Public energy company: outline business case

5 Commercial Case

5.1 Introduction

The commercial options appraisal in this section assesses the preferred delivery option and the corporate, legal and commercial structure of the Public Energy Company. The objective of the commercial options appraisal is to determine what the level and nature of involvement of Public Sector investors and what vehicle/strategy should be pursued in order to achieve the preferred solution. In addition, legal considerations for each option are also discussed. As the Project progresses, full legal advice needs to be sought and a thorough legal review of the OBC will be performed.

The Commercial options appraisal process took place over the period December 2018 to March 2019.

Based on the work conducted through the SOC, the Strategic Case and the Economic Case, the preferred approach to be delivered is:

Table 33 - Preferred option

White Label Model (with option for Joint Ownership)

The Public Energy Company is established by interested Public Sector parties, having chosen a suitable White Label partner in line with criteria determined as part of a formal tender process. Management of the resultant entity is undertaken collectively by the participants.

In this role, Scottish Government would serve in an arms-length capacity through market support and other assistance to establish common cross-boundary rules.

5.2 Required Services

As previously discussed, the Project has the following key objectives:

• To deliver a Public Energy Company to a timetable deliverable by March 2021
• To be sufficiently financially robust to be self-financing in the longer term
• Assist in the delivery of competitively priced energy to help alleviate fuel poverty in Scotland
• Actively engage with disenfranchised customers, particularly those suffering from fuel poverty
• To be presented in a form that allows for Local Authorities to 'opt in' as equity owners
• A Commercial structure designed to allow for the expansion of business objectives beyond the initial scope of the Public Energy Company

5.3 Roles and responsibilities

There are a number of key stakeholders involved in, and impacted by, the creation of a Public Energy Company in Scotland. The Public Sector investors who opt to be rigorously engaged in the activities of the entity will be responsible for the governance and running of the entity. The chosen commercial partner, providing energy to the Public Energy Company under a White Label arrangement is another key stakeholder, as are the consumers themselves, who the Public Energy Company will hope to attract.

• - Potential sponsors:
  • Scottish Government
  • Engaged Local Authorities
• - Customers:
  • Scottish domestic customers in fuel poverty
  • Other Scottish domestic customers
  • Other UK based customers
• - Energy suppliers:
  • Selected White-Label Energy supplier

5.4 Possible commercial structures

The First Minister announced the intention to establish a publicly owned energy company (Public Energy Company) on 10 October 2017. The commitment was made to establish the Public Energy Company by the end of the current parliament (March 2021), therefore the preferred delivery option and chosen commercial structure is intended to be achievable in this timeframe. As noted above, the initial key objective of the Public Energy Company is to help reduce fuel poverty in Scotland by offering competitively priced energy (gas and electricity) and encouraging disengaged customers to switch suppliers in order to secure a better deal than their current provider. The focus will be on domestic customers in Scotland.

It is anticipated that the entity will be set up as a not-for-profit entity, with surpluses generated from business activities being reinvested to provide support to projects aiming to help alleviate fuel poverty in Scotland. Although many of the day to day functions required by the Public Energy Company in delivering energy to customers will be met by the chosen third party White Label Supplier, the Public Energy Company will be required to deliver functions including negotiation and ongoing management of the White Label supply arrangement, administration of the business and Public Energy Company specific marketing.

Given the above objectives and based on previous experience of developing delivery vehicles for Public Sector organisations, consideration has been given to potentially suitable legal forms in the table below, along with outline descriptions for each and other relevant commentary. The options have been developed and shortlisted by advisors however they are subject to full, thorough legal review.

Table 34 - Possible commercial structures

Company Limited by Shares (CLS)

A private company limited by shares is a company that is managed by directors and owned / controlled by shareholders. CLSs are easily understood structures and backed by the Companies Act 2006.

A CLS can trade, raise finance and invest in or be sold to third party investors.

A CLS is liable to corporation tax on any taxable profits arising within the company.

Should the CLS be dissolved any surplus would ordinarily be distributed to the shareholders in proportion with their interests.

Company Limited by Guarantee (CLG)

A CLG is a legal form of organisation which is typically established to conduct business for the benefit of the community. As above, we assume the CLG will be a "not for profit" entity on the basis that any profits arising will be used to reduce fuel costs for customers.

The organisation may "trade" but only in accordance with its objects. Profits will not be distributed and instead will be reinvested for community benefit. Financing is largely achieved through external loans.

A CLG is a body corporate and is subject to corporation tax on its taxable profits.

A CLG may be charitable, in which case if approved by HMRC certain sources of income may be exempt from corporation tax. Further information about the tax benefits of charities is provided below.

Under this approach the Public Energy Company could be set up as a Charity, with a trading subsidiary company (enabling the trading activities of the White Label company to be kept separate from any other energy initiatives the Public Energy Company may wish to pursue in future.

Community Interest Companies (CICs)

A CIC is a company that can be formed as a CLS or CLG. It is a limited liability company that is specifically designed for social enterprises aimed at providing a benefit to a community.

A CIC includes provisions such as an asset lock which would mitigate against any future disposal to the private sector and consequent realisation of the public sector's investment, although it is noted that this is not an 'exclusive' benefit of a CIC.

Profits and assets must be retained within the CIC for community purposes.

As a company, any income or gains arising will be subject to corporation tax. A CIC cannot have charitable status.

If the CIC is dissolved, any assets held can be transferred to another CIC or a charity.

