potential of Scotland's huge renewable energy resource, and its ability to meet our local and national heat, transport and electricity needs – helping to achieve our ambitious emissions reduction targets."
6	Oil and gas industry strengths	"We will support investment, innovation and diversification across our oil and gas sector, working with industry to advance key priorities such as maximising the recovery of remaining resources, subsea engineering, decommissioning and carbon capture and storage – collaboratively addressing the challenges of today and preparing the sector and its workforce for a positive role in Scotland's future energy system."

There are a number of different ways the creation of a Public Energy Company could support these objectives:

1) Consumer enagagement and protection

The emergence of new energy companies in recent years has helped to improve competition in the market outwith the six biggest energy companies. For reference, the Big Six suppliers are;

• Npower;
• EON;
• EDF;
• Scottish Power;
• SSE; and
• British Gas.

These new companies give consumers more choice however, some consumers chose to remain with their existing energy provider over the long term and switching rates in Scotland in particular are lower than the rest of Great Britain^[6]. There can be many reasons for this, including:

• Brand loyalty;
• Lack of knowledge of the energy market in general, including a lack of awareness of different tariffs, incentives and different payment methods;
• Not knowing how to switch supplier, often coupled with a belief that it is difficult or laborious to do so; and/or
• Having a perception that switching cannot and will not result in lower bills; and/or
• Financial savings are not sufficient enough to drive switching.

Encouraging consumers to switch suppliers to one which best fit their needs is a key challenge for all energy companies and would be a key obstacle for the Public Energy Company to overcome in order to attract sufficient customer numbers. There is an opportunity for the Public Energy Company, as part of its wider role in the Scottish energy sector, to encourage inert consumers to become active, thereby helping to mitigate the potential loyalty penalty^[7] associated with an absence of engagement and switching. In doing so, it can supplement the immediate financial approaches to targeting fuel poverty through its own tariffs with a wider educational and informational aspect of its operations. It is estimated that 8 in 10 billpayers are being charged significantly higher prices for remaining with their existing supplier in at least one essential market^[8]. The cost of this work to improve consumer knowledge and engagement will be part of the initial and ongoing marketing costs of the Public Energy Company, these projected costs are set out in section 6.9

To address inertia, potential areas of activity for Public Energy Company could therefore include (not exclusively):

• Engagement with national government departments and bodies such as Ofgem and Citizens Advice to help reduce inertia and promote switching by customers through greater engagement with the energy market, and through the support of both new initiatives and current work by these parties as a means by which to mitigate the loyalty penalty;
• Facilitate understanding of the loyalty penalty, which customers gain from it, which customers lose out from it, and what are the causes of it – doing so through independent research. This can then facilitate specific targeting of vulnerable customers and the fuel poor, given the hypothesis stated above;
• Utilising the same approach, seek participation from energy suppliers to inform and engage with their customer bases, while also promoting or supporting legislative measures that yield enforcement against those businesses responsible for harmful and unacceptable business practices; and
• Provide support to consumers to engage with the energy market through the support of measures such as collective switches, automated switching services, the provision of face-to-face support or facilitating the use of other intermediaries (e.g. price comparison sites) – thereby making comparison of supplier tariffs easier and more transparent.

There are also many schemes relating to energy already in place, including winter fuel allowance and warm homes discount which could be supported and promoted by the Public Energy Company. The importance of protecting vulnerable customers is crucial to Scottish Government and schemes including the Priority Services Register help to provide additional services to those in need.

2) Energy efficiency

One of the aims of the Public Energy Company could be to encourage and promote a reduction in energy usage in order to reduce bills and therefore help to ease fuel poverty. The Public Energy Company could therefore create and promote initiatives to improve public education of energy usage and promote ways in which households could reduce the amount of energy used. This has benefits in terms of both, fuel poverty and environmental impact. This would involve costs however could be integrated or paired with the Public energy Company's marketing spend or could also be a channel for any funds generated to be reinvested into helping to alleviate fuel poverty.

The roll-out of smart meters would also impact energy efficiency and the Public Energy Company. OFGEM projects that 75% of smart meters will be installed by the end of 2020. The delivery option chosen for the Public Energy Company will determine which party is ultimately responsible for the completion of the smart meter rollout. Current legislation places the obligation for completing the smart meter rollout on licensed suppliers. Therefore, if a White Label arrangement is chosen, the responsibility for installing smart meters will lie with the Fully Licensed partner supplier.

