2 Executive Summary
This Outline Business Case (OBC) examines the potential delivery options for the establishment of a publicly owned energy company (Public Energy Company) and recommends a preferred delivery option, building on the work previously commissioned by Scottish Government in the development of a Strategic Outline Case (SOC).
In accordance with HM Treasury Green Book guidance, this OBC has been developed using the Five Case Model. The purpose of this Executive Summary is to summarise the findings under the five cases, namely the:
- Strategic Case;
- Economic Case;
- Commercial Case;
- Financial Case; and
- Management Case.
Throughout this OBC, reference is made to the actions that could be undertaken in the establishment and ownership of the Public Energy Company. It should be noted that, at this time, the final form and ownership structure of the Public Energy Company is yet to be determined – this will follow discussions with Local Authorities, which are ongoing. As such, where the document refers to actions the public energy company owners will take in respect of the Public Energy Company, this should be read as referring to the actions of the public sector investors working in collaboration to deliver a viable and successful Public Energy Company.
2.2 Strategic Case
This case provides the strategic justification for the Project, it outlines the background and objectives of the Project and assesses the stakeholder impact, key benefits and risks.
The Scottish Government wish for a Public Energy Company to be established, with the principal aim in the first instance of helping to alleviate fuel poverty in the Scottish market. 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 which include establishing a Public Energy Company.
As explained further in the Strategic Case, 24.9% of households in Scotland are classified as being in fuel poverty, therefore it is clear there is a need for work to be done to reduce this figure. On 10 October 2017 The First Minister announced the intention to set up a Public Energy Company before the end of the current parliament (March 2021). Following this, Scottish Government developed the SOC, which presented the case for change and explored the initial options as well as the feasibility of the Project. It concluded that it would be possible to establish a Public Energy Company which would be capable of delivering competitively priced energy to help alleviate fuel poverty in Scotland.
The key objective of the Public Energy Company is to reduce fuel poverty in Scotland which is both a short and a long-term goal. In order to do this the Public Energy Company aims to offer competitively priced energy and to encourage and increase consumer engagement with the market in order to encourage switching of suppliers by customers to obtain a better deal. There are also additional long-term objectives which the Public Energy Company seeks to achieve, including:
- Addressing climate breakdown and utilising renewable energy sources;
- Providing support to off-grid customers;
- Streamlining and consolidation of existing government energy policies; and
- Broadening of the Public Energy Company's initial target market.
Details of these, and other project objectives, are presented in the Strategic Case.
The Project has a number of key stakeholders:
- Local Authorities in Scotland;
- Fuel poverty organisations;
- Utility Companies; and
It was and remains important that these stakeholders are involved and considered in the consultation and decision-making process. The Scottish Government has highlighted the importance of Local Authority engagement and involvement in the Public Energy Company and therefore their participation is crucial.
2.3 Economic Case
The purpose of the Economic Case is to demonstrate the economic benefit of the preferred solution, determining which option to take forward into the commercial options appraisal (conducted in the Commercial Case). It presents the proposed delivery options for the Public Energy Company and the methodology behind the initial selection of these options. It then discusses the criteria against which each of the chosen delivery options have been assessed to reach a preferred option. This preferred option has then been subject to economic modelling and has been risk assessed.
The Economic Case outlines the following proposed delivery options:
- Option 1: Fully Licensed Supply – A Public Energy Company would be established as a licensed gas and electricity supplier with full responsibility for complying with all regulatory requirements.
- Option 2: White Label Supply – Contracting with an existing licensed energy supplier to provide Public Energy Company branded gas and electricity to customers. The chosen third-party supply company then pays fees to the Public Energy Company for each customer that switches. This generates income for the Public Energy Company.
- Option 3: Do Nothing – Continue with existing energy policies and do not establish a Public Energy Company in Scotland.
These options are an evolution of the options considered in the SOC. The purpose is explained in greater detail in section 3.4 of the Strategic Case.
The Economic Case scores these options against evaluation criteria to determine the preferred delivery option.
Each option was assessed on a yes/no basis against two mandatory criteria, to 'pass' required the option to be a yes to each of the criteria, a no to either criteria resulted in automatic exclusion as an option. The two mandatory criteria were;
- The chosen option must be capable of being fully implemented and be operational no later than March 2021 (in order to align with the First Minister's stated intention to establish the Public Energy Company by the end of the current parliament).
- The chosen option must be capable of being implemented without any breach of State Aid legislation.