Community Benefit Company or Society (CBCS) or Industrial and Provident Society (IPS)

Involves the provision of services through a "not for profit" entity. The community benefit organisation may be a company limited by guarantee (CLG), Industrial and Provident Society (IPS) or a Community Interest Company (CIC). The organisation will conduct business for the benefit of the community. May be established as a charity if it has charitable objectives.

There should be sufficient powers to participate in the organisation under incidental, wellbeing or general power of competence. The organisation may "trade" (unless it is a charity) but only in accordance with its objects. Profits will not be distributed and instead will be reinvested for community benefit. An IPS will be able to raise share capital but a CLG will not. Otherwise finance will be raised through loans.

The community benefit organisation may have a contract for services with the Public Sector investors provided this has been awarded in compliance with public procurement rules. Alternatively, the organisation may be a standalone service provider. The organisation will contract with third parties in furtherance of its business

A CIC includes provisions such as an asset lock which would mitigate against any future disposal to the private sector and consequent realisation of the public sector's investment.

CLGs are commonly used in the public sector. A CLG is more suitable to a body that is not designed to be a wealth creator for the members, but rather a vehicle to manage specific activity. A CLG would not facilitate any future disposal of the Public Sector investors' interests to the private sector. A CLG is liable to pay tax. Should the CLG be dissolved any surplus could be distributed to the members in proportion with their interests.

An IPS is a society with a co-operative structure that is established for member benefit rather than public benefit. A key feature is the 'one member, one vote' principle although there are several different types of cooperatives. They cannot be charitable, except possibly in a case where a necessary condition of membership is to be within a class of charitable beneficiaries (for example, being a resident in financial need in an area of deprivation).

Limited Liability Partnership (LLP)

A limited liability partnership is a hybrid of a company and a partnership. Like a company, an LLP is a separate legal entity and an LLP member's liability is limited. The relationship between the members of an LLP is governed by private agreement. An LLP does not have shareholders or directors and is taxed like a partnership. The main advantage of an LLP structure is that the limited liability protects the member's own assets from the liabilities of the business. Profit cannot be retained by an LLP like a company can, it should be distributed each year. However, as the Public Energy Company will be a not-for-profit entity with any surpluses reinvested into helping alleviate fuel poverty, this is an issue that it should be possible to mitigate against.

From the above we can see that any of the company structures discussed have the potential to deliver the Public Energy Company's objectives and requirements. However, the structure chosen, particularly where there are a number of vehicles involved in the structure (as discussed in the tax section below), will ultimately depend upon the advice of Scottish Government's legal advisors, who can assess the various structures from a legal perspective and advise on the most appropriate form in conjunction with our tax advice.

There are several important considerations when determining the potential legal form of the Public Energy Company. The key considerations that Scottish Government need to address are as set out below:

Table 35 - Legal structure requirements

Consideration	Comments
Control and governance	The Scottish Government have a number of key strategic objectives that it is seeking to realise through the Project such as supporting reducing fuel poverty and supporting existing energy policies. It would therefore wish to retain some control over the governance of the Public Energy Company to ensure it can align with these broader objectives.
Stakeholder management	The Scottish Government recognises the need for Local Authorities to be involved in and invest in the Project. Due to the nature of the Public Energy Company and its association with Scottish Government, there are a number of key stakeholders who's wants need to be managed, not to mention 'interested parties' who will be paying close attention to the development of the Public Energy Company.
Growth	The Scottish Government have longer term goals to expand the aims and operations of the Public Energy Company in future. They will therefore wish to have the capacity to, for example, evolve the Public Energy Company into a Fully Licensed energy company. The chosen commercial structure therefore needs the ability to grow with the Public Energy Company.
Exit strategy	Public Energy Company owners may desire in future to be able to exit from the Public Energy Company if it is not delivering to their broader objectives.
Self-financing	Over the medium term, the Public Energy Company must generate sufficient income (following initial investment costs) to fund its own operations.
State aid compliant	The structure and related contractual documentation of the Public Energy Company should be compliant with relevant State aid requirements.
Tax efficient	The aim is for the Public Energy Company to reinvest surpluses to address fuel poverty and other energy inequalities in Scotland. As such the Public Energy Company intends to be a not-for-profit entity and a commercial structure which minimises the risk of tax leakage is required.

Based on the above, it is anticipated that the Limited Liability Partnership could have the greatest potential to deliver against the Public Energy Company's objectives and requirements.

However, further consideration of the potential commercial structures is given below.

5.5 Alignment of proposed commercial structures to the objective

This section considers the alignment of the three shortlisted commercial options in terms of:

• Responsibilities
• Ownership and control
• Procuring goods and services
• Funding and financial incentives
• Supply

As the Project proceeds into commercialisation and procurement, we recommended the commercial structures options are thoroughly reviewed by legal advisors.

We have also set out below the high-level tax considerations of the potential vehicles that SG could use for this scheme. However, we would highlight that this report does not consider the detailed tax position for each of the potential vehicles. We recommend that further detailed work is undertaken to model the corporation tax position for the vehicles and potential structures.