Domestic homes having smart meters also provides an opportunity for the Public Energy Company to promote energy efficiency in new ways and use the information smart meters can provide to educate consumers on how to make improvements and savings in their own homes. Similarly, smart meters provide accurate consumption information to suppliers, making billing overall more accurate and removing the need for meter readers or for customers to provide readings. Consumers can also access real time information on this energy usage via an in-home display. This is expected to improve consumer experience of the energy market by reducing estimated bills, meter read requirements, and improving knowledge of energy use.

Additional Energy Efficiency Measures

The Energy Company Obligation (ECO) scheme places an obligation on larger domestic suppliers to support affordable warmth for households through the installation of accredited energy efficiency measures. The ECO is the latest iteration in a long line of energy efficiency programmes delivered by licensed suppliers dating back to 1994.

ECO is a target-based scheme, with responsibility for meeting the overall targets split between all obligated suppliers. Suppliers that supply less than 250,000 are exempt from the scheme, although as with the WHD, participation thresholds are reducing to 150,000 accounts by 2020.

Both White Label Suppliers and Fully Licensed suppliers are obligated to provide these services once they breach the threshold, or their parent supplier in the case of White Label.

In addition to these mandated energy efficiency activities there are likely to be wider opportunities for the Public Energy Company to engage in this segment of the market. ECO is not tied to suppliers' own customers but is based on meeting their overall delivery target. This means that public entities are ideally placed to identify groups of residents who would benefit from energy efficiency measures and taking these to obligated suppliers.

For example, it could potentially combine its current understanding, or that of the Scottish regional authorities, of resident vulnerability with information from suppliers to build a more complete picture of customer vulnerability. This knowledge could either be combined with the ECO obligation to identify potential ECO installation targets or for broader action. This broader action could range from 'thin' measures such as providing a holistic approach to fuel poverty to recycling of profits into energy efficiency installations to directly address issues.

3) System security and flexibility

The creation of a Fully Licensed Public Energy Company would allow Scottish Government to have more influence and control over the reliability of supply. However, of the delivery arrangement options being explored, as noted in the commercial case, the option of creating a Fully Licensed Public Energy Company has been ruled out in the short term. Therefore, the ability to achieve this goal is potentially limited.

4) Innovative local energy systems and

Similarly, the ability to empower communities by supporting the development of innovative and integrated local energy systems and networks may be restricted by the choice of delivery arrangement. If White Labelling was chosen as the preferred delivery method, a focus on the specific terms of the contract and engagement could help to ensure inclusion of terms in relation to these objectives.

5) Renewable and low carbon solutions

A Public Energy Company could be leveraged to support renewable and low carbon solutions in Scotland to a degree. However, as stated above, the ability to support this could be restricted by the choice of delivery arrangement. If White Labelling was chosen as the preferred delivery method, a focus on the ability to sign Power Purchase Agreements (PPAs) with local generators and potential reinvestment of revenues from the Public Energy Company should be considered.

3.8 Off gas grid consumers in the Scottish market

There are a number of challenges which are specific to the Scottish market. A significant area of challenge is the higher percentage of consumers who are 'off grid' for gas in Scotland compared to elsewhere in the UK as a result of the geography of the country and the isolated nature of many of these communities. These households therefore rely on electricity and other sources of energy to heat and power their homes.

Table 10 - Estimate of Scottish households not on the gas grid - 2017 ^[9]

Country	Number of domestic gas meters (000s)	Number of households (000s)	Estimated number of households not connected to the gas network (000s)	Estimated percentage of households not connected to the gas network
Scotland	2,066	2,464	486	20%

Source: BEIS Sub-national estimates of households not connected to the gas network

Additionally, competition and pricing in the energy sector for non-gas customers remains an area of challenge. The majority of supplier tariffs are designed around a duel fuel offering, and in some cases the most attractive tariff and some discounts are not available to single fuel customers.

