Energy crisis will take retail market to ‘a better place’

The recent turmoil caused by the global spike in gas prices will ultimately be “hugely beneficial” for the energy retail market, an industry analyst has claimed.

Martin Young, senior analyst at Investec, said the crisis, which has contributed to the failure of more than 20 suppliers so far this year, should “hopefully mark the end of this insane desire for switching for switching’s sake.”

“If you went back in time, there was a narrative from Ofgem where they said by switching supplier you could save two hundred pounds or more,” Young told Utility Week.

If you stripped out the profit margin and headroom from Ofgem’s stack of costs for calculating the price cap, and even imagined an “extreme situation” in which suppliers had no operational costs, Young said “you would still not get to a level where you could save two or three hundred pounds versus the cap.”

The regulator was therefore “providing oxygen to companies that were loss-making and, as has been all too clearly proved, unsustainable in their business models.”

“Hopefully this massive wake-up call leads government to realise it’s wrong with this idea of opt-in/opt-out switching – so let’s get rid of that as well – and let’s get onto the real thing that we need to do here, which is we need suppliers who do more than offer you electrons and molecules.”

He continued: “We have to move to energy as a service and I believe shaking the tree, getting rid of the dead wood, the poorly-run companies, the financially unsustainable companies, ultimately gets us to a better place.

“How many people do you need for competition? I’m not going to sit here and suggest that we’re going to be down to three or four people but if you are down around the 20 mark, surely that is still enough to have competition in the energy market.”

Young welcomed Ofgem’s recent announcement of a series of actions it is taking in response to the crisis, including expediting Last Resort Supply Payment claims by suppliers of last resort: “In the past we were generally dealing with small numbers that, by and large, related to the parts of the consumers’ credit balances that the supplier of last resort wasn’t willing to bear on their own accounts”.

“But those were relatively small numbers and clearly the supplier of last resort would have been able provide to liquidity to fund those, so timing wasn’t necessarily an issue in the past.”

He said this isn’t the case now suppliers are claiming for wholesale energy costs that they are unable to recover because of the price cap: “As we all know, the commodity costs are higher than the commodity costs allowed for at the current level of tariff cap and a supplier of last resort is having to provide liquidity for that particular cost. Speeding that up so they get their money sooner rather than later is 100% sensible.”

Young similarly welcomed Ofgem’s plans to hold a review of the methodology for setting the price cap: “That’s a question of the mechanics of the cap, the nimbleness, the frequency of the updates and so on, so presumably you should be able to do something that addresses these seismic changes we see in the component parts of the stack that go to form the tariff cap.

“You would question why it wasn’t stress tested to that extent at the outset, but maybe nobody anywhere foresaw prices of this ilk for a sustained period of time.”

He said there will be challenges in transitioning from one methodology to another “because if you think back to the beginning of the tariff cap where British Gas was joined by others in a judicial review against Ofgem changing its mind at the eleventh hour, it shows you the pitfalls of making a change when large parts of the industry will have gone down a particular route in terms of commodity and price hedging.

“How do you flag change sufficiently far in advance that you avoid that problem, but isn’t so far in advance that it doesn’t address the problem that you’re facing in the here and now?”

Despite its imperfections, Young said he believes the price cap has been good for the industry, pushing legacy suppliers like British Gas, Eon and EDF – the last of which recently announced plans to adopt Octopus Energy’s Kraken platform – to drive down their operating costs and become more efficient: “If the tariff cap has forced changed in that respect, then the cap has done something that is clearly beneficial.”

On Ofgem’s plans to apply greater scrutiny to suppliers and their finances, Young said “the fox was already in the hen house. It’s like shutting the stable door after the horse has bolted, and so on. It’s the right thing to be doing but clearly it’s too late and we shouldn’t have been in this situation in the first place.”