Table 36 - Legal structure of Option 1 - Company Limited by Shares ( CLS)

Element	Comments
Ownership/ control	Public Sector entities, who have opted to invest in the Public Energy Company, will be shareholders in the CLS and will enter into a Shareholders' Agreement. The shareholders have roles and duties to perform for the CLS, as specified and described in the Companies Act 2006 and the CLS's articles of associated.
Procuring goods and services	The Limited company will procure an agreement with a selected third party energy supplier who will act as the White Label provider and will provide gas and electricity to the Public Energy Company's customers.
Funding & financial objectives	Public Sector investors will fund the capital cost of the set up (by way of equity and/or debt finance). Noting that the use of White Labelling will limit capital costs significantly compared to other delivery options, such as Fully Licensed supply.
Other	Shareholders in the CLS limit of financial responsibility is restricted to the value of the shares they hold. A CLS is liable to pay tax and therefore profits would be taxable under corporation tax laws.
Tax considerations (non-charitable company)	A CLS or non-charitable CLG / CBS will be subject to corporation tax on its profits. The current rate of corporation tax is 19% (expected to reduce to 17% with effect from 1 April 2020, although this could be subject to change). As outlined above, where the non-charitable company is a subsidiary of a charity, it may be possible to shelter taxable profits arising through payments of gift aid to a parent charity. This report does not consider the determination of taxable profits further, but we recommend that further detailed work is undertaken to model potential corporation tax costs, should the Government choose to set up a non-charitable company.
Tax considerations (charitable company)	Charities are exempt from corporation tax on certain sources of income received (an important exception being trading profits which could include the receipt of commission from energy suppliers – but see further below). A charity can be established as a CLG or CBS and will need to be verified by HMRC as a charity before it can avail of reliefs and exemptions. In principle, and subject to obtaining legal advice, the Charity could be used as a vehicle for administering the surpluses generated to customers who are determined to be in fuel poverty. This would potentially be in accordance with a charitable objective of alleviating poverty. SG should consider establishing a Charity and a wholly owned subsidiary which will conduct any trading activity. This will have the benefit of separating out the trading activities of the White Label company from the Charity's function to receive surplus receipts and redistribute them to the ultimate customers. A trading subsidiary would be subject to corporation tax on its profits but is potentially able to shelter its taxable profits through payments of gift aid to its parent charity. We would highlight that the practicalities of the scheme would need to be reviewed to consider whether a structure involving a Charity and a wholly owned subsidiary is appropriate. Further consideration should be given to the purpose of the Charity and how surpluses will be distributed to customers deemed to be in fuel poverty.

Table 37 - Legal structure of Option 2 - Community Benefit Company or Society ( CBCS)

Element	Comments
Ownership/ control	Under this option, the Public Energy Company would be set up as either a Company Limited by Guarantee (CLG), Industrial and Provident Society (IPS) or Community Interest Company (CIC). The Public Energy Company would be controlled independently, with neither Scottish Government or Local Authorities controlling the entity. Due to the lack of control retained by Scottish Government and Local Authorities under this option, the ability to influence the entity and its operations is more restricted.
Procuring goods and services	The CBCS will procure an agreement with a selected third party energy supplier who will act as the White Label provider and will provide gas and electricity to the Public Energy Company's customers. As the CBCS will operate independently of the Public Sector investors, any services which can provided by them, such as Public Energy Company Specific marketing, may contract with the Public Sector investors for these services. However, these services must be awarded to the provider in compliance with public procurement rules. This requirement to comply with public procurement rules could result in additional time and resource required for set up.
Funding & financial objectives	The form of funding will depend on whether the CBCS is set up as a CLG, IPS or CIC. An IPS can raise share capital but a CLG cannot. Otherwise, funding will be in the form of loans.
Other	Profits are not distributed under this option, with any surpluses generated being reinvested for community benefit, this is in line with the Public energy Company's intentions for surplus funds generated.
Tax considerations	Any income or gains arising in the CIC will be subject to corporation tax. However, it this vehicle does not lend itself to sheltering taxable profits if any surplus would be retained by the CIC rather than donated to a charity. On this basis, we do not expect a CIC to be an appropriate tax efficient structure, as it is likely to be subject to corporation tax on its receipt of commission and may not be able to claim relief for application of surplus to alleviate fuel poverty.

Table 38 - Legal structure of Option 3 - Limited Liability Partnership ( LLP)

Element	Comments
Ownership/ control	Public Sector entities who have opted to invest in the Public Energy Company, will be partners in the LLP with those other parties which opt for partnership in the Public Energy Company. The parties will enter into a Limited Liability Partnership Agreement, setting out the terms of the investments and to establish the terms of the relationship.
Procuring goods and services	The LLP will procure an agreement with a selected third party energy supplier who will act as the White Label provider and will provide gas and electricity to the Public Energy Company's customers.
Funding & financial objectives	The investors will fund the capital cost of the setup, noting that the use of White Labelling will limited capital costs significantly compared to other delivery options, such as Fully Licensed supply. Partners in an LLP are not personally liable when an LLP cannot pay its debts and therefore their liability is limited to the capital they have invested into it. An LLP therefore helps to reduce risk to the participating parties as the main advantages of an LLP structure is that the limited liability protects the member's own assets from the liabilities of the business
Other	In an LLP, the partners receive untaxed profits and pay tax themselves on earnings and the LLP itself does not pay tax. However, as the Public Energy Company will be a not-for-profit entity, with any surpluses being reinvested into helping alleviate fuel poverty, this is unlikely to be an issue.
Tax considerations	As outlined above, an LLP is generally a tax transparent vehicle provided it is carrying on a business with a view to profit. If this is the case, any profits arising in the LLP should be subject to tax on the partners in the LLP. Given that the members of the LLP would be likely to be tax exempt public authorities (which needs to be confirmed), then this structure, if it is workable from a legal perspective, could allow both flexibility (for Local Authorities to join as new members) and tax efficiency. One key aspect to consider is the ability for the LLP to retain its surplus to apply for alleviating fuel poverty (or for each member to allocate its surplus for that purpose). As mentioned above, the LLP itself needs to be carrying on a business with a view to profit. In principle we consider this test may be capable of being met, if the application of surpluses by the members to relieve fuel poverty is a separate decision made by the members through the LLP agreement. We would strongly recommend that the viability of using a LLP is tested further with your legal advisers.

