EDF MD: Liquidity is the looming challenge for the energy sector

Three years after arriving in the UK from France, EDF managing director of customers, Philippe Commaret, speaks to Utility Week about some of his key concerns amid the current energy crisis and highlights a disparity between public perceptions and reality when it comes to the profitability of the sector.

It’s fair to say Philippe Commaret has not had a smooth ride since taking on the role of managing director of customers at EDF Energy.

Commaret started his UK role in December 2019, a decade after first joining EDF as marketing director in its home territory of France.

Mere months after his arrival, the world was in the midst of a once in a century pandemic which forced the retailer to completely re-evaluate its approach to supporting customers. Just as the industry was emerging from this upheaval, the impacts of rising wholesale gas prices plunged the fragile UK energy retail sector into meltdown. Since then Russia’s invasion of Ukraine has added even more volatility to a situation in which energy retailers are in the spotlight of a cost of living crisis.

Three years on from his appointment, Commaret reflects on the lessons he has had to rapidly learn about the UK energy retail market and the challenges he perceives going forward.

Key amongst these is liquidity, specifically the amount of energy available on the wholesale market for energy retailers to buy from generators. Wholesale liquidity, he adds, has been halved over the past year and as such is “absolutely a critical topic to be addressed”.

He points to a number of reasons as to why there is a lack of liquidity on the forward markets. These include the Contracts for Difference (CfD) scheme disincentivising generators to sell forward their energy.

Generators also face a risk of being unable to provide the power they have committed to if, for example, a plant stops generating. This means they then have to buy back this power from the market to fulfil the trade, often at high prices.

Another reason is the fact that sellers are required to put up more credit/ collateral to back trades, which have increased in value. Furthermore, higher prices mean generators need to hedge a lower volume in order to cover their costs.

All this, says Commaret, has consequences for supplying consumers with energy and “creates an imbalance” between supply and demand.

“This liquidity issue has a consequence on the prices for customers, it has a consequence on the ability for customers to contract at any time, because there are some times where there is not enough liquidity for them to contract with us and we are not able to make offers at that point in time.

“Also, a liquidity shortage creates higher volatility. Higher volatility means if ever a supplier were not to hedge because they have contracted with a customer and they don’t buy the energy on the wholesale market, they are exposed to a loss. That could incur further disruptions and bankruptcies in the market.”

Acting on liquidity, Commaret says, will reduce costs not only for suppliers and customers, but also the costs being incurred by the government for its Energy Price Guarantee to cap energy unit rates

The government has also launched a £40 billion Energy Markets Financing Scheme which is intended to provide financial liquidity to energy companies facing large margin calls on their hedging activity as a result of volatility in wholesale markets.

Yet the high interest rates facing companies accessing the scheme are, according to Commaret, “aggravating” the issue of wholesale liquidity.

He continues: “It disincentives the generators to access this scheme… This scheme has been designed in a way which is not incentivising the generators to hedge forward.

“It has been designed rather to provide a solution if ever someone were eligible for this and had the appetite to pay a very high rate. And you can see that nobody has applied for this scheme. To my knowledge not a single generator has applied for the scheme.”

One way of mitigating this, he says, is to encourage take up by lowering the interest rate on the loan, making it more affordable to generators with less capital.

He adds: “I think that the government has to find the right balance in all the features of this scheme. They have to tweak the conditions to have access to the scheme, to open the door and create more appetite for the generators.

“But there is also something that should be included within the scheme, which is that it should come with a duty for generators to hedge forward. We have to find a way to create the appetite for access to something which is interesting from a financial point of view and will have a real impact on the wholesale market.”

He further raises concerns about the price cap’s methodology, which he says adds to the burden on retailers.

He continues: “The reasons suppliers are failing are because the cost at which they are buying energy is much bigger than the cost which is recognised in the price cap. That’s the reality. The price cap is based on a formula which assumes a cost for the energy, but because of the lack of liquidity on the wholesale market it isn’t easy for suppliers to have the ability to match the price assumed in the formula.

“At the moment I think there is still a lot of risk in this market and the cap on prices has aggravated the risk for suppliers to go bust. That is what should be looked at carefully; how to avoid those insolvencies. That’s really something that we need to sort out.”

A lack of liquidity is not the only thing that is currently threatening the stability of the energy market.

In recent weeks Ofgem has confirmed that, for the fifth consecutive year, the mutualisation of missed Renewables Obligation (RO) payments has been triggered after a number of suppliers failed to pay by the 31 October late deadline.

As of 1 September, 36 retailers, most of which are no longer active in the market or are insolvent, left a £163 million shortfall in the RO buyout funds.

“We know that the way the RO is set up is creating this type of risk because there is a huge lag between the moment where the obligation is incurred and is stacking up and the moment where the suppliers have to pay for the obligation,” says Commaret.

He says these issues have resulted in the inability of retailers to generate a profit in the market, despite the widespread public belief they are.

“For me, that’s really the key point – how to create a market where there is a profit for the suppliers.

“That is completely counterintuitive to the public opinion because the public sees the massive profits of the oil and gas companies. But the reality is that the suppliers in the UK market haven’t made any profit in the last few years.

“So that’s really what has to be sorted if we want to avoid finding ourselves in a situation where industry costs like the Renewables Obligation are mutualised.”

Ensuring those most in need are protected from the worst of the price shocks is clearly a key priority for Commaret and EDF. But the market needs stability in order to give customers the service they need and this will not be achieved without urgently addressing the issues of low wholesale liquidity.

As Commaret observes, it is “absolutely a critical topic to be addressed”.