Discretionary scoring was applied as a weighting to the importance of each criteria multiplied by the perceived ability of the option to deliver against this criterion. This resulted in each option receiving a score between 1 and 10, with 1 indicating a 'weak' performance and 10 a 'strong' performance. It should be highlighted that an option with a 'strong' performance score that 'failed' either of the two mandatory criteria resulted in automatic exclusion.
Based on the scoring of the options, White Label Supply was assessed as the preferred delivery option. While a Fully Licensed Supply option would have also received a competitive score, it was excluded as a result of the mandatory criteria, as it has been assessed as not being deliverable within the required timeframe (by March 2021).
It was also noted that the Fully Licensed Supply option also carries with it significantly greater initial set-up costs and has a much higher working capital demand, as well as a significantly greater risk exposure. In addition to initial set-up costs estimated to range from £2.5m - £4m and a working capital requirement estimated to be in the region of £3.5m, there would also be a requirement for significant credit for balancing and settlement, network charges under industry codes with wholesale trading partners and under renewables schemes such as the Contracts for Difference, with a credit requirement of c.£7m expected during the winter months per 100,000 customers. Furthermore, it is noted that Fully Licensed Suppliers are often significantly loss making during their initial years of operation – for example Robin Hood Energy has been funded to a total of £25.5m by Nottingham City Council and Bristol Energy in the region of £36m by Bristol Council. This presents a significantly greater risk profile and level of exposure than that experienced under the White Label Supply option.
The preferred delivery option is therefore to establish a Public Energy Company under a White Label Supply arrangement with an existing fully licensed supplier operating in the market. A White Label Supply set up also puts a flexible vehicle in place which can demonstrate the success of the Public Energy Company and allows for development into a Fully Licensed Supplier in the future if desired. The table below demonstrates the outcome of the scoring – please refer to the Economic Case for the detailed scoring breakdown.
|Detail||Fully Licensed Supply||White Label Supply||Do Nothing|
|Mandatory Pass/Fail: Can option be fully implemented and be operational no later than March 2021||No||Yes||Yes|
|Mandatory Pass/Fail: Can option be implemented in compliance with State aid legislation||Yes||Yes||Yes|
|Overall weighted score (out of 10)||N/A||6.83||1.59|
2.4 Commercial Case
The objective of the commercial options appraisal is to assess the preferred delivery option and the corporate, legal and commercial structure of the Public Energy Company by considering each options' benefits and associated risks. The proposed 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 proposed ownership structure allows for the exact split of ownership to be determined once more information on the various Local Authorities position in respect of the Public Energy Company is known. It should be noted that as the Project proceeds into the commercialisation and procurement phases, we recommend the below structure is reviewed in detail by legal advisors.
Commercial Options Appraisal
The following commercial options were considered by the advisor team:
- Company limited by shares (CLS) – A private company limited by shares is an easily understood structure which is backed by the Companies Act. This structure limits liability of stakeholders and the limited company itself is liable to taxation. A CLS can trade, raise finance, invest in or be sold to third party investors;
- Company Limited by Guarantee (CLG) - Compared with a CLS, a CLG will not have any share capital and it will have members rather than shareholders, who contribute a nominal sum to the liabilities of the company which are repaid in the event of the CLG being wound up;
- Community Benefit Company or Society (CBCS) – 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 entity conducts business for the benefit of the community, it may also be established as a charity if it has charitable objectives; and
- Limited Liability Partnership (LLP) – A limited liability partnership is a hybrid of a company and a partnership. It is a separate legal entity and 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 of directors and is taxed like a partnership.
For the appraisal a number of considerations were outlined:
- Control and governance;
- Stakeholder management;
- Exit strategy;
- State aid compliant;
- Tax efficient;
- Future flexibility and strategic development
- Potential for charitable status; and
Per the evaluation undertaken in the economic case, a Public Energy Company established under a White Label approach with a licensed energy supplier has been selected as the preferred option. One of the key benefits of this approach is that the level of funding, both up-front and ongoing, and resource requirements needed to establish the Public Energy Company is significantly lower than would be required under other options, such as the establishment of a Fully Licensed energy company. In addition, the amount of work required to establish such an entity is also minimised. This is due to the significant capital and regulatory costs that are necessary to be incurred in the establishment of a fully licensed energy supply company, details of which are described in greater detail in section 4.2.1. In contrast, for a White Label arrangement the set-up costs are anticipated to be c.£250k. A full breakdown of this figure can be found in Appendix D. The set-up costs include items such as legal support, tendering for a White Label partner supplier, marketing strategy and web design.
The proposed delivery option of a White Label agreement has no capital expenditure requirements (although there are still set-up costs and early year anticipated deficits as the company gets established). Consideration of the costs of the various options is included within the Economic Case. In addition, the third-party energy supplier selected to be the White Label Energy Supplier would be expected to provide many of the support functions required by the Public Energy Company, including customer service.