Funding

The proposed initial phase arrangements for the Public Energy Company has no capital requirement. Additionally, many of the support functions which the Public Energy Company will require shall be met by the commercial partner to the Public Energy Company and negotiated as part of the White Label supply arrangement. There are, however, various initial set-up costs and associated working capital requirements – the assumptions surrounding these are detailed in the Financial Case (note, procurement costs are excluded from this assessment).

It is anticipated that there will be Public Sector involvement in the establishment of the Public Energy Company, with Local Authorities given a degree of flexibility over the level of their involvement in the Project. Therefore, the exact source of funding will partially depend on the appetite of individual Local Authorities to invest directly into the Project. There are 32 Local Authorities in Scotland who may choose to participate and/or invest. While the tariffs of the Public Energy Company will be available to all domestic customers in Scotland (and indeed the United Kingdom), it is anticipated that the initial focus of the targeted advertising of the Public Energy Company will be towards those Local Authority areas where the relevant Local Authority has contributed to the running costs of the Public Energy Company.

The proposed ownership structure of the Public Energy Company is shown in the figure below. Owners of the Public Energy Company are represented at the top of the diagram. The proportion of ownership amongst different stakeholders is to be determined, based on further discussion with the Local Authority cohort on both an individual and combined basis. In effect the structure proposed allows for a 'sliding scale' of ownership and involvement. It is hoped that ultimately the Local Authority cohort will want to 'take ownership' of the Public Energy Company as their own – as such a commercial structure has been proposed that allows for stakeholders in the Public Energy Company to have clear and plausible exit options. The structure below allows for this flexibility and also allows for Local Authorities who, for whatever reason may not initially wish to invest in the Project, to do so at a future point in time. For example, it is possible that once the Public Energy Company is established and operating, more Local Authorities wish to get involved.

5.6 Governance Arrangements

Under the preferred commercial structure and associated funding approach, Scottish Government would retain a degree of delivery and financial risk for the Project. It is therefore important that Scottish Government has in place rigorous and robust procedures for monitoring the progress of the Project, both during the development stages and its active operation, and its financial viability going forward.

Under the commercial structure adopted, there will need to be appropriate governance arrangements in place to enable the Public Energy Company to operate flexibly and without undue involvement from company owners, whilst maintaining the necessary oversight and control to reflect the investment of public funding and responsibilities of Scottish Government. Key to achieving this will be:

1. A clear matrix of delegations from Scottish Government and Local Authorities to the board of the Project entity;

2. A clear allocation of function between Scottish Government, Local Authorities and the Public Energy Company and a governance structure which is reflective of this;

3. Details of how potential conflicts between Scottish Government, Local Authorities and the Public Energy Company are to be resolved;

4. Alignment of the business decision made by the Public Energy Company with Scottish Government;

5. Ensuring all directors/responsible individuals appointed to the board(s) of the Public Energy Company receive training in their roles and responsibilities;

6. Other set up requirements such as policies and procedures are adequately addressed.

5.7 Risks and potential for risk transfer

This section considers the risks associated with the Project and the potential mitigations provided by White Label supply as the preferred option.

Table 39 - Risks and mitigations

Risk	Comments	Mitigation
Energy prices	Fluctuation in wholesale gas and electricity prices could impact the prices the Public Energy Company is able to secure with the Energy supplier and ultimately impact the cost to customers.	The term and conditions of the White Label agreement will help to mitigate this risk. Energy companies usually also enter into forward contracts for the purchase of energy which can help to reduce the impact of changes in wholesale prices have on the end customer. The ability to negotiate these contracts will depend on the experience and size of the energy company.
Insufficient sign up levels	There is a risk that there is not sufficient uptake by customers for the Project to be viable and to ultimately deliver on the objective of helping to alleviate fuel poverty.	A structured and well-developed marketing strategy as well as securing the best White Label agreement will help to encourage disengaged customers to switch from their current provider, coupled with an engaged Local Authority cohort committed to educating their residents on the benefits of switching
Reputational risk	There is a risk of adverse publicity or association resulting from poor offering or service provided by the Public Energy Company. Due to the relationship with Scottish Government this Project involves there is an increase in the level of public scrutiny it is likely to receive. This could impact Scottish Government, Local Authorities and the White Label energy supplier.	Ensuring the terms of the White Label agreement are thorough and clear and that the chosen supplier's values align with those of the PEC will help to mitigate this risk.
Regulatory requirements	There is a high level of regulation in the energy market which can be costly and time consuming to ensure compliance with.	By partnering with a supplier under a White Label arrangement, much of the regulatory requirements will be met by them, greatly reducing the cost and resource burden on Scottish Government and Local Authorities.