3.9 Stakeholders and Consultation events

Key Stakeholders

During the development of the Project, a number of key stakeholders have been identified who should be included in the consultation and decision-making process. A list is provided below of stakeholder groups for inclusion in stakeholders events and consultations.

Table 11 - Stakeholder Groups

Group	Description
Local Authorities in Scotland	Local government
Government	Scottish Government representatives
Fuel poverty organisations	Charities such as National Energy Action
Utility Companies	Existing energy companies
Consumers	Users of heat and electricity

Local Authorities

It was identified early on that the first stakeholder event should focus on Local Authority participation as their involvement is crucial to the success and ultimately, the progression of this Project. Their engagement and participation is fundamental to the creation of a Public Energy Company. The Scottish Government noted at the outset that the aim would be to include representation from all 32 Local Authorities in Scotland.

During the preparation of the SOC, there was minimal Local Authority involvement and therefore there was a focus on ensuring this during the OBC stage. It was determined that a series of stakeholder engagement events should be organised, with the first event aiming to achieve attendance from as many of the 32 Local Authorities as possible. It was recognised that there were certain geographical challenges in Scotland which could prohibit some of the Local Authorities attending.

The formation of a Public Energy Company will rely on support from the Local Authorities and therefore it was deemed imperative from the outset, that representatives from Local Authorities were involved in the process and were able to give their opinions. For the Public Energy Company to be successful, particularly in some of the delivery options being explored, Local Authorities must be involved and onboard. The Scottish Government wanted to gather information that could not be obtained at a higher level, from the people close to their communities.

Given the decision to widen the scope of the Project to include input from Local Authorities, on 28 August 2018, Scottish Government wrote to COSLA inviting the Scottish Local Authorities to work with Scottish Government in developing the Public Energy Company proposition. COSLA have continued to be engaged in the development of the Public Energy Company strategy and are anticipated to input further as the Project moves closer to delivery.

Stakeholder events

Consultation with Local Authorities

The first stakeholder event was held on 27 November 2018. The purpose of this event was to engage with representatives from Local Authorities across Scotland to give them details on the Public Energy Company Project and gather opinions. It was an opportunity to discuss key issues associated with the development of an OBC for a Public Energy Company for Scotland.

There were speakers from Scottish Government, Grant Thornton and Aberdeen City Council, followed by discussions in table groups. Local Authority representatives were asked about a variety of items, including what their communities want and need, and how the creation of a Public Energy Company could help address these needs.

From the discussions throughout the event, below is a summary of some of the key points which have been considered throughout the OBC.

Pricing

• The importance of pricing for the Public Energy Company was highlighted, with a number of 'tiered' structures suggested, including linking pricing to usage (i.e. higher users pay more per unit once past a set threshold). Standing charges were also raised, with some of the delegates present stating they should be scrapped; and
• The conclusion on pricing from the group was that in order to tackle fuel poverty the cheapest pricing must be offered to those households who are 'fuel poor'. It was suggested that the Public Energy Company should be a not-for-profit entity, re-investing any surplus funds.

Customer Attraction

• The number of customers in Scotland who do not or are not willing to switch supplier was highlighted in the SOC and discussed in greater detail at the stakeholder event. Delegates agreed that in order to attract and incentivise customers to switch, the Public Energy Company must be able to teach the public and become a trusted entity in order to encouraging them to switch supplier.
• Renewable energy and carbon reduction were also discussed as issues communities are concerned about. It was noted that the Public Energy Company must have a unique selling point in order to be attractive to customers. It was suggested that the not-for-profit element, whereby surplus profits are reinvested locally, for example into community generation projects, could be the unique selling point.

Delivery Options

• In terms of the delivery options for the Public Energy Company, the workshop discussed the pros and cons of White Labelling on either a local or national level. At a local level, it was noted that customers may trust a Local Authority brand more than a Scottish Government brand, but also that the Local Authorities may not have the resourcing capacity and skills required to implement a Public Energy Company of their own. From a national perspective, there would be economies of scale with a national Public Energy Company able to reduce duplication of some of the work involved that would be incurred were a Public Energy Company to be set up 32 times across each Local Authority. They would also likely to be able to offer more competitive pricing, which has already been identified as key in the success of the Project, by having increased buying power and access to a larger pool of customers. However, regional differences could make it difficult for a centralised national Public Energy Company to meet the needs of all 32 Local Authority areas.

