Don’t regulate away suppliers’ ability to compete

An unprecedented number of supplier failures has further highlighted concerns over poor hedging strategies and risky business practices. There is now a general consensus that rule changes are sorely needed. Yet there are fears the industry “might as well be nationalised” if mandated hedging becomes a requirement. From naming and shaming suppliers to introducing a risk index, Utility Week asks, what next for energy hedging?

“With 27 retailers having exited the market so far this year, most recognise there is probably a need for a greater degree of oversight to make sure participants are well prepared for external shocks. I think there is a general consensus that Ofgem needs to be doing more in that space,” Dan Alchin, Energy UK’s deputy director of retail, tells Utility Week.

These “external shocks” Alchin refers to are the soaring wholesale costs seen over recent months, the impact of which has been further compounded by the failure by some to properly hedge the energy they supply.

A damning report by the administrators of one failed retailer, Avro Energy, revealed the supplier of 580,000 customers had “no external funding or security over its assets” and relied solely on working capital. It further confirmed that Avro’s “lack of any hedging instrument in respect of its energy purchases” left it at the mercy of soaring wholesale prices.

Bulb, which recently became the first energy supplier to enter the special administration regime, is another retailer that has been known to hedge short. Company founder and chief executive, Hayden Wood, previously revealed Bulb purchased energy just three months in advance.

For its part Ofgem has published an ‘action plan’ in which it outlines proposals to increase the financial resilience of suppliers. This includes ensuring robust minimum standards, meaning suppliers need to be adequately hedged or hold sufficient capital to manage a wide range of market scenarios.

“Within this, suppliers are responsible for their own commercial strategy but must have a robust management control framework in place to support it and manage their risks,” the regulator added.

While it is argued there is a case for some regulatory intervention, several industry experts tell Utility Week about their concerns the impact mandating hedging positions will have on supplier competitiveness.

As Alchin observes: “It’s also important we remember that hedging is one of those areas where you can compete as a supplier, through different strategies, and so long as a supplier is in a position to support that strategy, you wouldn’t want to regulate out that ability to compete.”

He is not alone in sharing these concerns.

Tom Eckerlsey is former head of hedge modelling and operations at Npower and also served as head of hedging at the recently failed disruptor brand People’s Energy. He believes that sharing more information with the regulator, perhaps through frequent requests for information (RFIs), could be a way of creating a market more resilient to shocks.

There is precedent for such a move and Eckersley cites the fact the Competition and Markets Authority (CMA) asked suppliers for a “whole host of data” in relation to hedging strategies prior to the introduction of the price cap.

Similarly, Ofgem has in the past intermittently issued RFIs on hedging and in its newly-published action plan it reveals it will, where necessary, expand the scope of reporting from suppliers, which will likely include information on their approaches to hedging.

“It would highlight those suppliers that are doing something that is materially different and therefore are going to be incurring a commodity cost that is materially different from what the cap implies…If nothing else, it’s going to point to suppliers that are at risk by virtue of the way they are buying commodity,” he explains.

However, like Alchin, he also believes that suppliers alone should be responsible for the amount they hedge. Eckersley believes there is a question over what the role of Ofgem is in the future and whether it should have the ability to exert pressure on those suppliers which are not hedging according to the cap.

“That to me seems like a bit of an overstep. Ultimately these are commercial companies and it is a commercial decision. Whilst it’s an incredibly sensible one in my mind, to match the cap, it is ultimately up to the supplier,” he says.

He adds: “If anything, publishing that information is like an early warning system. It’s an indicator. But what can the regulator then do with that – mandate them to behave differently? I don’t think so because then they might as well be nationalised.”

Despite these worries over competition, there are some who warn that limited regulatory controls over hedging mean people are more willing to take risks in the sector, leaving the rest of the market to pick up the pieces.

Andrew Mack, chief executive of Octopus Energy Germany, has recently written his thoughts on hedging in a blog and believes there should be rule changes to make running a risky business more difficult.

Sharing his views on his former patch, Mack, who previously served as head of strategy at Ovo Energy, says: “You could argue that suppliers should have to prove an appropriate level of hedging.

“I have seen this before in Germany, where suppliers deliberately don’t hedge and just place bets on energy prices falling. If prices do fall, unhedged suppliers win but if they rise and the business goes bust it will get picked up by the supplier of last resort in the UK.”

The Supplier of Last Resort (SoLR) process, he says, may encourage “bad behaviour” in the market by those running the businesses.

Mack adds: “They have lost a business, but they are not really responsible for what they have done. I don’t think the answer is to make the SoLR process harder, but it should be harder to intentionally run a risky business and/or to take advantage of large changes in commodity costs at the customers’ – or taxpayers’ – expense.”

He suggests that a way around this could be to highlight suppliers who are largely unhedged – a way to warn customers tempted by low offers from retailers.

“That might be a good place to start, just to see if simply making it public knowledge was enough to discourage that kind of behaviour.

“If you are a customer and signing up for a one, or two, year fixed price deal and somebody in the press was saying you shouldn’t sign up with that company because they have taken a bet on prices falling and that if prices rise, they will go bust, that might be enough disincentive for customers to sign up.”

However, Adam Bell, head of policy at management consultancy Stonehaven, believes such a move would have major consequences for the market, while not having much effect on consumers.

He explains: “It does change an awful lot of the commercial thinking in this space because it would of course enable all the suppliers to see what their competitors were doing on hedging and it would probably change the structure of the market quite fundamentally.

“If everyone knows what risk everyone is insuring against, the cost of insuring against those risks goes up because there’ll likely be more demand for similar hedging products. I think it would push up some costs but I don’t think it will have a significant impact on consumers.”

He instead suggests Ofgem could create a risk index in order to give the regulator a better idea of the levels of risk suppliers expose themselves to, giving it a better picture of supplier resilience.

Bell says: “You could look at their hedging positions, what contracts they have taken out and the extent to which they are insulated against price rises and over what period.

“Once they have done that and they have got a sense as to how secure a particular company is, Ofgem can say ‘company x is not resilient enough’ and that it wants the company to have a particular score on a resilience index. In aggregate across the market, this will enable Ofgem to say in the event of another price crisis, they expect X number of companies to go under.

“The downside of course is it makes it much harder for smaller companies to get into the market as they need more capital than they otherwise would have done.”