Publication - Independent report

Public energy company: strategic outline case

Published: 16 Apr 2019
Directorate:
Energy and Climate Change Directorate
Part of:
Economy, Energy
ISBN:
9781787817357

Independent strategic outline case to consider how Scotland's public energy company could be developed suggests that a phased approach would work better.

Public energy company: strategic outline case
3. Socio-economic Case

3. Socio-economic Case

3.1 Introduction

A key focus of the SOC is to objectively explore potential delivery structures for the Energy Co. This section reviews the proposed long list of options and provides initial considerations for appraisal to arrive at a short list. We also summarise the likely Office of National Statistics (ONS) classification considerations for the Energy Co.

3.2 Long list of options

A long list of options has been compiled from a desktop review to identify existing delivery structures. This has been supplemented with input from SG's project team. The long list captures the range of options available to SG a national Energy Co. The list also includes structures that would facilitate regional influence at a LA level.

The appraisal shortlisting process involves undertaking a qualitative review of the long list of options before identifying and excluding delivery structures that do not adequately meet the objectives of the project. The following table describes the delivery structure options, including initial commentary on governance and budgetary matters.

Table 5 - Long list of delivery structure options

Delivery Option

Description

1

Do nothing

SG does not pursue the creation of the Energy Co. This option forms the counterfactual for the SOC.

2

New internal unit

The Energy Co. would be an internal unit within the Energy and Climate Change Directorate of SG. The unit would be responsible for delivering the agreed aims and objectives. SG will retain direct control and it will be delivered by a dedicated team within the Directorate and no formal separation would exist. The funding of this model would fall within the existing SG budgetary arrangements.

3

Existing socially minded supplier

The Energy Co. would utilise an existing socially minded supplier as the future delivery structure. Existing ownership and governance arrangements may need to be reviewed to ensure appropriate SG control.

4

Existing Public Corporation, for example, Scottish Water

The Energy Co. would utilise an existing Public Corporation, for example Scottish Water. As a subsidiary within Scottish Water, the Energy Co. would likely be a government controlled market body, providing a service for sale of energy to the general public.

As a part of Scottish Water, the Energy Co. could draw from the (non-domestic) customer facing capabilities of the existing Business Stream subsidiary. Therefore, and in order to draw on that capability directly, it may make sense to consider establishing the Energy Co. as a subsidiary of Business Stream. Careful consideration would need to be given to how SG would retain direct control of such a subsidiary, given the complex current Scottish Water corporate structure (Business Stream is not a direct subsidiary of Scottish Water) as well as the regulatory separation of Business Stream and its (ultimate) parent Scottish Water.

5

Executive Agency

SG will create a new distinctive Executive Agency responsible for carrying out the objectives of the Energy Co. Executive agencies can be used to carry out discrete areas of work on behalf of government under the responsibility of a specific Department. Examples include Transport Scotland.

An appropriate governance framework would need to be developed in order to give SG (and the Energy Directorate) appropriate policy control, with delegated authority given to management to deliver on the Energy Co.'s operational objectives. It will be funded by SG and would fall under SG budgetary arrangements and classed as General Government.

6

Non-departmental public body (NDPB)

Creation of a new NDPB. This would be an arm's length Government Body, outside the direct control of Ministers. Examples include Scottish Enterprise and Highlands and Islands Enterprise. Once incorporated, NDPBs are typically somewhat self-determining (subject to delivering a specific Statute). NDPBs receive funding from SG (to meet statutory obligations), but are able to supplement their income from other sources. NDPBs may also have borrowing powers.

7

Charity

A separate charitable organisation could be established, including a charitable incorporated organisation or company charity. The organisation would be regulated by the Office of the Scottish Charity Regulator (OSCR). A charity would be able to be funded through charitable donations and/or grants.

8

Community Interest Company (CIC)

The Energy Co. would be established as a CIC. As a CIC, the Energy Co. would use its profits and assets for the public good, for the benefit of a community. A CIC may be established as a company limited by guarantee or limited by shares subject to the Companies Act. The CIC would have governance through a board of directors.

9

Local Authority Energy Service Company (ESCo)

The ESCo would be an arm's length incorporated company (from SG). It would be jointly owned by one or more LA and SG would have no direct control over the ESCo. Funding can be provided by the LAs (or raised externally).

10

Local Authority Joint Board

The Energy Co. would consider an un-incorporated delivery structure run through a Joint Board between several LAs. Governance models for Joint Boards are flexible and largely at the discretion of the relevant LAs. The Joint Board of representatives would oversee the delivery of the joint undertaking. Funding would be provided by the respective LAs.

11

Government owned company

Creation of a new limited company (by shares or guarantee). It would be 100% owned by SG, governed by the Companies Act and would include an appointed Board of Directors. An example of a relevant entity would be Skills Development Scotland.