Overall, the event highlighted the need to ascertain what the role of the Local Authorities will be, which will largely be down to the choice of delivery option and the extent to which individual Local Authorities wish to engage with the development and subsequent operation of the Public Energy Company. As such, the OBC clarifies this further through the Economic and Commercial Case and also considers further the opinions of the delegates from this event. Whilst not all desires highlighted from the stakeholder events are likely to be met in the short term by the preferred solution of White Label supply, many are and some are also part of the long-term objectives of the Public Energy Company, as detailed at Appendix A. The issues of encouraging customers to switch and the Public Energy Company being a not-for-profit entity with surplus profits being reinvested into helping alleviate fuel poverty have been detailed in the Strategic Case and are a key focus of the Project.

Following on from the stakeholder events a further engagement session was undertaken on 30 May 2019 with SOLACE involving local authority Chief Executives and Senior Managers. The Chief Executives were provided with details of the draft OBC and were asked to respond as to their level of interest in the emerging public energy company. As part of the discussions Chief Executives expressed an interest in exploring the additional option of utilising or developing a switching app to help consumers identify competitive energy pricing options that could reduce their consumption costs.

Other Stakeholders Consultation

A second stakeholder event was held on 16 January 2019, with representatives from Scottish Government, Grant Thornton, Cornwall-Insight and Ecuity present. The purpose of the event was to discuss key issues associated with the development of the OBC for a Public Energy Company for Scotland, with a range of stakeholders from various sectors, including energy, education and housing.

From the discussions, it was noted that the stakeholders believe the top 5 community wants and needs to be as follows:

1. Low Price – However, sustainability of price over time may be more important than absolute lowest in market from the outset;

2. Support for environmental objectives;

3. High level of customer service – it was noted an online only presence only would not be sufficient therefore the ability to answer customer calls from a manned call centre would also be required;

4. Pool of experience for the Public Energy Company within Local Authorities and Communities; and

5. Support for fuel poor households.

Whilst point 5, supporting fuel poor households, is a fundamental aim of the Public Energy Company in the short term, pricing will be required to be competitive in order to achieve this as already noted. In terms of the costs of customer service provision, in the case of White Labelling, these costs would lie with the White Label provider. The support for environmental objectives would likely fall into a longer-term goal due to the current time and scope restraints, however, addressing environmental concerns has been noted as a future objective of the Public Energy Company. Summary documents outlining each stakeholder event are included in the appendices.

3.10 Market information (including opportunities and risks)

3.10.1 New entrants to the market

In recent years, there have been a number of new entrants to the energy market, some of which have subsequently ceased to operate, and others which continue to trade. The wholesale prices of gas and electricity are crucial in the success of new entrants to the market.

We observe that wholesale markets have been relatively benign following the economic crash of 2008 – although they have been more volatile since winter 2016 and were on an upward trend for much of 2018. This coincides with the timing of the flurry of new energy companies to the market, including some which are publicly owned. New entrants were able to take advantage of generally falling wholesale prices by passing them onto customers more quickly than the established players. This is because the nature of the energy sector and energy procurement means that larger, more established energy companies enter into contracts, often years in advance, to secure supplies in accordance with their market hedging strategy.

While market conditions are good, and wholesale prices for gas and electricity are falling, this is an advantage for new entrants as they are able to buy at lower prices than the more established suppliers, who are committed to the pre-arranged contract secured in line with their hedging strategy. However, the other side of this means that when wholesale prices are rising, new entrants pay more for their supplies and therefore struggle to offer competitive pricing in order to attract customers.

The key difficulty for new entrants is that when prices begin to rise, they face more difficulty in securing forward contracts for the procurement of their supply. This is due to a number of factors including relations built with suppliers over time and credit ratings. It is therefore extremely important for the predicted trends and current patterns of wholesale energy prices when determining the feasibility and delivery options for the creation of the Public Energy Company if a Fully Licensed Supply model is progressed.

Another factor which could be attributed to the success of some new entrants to the market is the continual political and media scrutiny on the Big Six suppliers since 2008.