5.8 Commercial considerations

Project sponsor and entity

The preferred commercial option involves a 100% public sector ownership model, with the proportions of ownership of different public sector organisations to be determined through ongoing discussion and engagement with Local Authority representatives. The ownership model will be legally defined in the commercial particulars and will ensure that strategic control is retained by the public sector partners. The nature of each element of the commercial considerations discussed below will be refined based on the progression of the ongoing discussions with Local Authorities and the subsequent commercialisation and procurements phases, identified partner supplier appetite, and the assessing of agreements and arrangements that are considered likely to provide the outcome the public sector partners wish to achieve.

Energy Supplier

The Public Energy Company will put in to place contractual arrangements for supply of energy to the Public Energy Company Customer base. This agreement will be reached with the identified supplier following commercialisation of the Project and negotiation with potential suppliers in the procurement phase. A competitive procurement process will be used to identify a suitable partner and help ensure an alignment of values with the Public Energy Company's aims. This is intended to be a long-term contract, incentivising the energy supplier to provide a quality of service to both the Public Energy Company and the identified customer base. This arrangement should also allow the public sector bodies to transfer a significant level of the operational risks to a third party. In reaching agreements with the third party energy supplier there is a balance to be struck between accepting risk by the client managing across contract boundaries, and the value that may be lost by outsourcing the responsibility. This will be examined further in the commercialisation phase and will be influenced by the outcome of the soft market testing to better understand market appetite.

Customers

The nature of the Public Energy Company utilising a White Label arrangement with a partner supplier is that the customer base will be 'owned' by White Label supply company. However, despite this, the perception of the customer base is that their arrangements will be with the Public Energy Company itself. The success of the Public Energy Company will be delivered by its marketing and customer engagement activity actively resulting in customers electing to switch/sign up to the Public Energy Company offering. In order to attract customers to the company, it is anticipated that tariff options that are competitive in the marketplace will be offered. It is recognised that it is unlikely the public Energy Company will be able to provide the cheapest offering on the market, however encouraging customers to switch, and a marketing campaign that moves customers to transfer from higher prices arrangements to the Public Energy Company, allows the Public Energy Company to succeed in engaging customers in reducing their exposure to fuel poverty.

Grid Connection

As a White Label company approach has been selected as the preferred option to pursue, the Public Energy Company will rely on the infrastructure assets of the partner supplier and the wider national grid. It is the intention and desire in future that Scottish Government could support, through the Public Energy Company, the encouragement of localised generation projects. These could be used to encourage small scale energy schemes to generate low carbon energy and provide this for use to the wider economy. In these situations, connection to the Scottish energy grid would be required. As these projects appear and progress, individual arrangements will need to be made with the regional grid owner for the connection of these projects to the grid. While not an immediate concern for the Public Energy Company, this could form part of future phases of the Public Energy Company.

Exit strategies

At a future stage one or more or the Project sponsors may wish to reduce or release their interest in the Project.

Delivering the Project through the Public Energy Company – a separate legal vehicle, will allow the sponsors to refinance (if required) or sell their shares to new investors/partners/existing partners as an exit route in the future if the need arises. For example, if the Public Energy Company was set up as a company limited by shares, sponsors would be able to sell their shares at a future date as an exit route. In addition, the Public Energy Company would have separate financial statements, showing the performance and position of the company, making it easier for other parties to understand the performance of the company.

5.9 Contract structures

The following key contractual arrangements will need to be put in place to implement the preferred commercial solution. They are not considered to be a complete list of considerations and are subject to full and thorough legal review by appointed legal advisors.

• Shareholder's (or Partnership) Agreement – between Public Sector investors who wish to take a stake in the Public Energy Company. This will set out the respective roles in funding and governance of the Project.

White Label Supply Agreement – between the Public Energy Company and a suitable White Label energy supplier identified through a competitive procurement process. This agreement will set out the requirements for the supply of energy and the contractual arrangements between the energy supplier and the Public Energy Company regarding remuneration and administrative arrangements and obligations.

• Lease – if required as identified, provided from an office provider to the Public Energy Company to provide a space for the limited number of Public Energy Company staff to operate from.
• Finance agreements – entered into by the Public Energy Company with the Public Sector investors, setting out the funding and equity/debt arrangements.

Indicative Terms & Conditions will require to be drafted, setting out the key contractual clauses between the Public Energy Company and the identified White Label energy supplier – it is anticipated that these will be developed in detail throughout the commercialisation and procurement phase of the Project.

The Scottish Government will also need to obtain specific legal advice to ensure compliance with relevant regulation, including:

• Vires (legal capacity)
• State aid
• Procurement regulations
• Employment Law
• Regulatory Law
• Financial treatment
• Office for National Statistics (ONS) treatment

The proposed commercial structure should be subjected to a Legal Compliance Check to ensure compliance with relevant legal requirements. State aid considerations are discussed in further detail in the Financial Case.

5.10 Proposed charging mechanism

As noted above, Heads of Terms will need to be developed for engaging in negotiations with potential White Label energy suppliers. The financial model has been developed, building on the economic modelling assumptions made in the Economic Case to present two alternative revenue assumptions in the outputs of the financial modelling.

There are two assumptions in the financial model relating to the revenue stream of the Public Energy Company – the Acquisition and the Retention models.

The exact tariffs offered to customers will be based on the market position and will be developed through the contractual negotiations with the successful White Label energy supplier.