SG would appoint the Chairman and Board of Directors to ensure its policy objectives and interests would be reflected in the Company Strategy and Business Plans. The Board would oversee an Executive Management Team.

12

Federal model

Creation of a SG incorporated "Topco" company with the potential for joint venture subsidiaries operated by individual LAs. The subsidiaries may White Label the supply of electricity and gas from the Energy Co. and bring a locally branded supply to the market. There is an opportunity for the products to be consistent across the LAs. Individual LAs will decided whether they participate in the vehicle.

The top company would be controlled by SG (through Board representation as per a Government Company). Governance arrangements would need to be agreed for the regional subsidiaries, including delegated remit. Funding would be through SG (as shareholder) with the potential for third party funding (including through trading profits).

Source: EY and SG

3.3 Assessment criteria

The suitability of each delivery structure was reviewed using an appropriate set of appraisal criteria. These are based on the objectives of the Energy Co. and can be summarised as follows:

  • Provide low cost energy and help alleviate fuel poverty
  • Locally sourced renewable energy - energy will be sourced, in the medium to long term, in Scotland and will be from renewable sources
  • Ownership and model – the Energy Co. will be publicly owned and will be run on a not-for-profit basis (either explicitly or de facto based on a commitment to re-invest any surplus/profits).

Based on these objectives, the following criteria has been developed. The list does not include a criterion that assesses the set up costs of each option. The initial legal and regulatory set up costs for each of the options is not considered prohibitive. The wider financial cost of establishing the Energy Co. has been examined in the Financial Case. These criteria have been discussed and agreed by SG.

Table 6 - Delivery Options Appraisal Criteria

Appraisal criteria Description
a. Oversight and control (Policy objectives) The model must ensure that SG's policy objectives are delivered and SG are able to influence the strategic direction of the Energy Co.
b. Quality and fairness of service Given the profile of the initiative and potential for scrutiny and public interest reporting, the Energy Co. must provide services that adhere to principles of quality and fairness.
c. Flexibility (e.g. changes in remit over time) In the event the remit of the delivery structure changes over time, it would need to be able to absorb such changes.
d. Operational / cost efficiency (Ability to self-finance) The objective of providing low cost energy will necessitate efficient and low cost delivery and operating models.
e. Time to set up The time required to establish the Energy Co. vehicle should not be prohibitive and should be completed by 2021.
f. Not-for-profit (explicit or de facto by commitment to re-invest) This principle will need to be accommodated by the model, whether explicitly or de facto (e.g. through a commitment to re-invest any profits).
g. Governance: Clear and transparent Similar to quality of service, the high profile and potential for challenge should drive a transparent and relatively simple delivery structure.

Source: EY and SG

3.4 Shortlisting process

Each of the long list options have been evaluated against the criteria to establish a short list of appropriate options to take forward to OBC. The following scoring mechanism has been used.

Table 7 - Shortlisting process

Indicator Description
green circle The delivery structure satisfies the appropriate appraisal criteria.
yellow circle The delivery structure partially satisfies the appropriate appraisal criteria.
red circle The delivery structure does not satisfy the appropriate appraisal criteria.

Source: EY

An evaluation exercise has been undertaken to review each option against the appraisal criteria. This has resulted in a recommendation whether to progress the option to the shortlist. If an option was shown not to satisfy the appropriate appraisal criteria, then it has been excluded from the short list.

3.5 Short list of options

Based on the analysis described, we recommend that the following four options are explored further:

1. Do nothing

2. Existing socially minded supplier

3. Government owned company

4. Federal model.

3.6 Alternative appraisal processes

The appraisal process described above has been developed on the assumption that the Energy Co. is established to address a specific set of objectives, namely to deliver competitively priced energy which will help to alleviate fuel poverty. As a result, the appraisal criteria and shortlisting process has been carried out with this fundamental principle at its core.

It is important to note, however, if this underlying principle were to evolve, the appraisal methodology can be updated. For example, SG may seek to refine proposals for the Energy Co. to adopt a more holistic set of objectives. Alternative objectives may include:

1. The Energy Co. focussing on the dual impact of tackling fuel poverty and driving economic development

2. The Energy Co. being implemented by a wider group of public sector stakeholders, including LAs.

3.6.1 A focus on economic development

SG may seek to expand the objectives of the Energy Co. to focus on the dual impact of tackling fuel poverty while also driving economic development. In the Strategic Case, we identified ways in which the Energy Co. could support economic development and economic growth. We noted that, as a market innovation, the Energy Co. has the potential to support a number of Scotland's Economic Strategy pillars, namely: Investment, Innovation and Inclusive Growth.