As a consequence, the 'Big Six' have been cast as offering expensive products and poor service, although it should be noted that this perception is not only limited to the Big Six. This has however, allowed new players to the market to capitalise on the low (although now improving) perceptions of the established players.

3.10.2 Supplier exits

After a period of relative inactivity in terms of supplier exits, the retail market has seen an increase in the level of supplier exits in recent years for both domestic and non-domestic suppliers via a number of different routes.

There are two main routes which suppliers typically exit the market via, these are:

• Trade sales – the 'conventional' route to market where a supplier operating in the GB market is purchased as a going concern; or
• Supplier of Last Resort (SoLR) – the Ofgem SoLR mechanism transfers a supplier's customers to another supplier if the supplier collapses and is forced to exit the market. Unlike in a trade sale an SoLR is only invoked if a supplier has failed and ceased trading. Ofgem holds a competitive process and appoints a supplier it considers best able to take on the customers and has provided the most competitive offer. The supplier who gains the customers can recover a proportion of the costs they incur from a socialised industry levy.

In the period from February 2018 to December 2018, Ofgem noted 13 supplier exits^[10]. The main reason for supplier SoLR exits in recent years has been due to suppliers' inability to recover sufficient revenues via their customer base to meet raising costs. This has been driven by a number of factors in the market, including: wholesale price spikes; discounted tariff offers set at a level that is unable to recover parties' costs, and rising non-energy costs faced by suppliers (for example network costs, smart meter rollout costs, policy costs) Ofgem's default energy tariff price cap^[11] can also impact upon this, limiting the ability of suppliers to raise prices on customers to offset losses on pre-existing customer contracts. Trade sales have been a mix of forced exits, such as Flow Energy, and parties exiting the market to achieve value, such as Opus Energy and First Utility.

For any potential new entrants to the market, this trend of supplier exits and the reasons for such exits should be considered fully to ensure the same issues are not repeated. On 25 January 2019, the board of Our Power Energy Supply Limited (Our Power) took the decision to close and the company entered administration. One of the key impacts of this is that they were the White Label Supplier to Hebrides Energy, whose customers were switched to Utilita under the Supplier of Last Resort (SoLR). Hebrides Energy will need to consider who the appointed supplier is and negotiate the terms of the new contract. The reasons cited for the collapse of Our Power include lack of funds due difficulties in billing customers and therefore timely collection of cash. This disparity caused the company to have insufficient funds to continue. It is clear that the Public Energy Company, if progressed to a Fully Licensed Supply option, will need to ensure it learns from the difficulties faced by Our Power to avoid these issues.

Following these exits, Ofgem has undertaken a review of the supplier licensing rules and introduced a more stringent entry regime for new suppliers. This includes greater scrutiny of financial stability, confirmation of suppliers' ability to deliver their regulatory obligations, and a more detailed – and hence longer – review process.

3.10.3 Re-municipalisation of energy

A recent trend in the retail market has been the growing interest from public bodies in taking a more active role in the energy markets. The reasons behind this are many but can be summarised as seeking commercial structures to offer tailored energy tariffs to support local residents and businesses (of notable relevance to the Public Energy Company); as a means to facilitate development of and extract value from local low-carbon generation; and potentially seeking an additional revenue stream as funding is removed.

The primary models adopted to date include Fully Licensed supply (e.g. Bristol Energy, Robin Hood Energy), traditional White Label supply (e.g. Peterborough Energy, Qwest Energy etc.), an emerging move towards 'White Label Plus' (White Rose Energy) and the development of private wire/network solutions often incorporating heat networks. Additional information on these options is presented in the Economic Case.

The rationale for establishing these suppliers has been the argument that they will be able to leverage their reputation and familiarity to attract customers otherwise unlikely to switch. Rather than trying to attract those customers that frequently switch by providing discounted competitive offerings, their strength is that they have the potential to attract those customers who are otherwise reluctant to switch and will view the public supplier as a more safe and recognisable service provider for this essential service.

Local suppliers often do not seek to be the cheapest on the market, but price products that will still save the disengaged and vulnerable customer segments significant amounts compared to be served by the local incumbent. For example, Bristol Energy stated on its website that, "We save our customers on average around £200 per year on average on their energy bills," although it gives no explanation of exactly how it has derived this figure^[12].