It is anticipated that there will be a mixture of interested public sector parties involved in the establishment of the Public Energy Company, with the level of Local Authority involvement to be determined through ongoing discussions with the Local Authority cohort. Therefore, the exact source of funding will depend on the appetite of individual Local Authorities to invest directly into the Project. There are 32 Local Authorities in Scotland who potentially may choose to participate and/or invest in the Public Energy Company.
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 (a Competitive Dialogue process has been considered, which would allow for deeper engagement with the market, however, the cost implications of this and the timetable to required operational commencement mean this approach was not considered appropriate). Throughout the process, it is recommended that Scottish Government externally appoint Technical, Financial and Legal advisers 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 (assuming the ultimate form of the Public Energy Company requires it) 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.
Market interest and soft market testing
Initial soft marketing has been undertaken by Scottish Government, with the primary objective of obtaining feedback on the structuring of the commercial offering and levels of interest from potential third-party energy suppliers into any procurement process.
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 the establishment of a Public Energy Company, there was sufficient interest across the space that suggests it is worth exploring further.
2) It should be noted that there are a number of different methods and approaches identified by which the market would like to engage with a Public Energy Company. Any procurement approach undertaken should seek to avoid being overly prescriptive. This will 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 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.
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
As noted throughout the Commercial Case, the comments made in this Outline Business Case 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 Scottish Government without further discussion and obtaining detailed legal advice.
2.5 Financial Case
The Financial Case examines the benefits and costs of the preferred solution. The basis for considering these benefits used the following metrics, which result from the manner in which the Project is commercially structured and how it is funded. These include:
- Internal Rate of Return;
- Net Present Value; and
- the overall financial benefit of the Project.
The financial case presents two key options for the proposed White Label solution, the Acquisition Model and the Retention Model:
|Retention Model||Acquisition Model|
|The Retention Model assumes that, once a customer has switched to the Public Energy Company, that the White Label Supplier the Public Energy Company is partnered with pays a monthly retention fee for each month that the customer remains with the Public Energy Company. This is assumed to be £1 / meter / month (so the supply company pays the energy company £2 a month for a customer on a dual fuel tariff).||The Acquisition Model, in contrast, assumes a £25 upfront payment by the energy supplier to the Public Energy Company for each new customer meter that switches to the company. There are no follow-on payments from the energy supplier to the Public Energy Company – this approach therefore improves the upfront cash position but requires the consistent identification of new customers for the network.|
These two models are considered to be in line with current market White Label arrangements . The option which is projected to yield the best result is explored further in full in the Financial Case however it should also be noted that the final option will somewhat depend on the appetite and preferences of the White Label energy suppliers. In addition, as part of the scenario testing undertaken in the preparation of the Outline Business Case, we have prepared a 'hybrid' approach scenario, which allows for a blend of the retention and the acquisition model.
The Financial Case assumes that the procurement process starts between September 2019 – March 2021 with operation commencing in April 2021. The Financial Model covers a period of 10 years from the point of operation.
As outlined above, the Financial Model has been used to calculate core Retention and Acquisition Models for the preferred White Label option. A number of sensitivities have also been performed to assess the impact on both of these scenarios. These are shown in the table below. In addition to sensitivities we have modelled core, optimistic and pessimistic scenarios. The assumptions underpinning these are detailed in the Financial Case. While only the Core scenario outputs are presented in this Executive Summary, the Financial Case provides the detailed outputs of each of these scenarios in turn and demonstrate both the potential upside and the potential downsides of the forecast returns, depending on the assumptions applied.
