Small suppliers ‘may not understand the risks they are taking’

Some smaller energy suppliers may not fully understand “the nature of the commercial risks they are taking”, analysis by Cornwall has warned.

The retail market is no longer divided between the big six and others but between “good suppliers and less good suppliers” with differing approaches to doing business.

“Nearly a decade since the last wholesale price spike, it may be some of them do not understand the nature of the commercial risks they are taking as well as they might,” said analysts at the market research firm. “Whatever one’s reading, it is clear that in the market there are good suppliers and less good suppliers, with different commercial models, and it is no longer just a case of large legacy suppliers versus the rest.”

Nevertheless, they said “well-resourced players with strong balance sheets” will still enjoy an advantage when wholesale energy prices are trending upwards.  

Cornwall published the analysis after GB Energy Supply ceased trading over the weekend, blaming its inability to hedge against rising wholesale prices. Co-operative Energy has since agreed to take on its customers.

With its “low cost outsourced business model”, GB Energy was the “forerunner of the second wave of new entry into the domestic energy markets”.

“Unlike the large suppliers, as a new entrant it did not have legacy customers to cede margin to, so could price its offering sharply enough to attract customers through the main price comparison websites,” said Cornwall. “It also retained the flexibility to reprice these contracts on 30 days’ notice if market conditions changed.”

The firm appears to have been caught out by rising and increasingly volatile power prices – partly the result of changes to the way suppliers are charged for not balancing their supply and demand – along with a flawed hedging strategy. Recent tariff increases – one of them of 30 per cent – were “too little, too late”.

The company’s collapse represents “the most significant commercial challenge to the retail energy market since the exit of TXU Energi in 2002” and will “naturally turn attention to similar suppliers with low prices and ‘pay as you play’ business models”.

Cornwall said GB Energy’s failure to properly hedge against rising prices was in part due to problems with the secure and promote (S&P) regime introduced by Ofgem in 2014, which forced larger suppliers to help smaller suppliers to access hedging, as well as “significant credit barriers”. Both, it said, “require urgent review”.

“Structurally we should ask whether the S&P is working as it was designed to. Ofgem needs to ask if small suppliers can access short-term hedging products (a structural problem) or can they not afford to pay the prices that these products are quoted at (a commercial problem)?”

Analysts also urged caution over further changes to the way suppliers are charged by National Grid for being in imbalance. They said reforms to the charging code due to be introduced in November 2018 will “further sharpen the imbalance process” and add to the volatility of prices.