3.11 Prioritisation of approach

Price and Service

A key consideration the Public Energy Company will need to address is the balance between competitive pricing and the level of service being offered. The level of importance each individual consumer will place on each factor will vary, therefore it is important to try to achieve the correct balance. Whilst pricing is key in helping to alleviate fuel poverty, service is crucial to attracting and retaining a customer base.

There are various suppliers in the market who offer minimal, skeleton customer service, often only available to contact online, however this allows them to keep overheads down and thus they can market that this saving can be passed on to consumers via unit prices and standing charges. On the other hand, many consumers place more importance on service and are willing to pay more for this. In particular, some consumers place value on being able to speak to a person directly, usually via the telephone. As a publicly owned entity, reputation will also be important to the Public Energy Company so this reputation cannot be risked by offering sub-standard service in order to keep pricing competitive.

It should be noted that if a form of White Labelling is chosen, the provision of customer service will fall to the third-party White Label Supplier. It is therefore key that the selection of an appropriate supplier considers the level of service the supplier provides, with corporate values including socio-economic and environmental policies that align with the Public Energy Company. An example of a White Label arrangement is M&S Energy, who until September 2018 provided energy to its customers through a White Label agreement with SSE. In September 2018 they switched this agreement to Octopus Energy, citing them as having aligned values with the ambitions of M&S Energy, including transparent pricing and digital-first customer service.

The Public Energy Company should carefully consider their selection of a White Label Supplier, if White Labelling is chosen, to ensure they have aligned values with those of the public sector investors, as well as values the target customers would approve of and get on board with. It should also be noted that the customers belong to the third-party White Label Supplier, in this case SSE, M&S Energy therefore encouraged and incentivised customers to move to with them to Octopus Energy. The Public Energy Company should therefore bear in mind that the customers belong to the third party supplier and thus when the White Label Agreement ends, customers remain with this supplier. They can however be encouraged to switch. This point is also important if the Public Energy Company was to become a Fully Licensed Supplier in the future as the same situation would apply whereby customers would need to be encouraged and/or incentivised to switch.

3.12 Long Term Aspirations of the Public Energy Company

The initial objective of the Public Energy Company is to help to alleviate fuel poverty. In order to do so it considers the four drivers of fuel poverty:

• Cost of fuel;
• Household income;
• Energy efficiency in the home; and
• How energy is used in the home.

As covered in the main body of the OBC, securing fair prices for consumers and encouraging switching through education of consumers will be key focusses from the outset. Working to improve an individual's position against the four drivers of fuel poverty will, in the long term, be the best way of working to help reduce fuel poverty levels.

In addition to the short-term goals of the Public Energy Company and how it is set up to deliver against these, there are also long-term objectives for the Public Energy Company and also objectives it may wish to pursue going forwards.

During the preparation of the OBC, a number of suggestions have been made for the long-term outlook and goals of the Public Energy Company, this appendix summarises those. These have come from a variety of sources, including stakeholder events, input from the Steering Group, and the parliamentary enquiry to seek views on the potential role of a Public Energy Company.

Long Term Goal – Addressing climate breakdown and utilising renewable energy sources

Throughout the OBC process, numerous stakeholders have expressed an interest in the Public Energy Company utilising its position to be able to introduce measures aimed at raising awareness of and combating climate breakdown.

In Scotland, where the green credentials of generated energy is increasingly important both to policy makers and consumers, as well as consumers being ever more aware of their environmental impact, being a 'green' energy company that is seen to support and promote renewable energy, as well as taking an active role in combating climate change was seem as essential to remaining relevant and being able to support governmental aims in the renewable agenda.

The Public Energy Company should, long term, have the capacity to invest in and capitalise on Scotland's natural advantage in renewable energy resources and expand into a generation role as opposed to just a supply. Alternatively, if it does not wish to enter a generation role it could look at ways to support it. It could also look to develop methods in which to use excess wind and solar power to provide free hot water storage, perhaps specifically to those in fuel poverty. This may, in the first instance, not be within the capacity of the Public Energy Company as a White Label company, however this should not preclude from either

a) In future transition to a fully licensed generation and supply arrangement to allow it to more easily pursue this objective; or

b) Ensuring it's governance structure is positioned in such a way that surplus profits from operations can be utilised in the pursuit of furthering this goal.