|1 / 2||Core Scenarios|| As noted in the Introduction, two 'Core' scenarios have been prepared – the Retention Model and the Acquisition Model
|3||Blended||Under this scenario, a blending of the retention and acquisition model is presented, with income received from the energy supplier for each new customer meter joining the company received both an upfront one-off payment of £12.50 (in the same manner as the acquisition model), but also an ongoing retention payment of £0.50 per month (in the manner of the retention model)|
|4 / 5||Optimistic||The optimistic scenario uses a similar set off assumptions to the Core scenario, however assumptions regarding revenue levels and customer take-up are improved, and projections of cost are reduced (as detailed in the Financial Case), in order to show how the Public Energy Company could develop under favourable market conditions.|
|6 / 7||Pessimistic||The pessimistic scenario uses a similar set off assumptions to the Core scenario, however assumptions regarding revenue levels and customer take-up are reduced, and projections of cost are increased (as detailed in the Financial Case), in order to give an indication of how the Public Energy Company may perform if projections are not as positive as those anticipated under the Core scenario.|
|8 / 9||Equity funding||The Core Scenarios assume that the working capital required to fund the development of the Project is made in the form of a revolving loan facility. Under these scenarios this is replaced with a contribution in the form of equity, repaid to the Investor at the end of the Project.|
|10 / 11||Grant for set-up costs||The Core Scenario assume that the working capital required to fund the development of the Project is made in the form of a 10-year annuity loan facility. Under these scenarios this remains true, however the set-up costs of c.£250k of establishing the company are provided in the form of a grant to the Public Energy Company to reduce the need for debt funding.|
|12 / 13||Increased interest charge||The Core Scenarios apply an interest rate to debt provided from investors at a rate of 5.09% (refer to Section 6.14 for details). Under these scenarios an interest rate of 11.09% is charged, should the Public Energy Company be identified as a 'high-risk' investment. Section 6.14 explains the reasoning for this.|
|14 / 15 / 16 / 17||Revenues + / -||Under these scenarios, the revenue assumptions used in Optimistic and Pessimistic scenarios replace those used in the Core assumptions, to assess the impact of improved/worsened revenue negotiations, without the other variations seen in the Optimistic/Pessimistic Cases|
|18 / 19 / 20 / 21||Costs + / -||Under these scenarios, the cost assumptions used in Optimistic and Pessimistic scenarios replace those used in the Core assumptions, to assess the impact of improved/worsened costs, without the other variations seen in the Optimistic/Pessimistic Cases|
One of the key benefits of White Labelling being the preferred option is the required level of funding is significantly lower than would be required under other options. There are no capital requirements under this option and the third-party supplier will carry many of the support function costs.
The core scenarios under the Financial Model assume that a Public Energy Company in the form of a limited liability company will be established, into which investors can make pinpoint equity investment in proportion to their ownership. However, it should be noted that this is an assumption made for modelling purposes and does not reflect an assertion that this presents the most appropriate commercial structure for the Public Energy Company.
The calculations performed in the Model demonstrate that there is an overall financial benefit for the domestic customers switching to the Public Energy Company, based on the tariff assumptions made. The values included in both the Public Energy Company scenarios and the Counterfactual scenario for the Preferred Option are based upon the commercial assumptions prepared by Cornwall Insight. Assumptions made are based on 'best estimates' available and knowledge of the market at the time of writing. It should be noted that these are high level assumptions and, as assumptions are projected into the future these become less and less certain.
Confirmation of the Preferred Delivery Option decision
The results of the two Core scenarios are as follows:
|Scenario|| Project IRR
|Investor payback period (years) (nominal)|| Investor net cash flow
|Initial Investment required £000s||Dividends paid by Public Energy Company £000s|
|Scenario 1 – Retention Model Core scenario||61.19%||34.45%||12,086||6||23,350||2,914||22,540|
|Scenario 2 – Acquisition Model Core scenario||141.75%||62.73%||3,251||3||5,680||297||5,597|
It should be noted that the IRR figures for investors include the impact of the return on money lent to the Public Energy Company at a State aid compliant rate (assumed to be 5.09% - refer to Section 6.14 for more details), with the remainder being a reflection of the dividends the Public Energy Company is able to pay which, it is assumed, would be used to address fuel poverty issues in Scotland. The right-hand column in the table above shows the dividends forecast to be paid under each scenario over the ten-year operating period.
Under each of the Retention and the Acquisition Model, the initial investment requirement is set at a level that provides sufficient working capital to meet the set-up costs and working capital requirements of the company, such that there is no requirement to draw down on additional funding or seek alternative funds – e.g. overdraft facilities. As the Retention Model provides lower initial cash flows than the Acquisition Model (as it receives income over time rather than an up-front payment), there is a greater requirement for an initial loan, however the long-term benefits are significantly greater.
While the IRR presents as better under the Acquisition model, it should be noted that the Retention model shows much greater long term cash flows (based as it is on a recurring revenue stream – this is best demonstrated by the comparative NPVs of the two approaches, as well as indicated by the Net Cash Flow position).
In summary, based on the work undertaken in the Financial Case, the preferred financial solution for the Public Energy Company is:
- An energy company providing energy to market through a contractual arrangement with a White Label Supplier.