5.11 Marketing Approach

Options

In considering the routes to market for the Public Energy Company, it should be noted that – in the context of its objectives – there are two primary areas on which it will wish to focus, namely promoting the awareness of the Public Energy Company itself and its objectives, and providing the information required to assist consumers in switching to be customers of the Public Energy Company.

As stated in the Economic Case, there is a wider education and awareness aspect associated with the alleviation of fuel poverty. This could include public information campaigns, or the use of a physical location that customers could visit to gain greater awareness of the energy market. Here, having personal contact rather than a website or a telephone call could prove more beneficial in encouraging energy market participation, particularly with regards to customers who are more at risk of fuel poverty or disengagement with the energy market. This would need to be coordinated with Energy Efficient Scotland.

Suppliers acquire and retain customers through a combination of competitive pricing, good customer service, marketing strategy and spend, as well as additional products and services. This applies, even in the context of the proposed White Label solution.

To participate in the energy market and obtain a lower cost deal, we assume that customers require awareness of and confidence in alternative offers, accurate information, opportunity, time and a suitable financial reward for doing so. We would therefore expect that measures that address such gaps in information and capability would help to encourage participation in the energy market.

Historically, and as highlighted by Ofgem in their annual Customer Engagement in the Energy Market surveys, it is younger people, those deemed to be social classification ABC1, owner occupiers and frequent internet users that are more likely than average to both have engaged and to have switched supplier. Conversely, older customers less frequently switch supplier but were found to be no less likely to switch tariff with their existing supplier.

While the 2018 survey challenges the perception that older customers are less likely to switch online, there remain notable differences in information awareness and switching across age and social grade.

In general, practical experience has shown that Local Authorities entering the supply market believe that their brand can encourage disengaged customers to switch supplier, and therefore increase switching rates, particularly amongst the more vulnerable segments of the population. We assume that the Public Sector investorsare operating under the same assumption.

In examining the standard marketing routes, we note the following customary routes to market which could be utilised by the Public Energy Company.

Price Comparison Websites

Price Comparison Websites (PCWs) provide an online function as a Third Party Intermediary (TPI) that allows consumers to review the choices of energy supply contracts available to them.

Online TPIs can be active or passive in that they stimulate engagement from the consumer through alerting them with replacements when their existing contracts are to expire or when a very competitive deal becomes available.

Sales by PCWs have been the main route to market for many new entrants in the domestic market in recent years. The costs for these vary slightly by platform and the supplier being switched to, but average £30-£40/customer for a dual fuel tariff.

Cashback sites

There are several cashback websites which pay consumers a fee if they click through to a third party website and buy a product or service from them. As part of the broader service, such sites typically charge a membership fee. The highest profile and largest are Quidco and TopCashback.

Energy suppliers and PCWs have from time to time offered payments to consumers for energy contracts either directly (as the supplier) or indirectly (through using the switching site).

In April 2019, suppliers promoting switching through cashback sites were typically offering customers £10-£20 for a single fuel switch and £20-£50 for a dual fuel switch – these excluding the commercial arrangement between the cashback site and the supplier itself. The higher payments are typically linked to long term (2-3 year contracts) with additional features, such as boiler cover or broadband.

Telesales

Sales conducted by telephone are typically more expensive than PCW sales but cheaper than face to face sales. Cornwall Insight estimates that the typical cost of route to market is £35-£45/customer on a dual fuel switch.

Face-to-face

Face to face sales are normally split by doorstep sales and event sales. This route to market faces the highest compliance threshold due greater opportunity for mis-selling. Typical sales costs for this route are £50-£65/customer on a dual fuel switch, this also being borne out by information published in respect of the legal case brought against Economy Energy and E (Gas and Electricity)^[28].

This indicated a tiered structure of payments that rose incrementally for each thousand customers switched within a calendar week, increasing from £25 per fuel to £30 per fuel, i.e. double this amount for a dual fuel switch.

One potential advantage of face-to-face sales in this instance would be as a means by which to promote the wider aims of the Public Energy Company, e.g. through event sales in the form of temporary stands or pop-up shops in local shopping centres, while the former could also be employed in council offices.

This physical presence could be based upon a largely standardised set-up determined by Scottish Government or established around a general template that could be developed to a bespoke local solution better reflecting the needs of each individual authority (discussed further in the Regional branding section below). The cost of this approach would therefore reflect commercial property rates applicable in each location, as well as assumed staffing costs.

Given the physical characteristics of the Scottish market – low population density across a large area – it is expected that face to face sales costs per customer gained would be correspondingly higher to reflect this, particularly outside of the main populated areas. This has been borne out by supplier activities in the market to date, with new entrant suppliers typically both entering the northern Scottish market last and competing less actively in this region.

It should also be noted that there is a general perception within the energy supply sector that a customer that switches through a non-online method will be less likely to make further switches once they have made their initial switch. As such, the higher acquisition costs associated with face-to-face switching would need to be considered against the prospect of a longer-term revenue stream from such customers.

Permanent physical location

As an example of a route to market engagement and awareness, the Bristol Energy Hub facility is described by the company as a "unique customer service point" that describes itself as offering "friendly and accessible customer care".

As well as serving as a means by which to promote Bristol Energy, it also provides general advice relating to the energy sector including on issues such as switching supplier, energy efficiency advice and understanding and paying energy bills. In terms of promoting awareness of Bristol Energy, the Hub is also used as a means by which to showcase issues such as investment in the community, charitable initiatives and social and environmental responsibility.