Additionally, in the future the Public Energy Company could explore district heating options to help reduce CO2 emissions and long-term overall costs of energy.

It was also suggested there could be potential to explore liaising with the Scottish National Investment Bank who could offer loans to new renewable energy projects – although whether the Public Energy Company itself would want to explore this or support local projects in pursuing their own applications would need to be defined in future.

Providing support to off-grid customers

Particularly in the Scottish market, there are higher levels of consumers who are off the mains grid and rely on other sources of energy, which are typically more expensive. This can be more laborious than traditional supply and can also be less reliable. There is scope for the Public Energy Company to utilise its profits from operations to invest in appropriate infrastructure to improve the options and quality of service available to these consumers. This could be an expensive investment however, there is a notable value-add opportunity in this area.

Streamlining and consolidation of existing energy policies

In Scotland, there are currently 36 active energy policies. There is an opportunity for the Public Energy Company to bring these together, seeking to 'unify' their impact on the market. Conversely, if not structured appropriately, there is a risk that the Public Energy Company could become a '37^th'. Focusing on aligning the objectives of the 36 policies into a coherent and understandable plan could be done and promoted by the Project. In particular, by being in partnership with Local Authorities, the Public Energy Company would also be well positioned to support local and community projects, as well as piloting new schemes.

Broadening of target market

Initially, the Public Energy Company is looking to support domestic households in Scotland, identifying these as its target market. However, it is recognised that there are other energy users that the Public Energy Company could look to target in future. A key identified source of energy users is the buildings across the public estate. The Scottish Government negotiate a 'Public Energy Contract' which covers public sector buildings. It is a 5-year contract, currently held by EDF, having been signed in 2018. However, in future there could be potential scope to expand the focus from domestic households and to include commercial premises and possibly public sector buildings, although it is recognised that procurement regulations etc. would need to be honoured if such an opportunity were to be pursued.

Other

A number of other suggestions have also been suggested by various sources, outwith those described in the headings above:

• Whilst the initial objective of the Public Energy Company is to focus on gas and electricity for domestic customers, there is potential in the future for this scope to expand to cover other areas including small and medium sized enterprises.
• To utilise the rapidly growing opportunities and challenges surrounding the collection and use of data. There is potential to use data sets to support vulnerable and fuel poor customers, thereby supporting the main initial goal of the Public Energy Company to alleviate fuel poverty. This opportunity has been greatly progressed with the roll out of smart meters, as discussed in the Strategic Case.
• Expansion of tariffs and price offering from initial point of set-up – It was suggested that there is the potential to expand the tariffs available in the future, for example, to include a 'high-use' tariff. This could charge higher rates per unit above a certain point of usage, with the additional amounts going towards helping the fuel poor. However, this could be seen to penalise those who have a requirement to use more energy for whatever reason, therefore it would be a tariff that would need to be structured appropriately, with various exemptions in place.
• To pursue longer term PPAs (Power Purchase Agreements) with 'a more social objective' – this could have a particular focus on the sources of energy being provided by the Public Energy Company's energy supplier – for example a commitment to provide energy utilised by the Public Energy Company's users from renewable energy sources.
• To investigate opportunities presented by blockchain infrastructure, which would allow the Public Energy Company to trial and potentially roll out an energy trading platform for solar and wind power generators (residential and SMEs). There is an example of this run by Australian-run firm Power Ledger in Thailand.

3.13 Conclusion

In summary, the Public Energy Company is setting out to help alleviate fuel poverty in Scotland. The strategic case has highlighted the need for change, including the low current levels of customer switching and the number of households in Scotland facing fuel poverty. Stakeholders have been consulted and involved through the delivery of stakeholder events, to promote engagement and gain an understanding of what communities want and need.

The energy market is not an easy market to operate in, with low margins, and the recent number of supplier exits has highlighted this as well as lessons to be learned. The Public Energy Company will need to ensure it has the ability to deliver competitively priced energy to customers both in the short and long term as well as guaranteeing excellent customer service to customers in order to be a success. The delivery options available in order to achieve this will be considered further in the Economic Case section of this report.