If this approach was adopted, the evaluation criteria could be expanded to include criteria that could appraise the long list of options.

If SG were to refine the appraisal methodology in this way, the shortlist of options may need to be re-examined. Nevertheless, based on an initial assessment, each of the identified options are capable of driving economic growth.

3.6.2 Non SG implementation, control and funding

There are a number of ways in which the objective of the Energy Co. may evolve, including the focus on economic development described above. It is important to note, however, that given the complex legislative environment, SG may seek alternative delivery models that involve other stakeholders. It may be appropriate for SG to seek alternative means of funding and controlling the Energy Co. This may be achieved by pursuing more localised implementation objectives at a LA level.

As before, a new appraisal methodology would need to be developed that focussed on this new objective. The long list of options already identifies a number of vehicles that could be appraised in this way. As before, if this new methodology were adopted, the shortlisting process should be updated to assess the most appropriate models to take forward. It is likely, however, that the NDPB, Local Authority ESCo, Local Authority Joint Board and Federal model would be most appropriate for these objectives.

We recommend that, prior to the development of the OBC, SG agree on the fundamental principles that underpin the development of the Energy Co.

3.7 Classification considerations

On establishment of Energy Co., its sector classification will be determined by the ONS. Appendix D summarises the principles and factors that we expect the ONS to consider in reaching that sector classification.

Our analysis suggests that the ONS is most likely to classify the Energy Co. as a public sector body, although it could reach a different conclusion. This is because shortlisted options require SG to own or control the entity (see table 2). In addition, if ONS determines that the Energy Co. passes the Market Test (revenue from sale of services meets 50% or more of total operating and finance costs including depreciation), it would classify Energy Co. as a Public Corporation, rather than to General Government, with the benefit of greater year end budget flexibility. In this case the Energy Co. will be able to retain surpluses, rather than SG having to absorb changes in its operating position.

If the Energy Co. passes the Market Test, the intention to set it up as a not-for-profit entity may result in a General Government classification, depending on to what extent SG would underwrite the Energy Co. financially. However, State Aid restrictions make any such SG underwriting (explicitly or implicitly) unlikely, thus increasing the likelihood of a Public Corporation classification.

Detailed analysis of classification and budgetary impact can be found in Appendix D.

3.8 Cost benefit analysis

As well as qualitatively assessing the options, a quantitative assessment of the costs and benefits of the options can be undertaken. This is a decision support technique recommended by HM Treasury guidance.

We recommend that a formal cost benefit analysis is undertaken during the development of the OBC. This will involve refining a cost base for each strategic intervention and weighing this up against the monetary benefits that the Energy Co. could achieve. For more information on the indicative set up and operating costs of the options, please see the Financial Case.

3.9 Conclusion

The appraisal process has refined the long list of option and has identified four options that should be explored further:

Table 8 - short list of delivery vehicles

Delivery Option Description
1 Do nothing SG does not pursue the creation of the Energy Co. This option forms the counterfactual for the SOC.
2 Existing socially minded supplier The Energy Co. would utilise an existing socially minded supplier as the future delivery structure. Existing ownership and governance arrangements may need to be reviewed to ensure appropriate SG control.
3 Government owned company Creation of a new limited company (by shares or guarantee). It would be 100% owned by SG, governed by the Companies Act and would include an appointed Board of Directors. An example of a relevant entity would be Skills Development Scotland. SG would appoint the Chairman and Board of Directors to ensure its policy objectives and interests would be reflected in the Company Strategy and Business Plans. The Board would oversee an Executive Management Team.
4 Federal model Creation of a SG incorporated "Topco" company with joint venture subsidiaries operated by individual LAs. The subsidiaries will White Label the supply of electricity and gas from the Energy Co. and bring a locally branded supply to the market. The products will be consistent across the LAs. Individual LAs will decided whether they participate in the vehicle. The top company would be controlled by SG (through Board representation as per a Government Company). Governance arrangements would need to be agreed for the regional subsidiaries, including delegated remit. Funding would be through SG (as shareholder) with the potential for third party funding (including through trading profits).

Source: EY

The short list of options should be formally evaluated during the preparation of an OBC. This will allow SG to select a preferred delivery structure for the Energy Co.

Importantly, the appraisal process has been developed on the assumption that the Energy Co. is established to address a specific set of objectives, namely to deliver competitively priced energy which will help to alleviate fuel poverty. As a result, the appraisal criteria and shortlisting process has been carried out with this fundamental principle at its core.

If this underlying principle were to evolve, the appraisal methodology should be updated. As an illustration, SG may seek to refine proposals for the Energy Co. to adopt a more holistic set of objectives. For example, to drive economic development.


Contact

Email: Alan.Clark@gov.scot