Although there is no information regarding the effectiveness of the Hub approach, a similar method could be employed by participating Local Authorities. As with the temporary displays, a standardised or template approach could be utilised.

Feedback from the local engagement events conducted in the preparation of this OBC highlighted the importance of face-to-face interaction for older people, which would lend itself to a format that is not exclusively digital or telephone-based.

In particular, one respondent noted that people would benefit from a "one stop shop" where they can find out information on the Public Energy Company, get advice on switching and energy affordability, and find out what initiatives (e.g. energy efficiency, Warm Homes Discount etc.) they are eligible for. Any such costs incurred in providing this service would need to be considered in the context of any potential State aid implications – legal advice would be obtained in order to understand this poosition.

This is also reflected in research undertaken by Glasgow Calendonian University, which highlights the importance of the face-to-face delivery of information on energy issues, particularly on the subject of fuel poverty^[29]. This also highlighted that the provision of support by telephone and online was "often insufficient for meeting the needs of vulnerable housholders" – highlighting the potential benefits of a physical presence.

Regional branding

As stated above, one of the main strengths of Public Energy Companies in general is their ability to utilise their unique brand to engage customers who would otherwise be disengaged with the market.

There is the potential for this to be further enhanced through the use of local regional branding by the Local Authorities involved with the Public Energy Company. Based upon the stakeholder engagement work undertaken it appears possible that there would be additional interests from residents in engaging with their Local Authority over a nationally branded company.

Marketing summary

Publicly-owned energy companies commonly seek to utlise their unique brand to engage customers that have not historically switched, thereby increasing switching rates. At present, the two fully licenced Local Authorities operating in the market – Bristol Energy and Robin Hood Energy – have tried to engage with the local market through the routes above but also beyond standard marketing routes, including through:

• Newsletters
• Educational pamphlets
• Email campaigns
• Workshops and seminars
• Physical shop windows

With only two Local Authorities having a full supply licence, it is still too early to fully understand whether or not councils are able to engage with disengaged customers and increase switching rates in this way.

However, anecdotal evidence and the development of schemes such as fitting smart prepayment meters in social voids and for vulnerable customers suggests that these suppliers are able to reach the targeted customer segments beyond that which a typical supplier is willing/able to do.

The Public Energy Company therefore has a number of available marketing strategies available which would require further detailed analysis to select those likely to yield the best return.

5.12 Procurement strategy

Given the wider public interest element of the roll out of the Public Energy Company, the current working assumption is that a Restricted Procedure process is followed. The Management Case provides detail on the procurement strategy. Throughout the process, it is recommended that Scottish Government have externally appointed Technical, Financial and Legal advisers in place to act in the best interest of the public sector and ensure that the procurement specifications are sufficiently detailed to achieve the desired outcomes. In order to maximise the recoverability of Project expenditure, it is anticipated that the Public Energy Company will be incorporated and VAT registered in advance of the incurrence of costs relating to the establishment of the operation. The costs of procurement, as not reflecting the costs of the Public Energy Company itself, have been excluded from the assessed costs of the Public Energy Company. The extent of these costs, which will be incurred in bringing the Public Energy Company to market, will vary depending on the procurement approach adopted and the complexity of the desired solution.

5.13 Procurement timetable

A full Project timeline from the OBC through to the Public Energy Company being operational has been outlined in the Management Case section of this OBC – this includes the multiple phase procurement timeline. The timetable has been designed to be flexible to allow for any delays that may be encountered in a competitive dialogue procurement.

5.14 White Label Agreement Contract Length

As part of the procurement stage, the length of the White Label Agreement should also be considered. There are other examples of Local Authority White Label energy suppliers with 3-5 year contract lengths. One option for the Public Energy Company could be to seek an agreement underpinned by a service level agreement (SLA) to help ensure the level of quality and service provided to customers, potentially in conjunction with one or more key performance indicators (KPIs). For example, this could be an initial 3-year contract with an option to extend by one year and then another year, for a total of a 5-year contract, provided the service agreement terms are met. This should be considered further as the Project progresses.

5.15 Market interest and soft market testing

Initial soft market testing has been undertaken, with the primary objective of obtaining feedback on the structuring of the Project vehicles and levels of interest from some potential bidders into any procurement process.

A high-level memorandum was developed and issued to the following entities:

• Bristol Energy
• Ecotricity
• Engie
• Good Energy
• Octopus Energy
• People's Energy
• Robin Hood Energy
• Scottish Power
• SSE
• Together Energy

The information memorandum provided the consultees with high level details of the Project, including outlining the opportunity, highlighting risks and outlining key questions Scottish Government were looking for feedback on from the consultees.

The responses were received via email, in face to face meetings and telephone, with initial thoughts on the key questions asked. Detailed below are anonymised the responses of each of the consultees (in no particular order).

Consultee One

Consultee one has values which are in line with Scottish Government aims in terms of helping to alleviate fuel poverty and ensuring fairness for consumers, including keeping prices as low as possible. The company also has values focussing on customer service, call waiting times and email response times as key performance indicators. They would consider being involved in the Project as long as the terms and Public Energy Company's use of funds was in line with their desires as a company. They see the Public Energy Company being set up as a separate entity which they would run under Public Energy Company branding. In terms of timelines, they indicated this would be possible in as short a time as one month (once Scottish Government procurement processes are complete) and therefore do not see the deadline of March 2021 as a concern.