- 100% public sector owned, with the flexibility to allow public sector partners to have an appropriate level of involvement;
- Public sector funding is assumed to be provided in the form of a 10-year annuity loan facility. 100% of all funding requirements are provided from the public sector;
- The maximum debt required, based on the core assumptions, is incurred in the year to March 2021 – the table above shows the values required under each scenario;
- Public sector sponsors are currently determining their relative share of this investment;
- Surpluses generated will be paid out of the Public Energy Company and used to fund programmes designed to help reduce fuel poverty in Scotland; and
- The proposal has the flexibility to allow for either the Retention or the Acquisition model of generating revenues – or, indeed, a blend of the two – this will be refined through discussions with the market in the commercialisation phase of the Project. The positives and negatives of each are summarised in the Financial Case.
It should be noted that if, as discussed in the Commercial Case, for example, the Public Energy Company is able to set up with a charitable arrangements in place, it may be in a position to improve this position further through reducing/removing the requirement to pay corporation tax. Further input from your legal advisors will be required to determine the most appropriate commercial structure, which will impact upon the financial modelling.
2.6 Management Case
The purpose of the Management Case is to set out the Project Management and governance arrangements as the Project develops from the OBC phase to an established Public Energy Company.
The current stages of the Project are as follows:
|Outline Business Case||This is the current stage which sets out the Business Case for the Project and how it will be delivered.|
|Confirmation/revision of the preferred solution through continued engagement with Local Authorities||Local Authorities will be presented with this OBC as a proposed path forwards for the establishment of the Public Energy Company. This process will be open to input and comment from Local Authorities, with the preferred option and OBC revised as necessary to support Local Authority objectives.|
|Confirmation of Commitment to the development of the Public Energy Company||Following any necessary revisions to the OBC, public bodies will review the information available and decide whether to progress with the Project on this basis.|
|Commercialisation Phase||The initial details regarding commercial agreements start to be negotiated (e.g. level of involvement and nature of commitment of Local Authorities wiling to be involved at the outset of the Public Energy Company). Additional market testing may also be undertaken at this stage if deemed to be required or perceived to add value.|
|Procurement Phase||The commercial agreements are negotiated (e.g. White Label negotiations with third party licensed suppliers) An appropriate White Label Supplier, a third-party energy supplier is selected, and the terms of the agreement concluded.|
|Final Approval||The Final Business Case and Final Decision is made and final sign off is obtained from all relevant parties.|
The Project, up to and including the OBC is being managed by a Scottish Government Project team, on behalf of Scottish Government's interests (maintaining an awareness of the aims and objectives of other public sector stakeholders, primarily through input obtained through engagement with Local Authorities).
As the Project moves into the commercialisation phase, it is likely a dedicated Project Manager will need to be appointed to fully manage the Project and ensure all stakeholders interests are safeguarded to the best of their ability. The Project Manager will have responsibility for Project managing the creation and set-up of the Public Energy Company and the procurement of the partnered energy supply company. Once the procurement approach has been confirmed, it will be necessary to ensure that any procurement processes undertaken are appropriate, including ensuring that the Public Energy Company itself is established at the appropriate time and the procurement is conducted under the appropriate entity.
The estimated timetable at time of writing has been set out in a manner designed to ensure the Public Energy Company can be operational by 31 March 2021. The detailed timetable can be seen in the Management Case.
The Project is expected to be achievable, with a dedicated Project manager and staff input into the Project as well as support from specialist legal, technical and financial advisers, as appointed.
The OBC presents a justification for taking the Project forward to commercialisation stage. The proposed structure of the Public Energy Company is that an active energy supply company will enter into a White Label arrangement with the Public Energy Company for the provision of gas and electricity. The Public Energy Company itself will ultimately need to determine the most appropriate commercial arrangements. However, under the form of a company limited by shares, it is able to generate positive returns that could be used to support reducing fuel poverty in Scotland or be invested into alternative measures to tackle fuel poverty issues.
Based on the work performed, when compared to the Counterfactual position of 'Do Nothing', there is an overall financial benefit for domestic customers switching their gas and electricity supply to the Public Energy Company.
|Description||Real £000s||NPV £000s|
|Net interest generated under the Public Energy Company (Retention Model)||810||624|
|Net dividends generated under the Public Energy Company (Retention Model)||22,540||12,290|
|Net cash generated under a Business as Usual position||-||-|
|Benefit to Scottish Government of the Public Energy Company (Retention Model)||23,350||12,915|
|Description||Real £000s||NPV £000s|
|Net interest generated under the Public Energy Company (Acquisition Model)||83||64|
|Net dividends generated under the Public Energy Company (Acquisition Model)||5,597||3,272|
|Net cash generated under a Business as Usual position||-||-|
|Benefit to Scottish Government of the Public Energy Company (Acquisition Model)||5,680||3,336|
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