In terms of the focus of the Public Energy Company, Consultee One highlighted that there should be an emphasis on reducing the gap in pricing between prepayment and credit term customers. Bearing in mind that those on prepayment tariffs are historically more likely to be in fuel poverty, addressing this gap in pricing would in itself help to reduce fuel poverty. It was noted that there is an additional cost to suppliers for providing the prepayment service, however this gap can be reduced.

With regards to a preference for either the Acquisition Model or the Retention Model, Consultee One indicated they would not have a particular preference. They would however be keen to discuss/understand further what this income to the Public Energy Company would specifically be used for (see the Economic Case for more details on the operating costs of the Public Energy Company).

Consultee Two

Consultee Two is not interested in being involved the Project.

Consultee Three

Consultee Three is interested in the proposition from the initial memorandum, and welcome further discussion with Scottish Government on the Public Energy Company and key considerations.

They highlighted that they support the stated aims of the Public Energy Company of helping to reduce fuel poverty and encouraging disengaged customers. They are keen to learn more and discuss whether the creation of a new White Label agreement would be able to achieve these aims.

In terms of the Acquisition Model versus the Retention Model, Consultee three does not have a preference at this point and the focus would be on finding a commercial White Label arrangement which is both sustainable, and suitable for all parties. Therefore, decisions and preferences on this would be pending further discussions with Scottish Government.

Consultee Four

Consultee Four is interested in the proposition from the initial memorandum and are keen to be updated as the Project progresses. This Consultee has White Label involvement currently and are actively pursuing opportunities which are value driven. They also believe they are well positioned to partner with Local Authorities.

In terms of the Acquisition Model versus the Retention Model, Consultee four is flexible on which option the Public Energy Company would prefer. They also proposed a hybrid option between the two, whereby there would be an acquisition fee and ongoing retention fees. As standard, they offer acquisition fee and a retention fee each month however they would be happy to discuss and agree on the best approach for the Public Energy Company.

Consultee Five

Consultee Five is not interested in being involved the Project as they are not currently looking at White Labelling.

Consultee Six

Consultee Six supports Scottish Government's intentions to offer a fair price to consumers, tackle fuel poverty and promote economic development. They would be keen to be involved in the Project however not as a conventional White Label Supplier. Their alternative proposed approach would be to set up a fully licensed energy company on behalf of Scottish Government that could provide white labels to local authorities. The energy company would be wholly owned by the Scottish Government which would allow them to retain full control. The set-up process would duplicate the systems and processes Consultee Six already has which would allow for a quicker and less costly process. Consultee Six provided indicative set up-costs in the region of £500k including both industry requirement set-up costs and operational set-up costs.

Consultee Six believes that fuel poverty issues can be alleviated as part of a bigger solution to offer publicly owned sustainable energy in Scotland. They believe that by being the actual supplier, Scottish Government have an opportunity to deliver real value and could provide a platform for future projects and investments.

Consultee Six would be keen to work with local authorities and mutual organisations to provide energy at fair prices and believe that by working with Scottish Government, they have the potential to make 'mutual and municipal' energy a reality by building a network of partnerships with influential organisations that can deliver real change. They believe this network could transform the energy market in the interests of customers and the Scottish economy.

The following conclusions can be drawn from the market engagement undertaken:

1) While not all the parties approached expressed an interest in engaging with the subject of supporting Scottish Government in establishing a Public Energy Company, there was sufficient interest across the space that suggests this is an avenue worth exploring further.

2) It should be noted that a number of different methods and approaches were identified by which the market would like to engage with a Public Energy Company. As such, any procurement approach undertaken to facilitate the establishment of the Public Energy Company should seek to avoid being overly prescriptive, in order to allow the market to present their own solutions for engaging with the Public Energy Company, thereby allowing potential innovative approaches to addressing fuel poverty.

3) There was no clear preference for a retention or an acquisition model – indeed a hybrid approach was also suggested as a possible solution. As such, the Public Energy Company should have a degree of flexibility in exploring the approach that it thinks will be most beneficial.

In summary, the early market engagement, from those who engaged, was received positively, and a plan for future engagement should be developed as part of the commercialisation process. Under the preferred delivery option, it will be necessary to secure a White Label supply agreement with an existing energy company to energy to the Public Energy Company's customers.

5.16 Summary and conclusion

Based on the analysis undertaken, it would appear that either a charity (set up as a CLG or CBS) with a wholly owned subsidiary (potentially set up as a CLS), or a structure involving an LLP could provide an appropriate commercial structure which is tax efficient. However, we would highlight that a number of confirmations would be required in order to investigate whether this is appropriate. In particular:

• Legal advice should be sought to confirm that the vehicles outlined above are appropriate
• Further consideration needs to be given to the mechanism by which any surpluses are applied

However, as noted throughout, the comments made in this note are for the purposes of informing a discussion on the possible structures that may be considered for the Public Energy Company. No action should be taken by SG without further discussion and obtaining detailed legal advice. We would be pleased to take part in further discussions in conjunction with your legal advisers.

For the purposes of the financial modelling performed in the Financial Case, we will assume that a commercial company is set up, in the form of a Company Limited by shares. As charitable status cannot be guaranteed at this time, we have made the assumption that the Public Energy Company will be exposed to corporation tax on its taxable profits. As the Project progresses to commercialisation and the delivery structure is refined further, this would represent upside to the Public Energy Company if it were able to mitigate against the requirement to pay corporation tax.