Energy retail: a way forward?

Ellen Fraser, energy retail partner at Baringa Partners, sets out her main observations about the ongoing crisis in the sector and discusses some of the changes that are needed to make sure it doesn’t happen again.

As so many articles are flagging, the energy retail market feels incredibly fractious right now with real frustrations on all sides and the need (but not necessarily the ability) to move at pace to navigate through these challenging times.

And all the while, customers are struggling to unpick their journeys through the supplier of last resort (SoLR) process and are finding it hard to know who to trust as price comparison websites withdraw and previous guidance to switch proves difficult with a lack of options available.

Stepping back from the frustration and the noise, there are four key themes that I find really striking:

• All of the efforts to open up the market over the last few years have been rapidly and dramatically unwound. The vast majority of new entrants have already folded or will soon collapse. With them will go lots of creative thinking, new platforms and capabilities and some very bruised investors who will be slow to return, if indeed they ever do. Scottish Power recently signalled their belief that there may be as few as five to six suppliers left by the end of winter, even more harsh than the Baringa prediction of “as few as 10”. These aren’t the same five to six companies as before, but nonetheless we seem to be moving back to a market dominated by a ‘Big Six’ which can’t be great for competition or customers.
• Industry estimates suggest over £5 billion of cost – which covers hedges, credit balances and the admin costs of managing the SoLR process – is being forced upon energy suppliers as the cost of failures are mutualised. This is an incredible amount for an industry that made a collective loss last year. Ofgem states that “customers are protected if their supplier fails”. In practice the most vulnerable customers will suffer the most. Why? Very simply, customers pay. You pay. Your Gran pays. The poorest in the country pay. Effectively customers indemnify the industry against failure. Clawing this cost back through your energy bill is a regressive mechanism as it’s not based on any level of means testing and it disproportionately penalises those who can least afford it. These extreme market conditions weren’t foreseen when the mutualisation mechanism was designed. Mechanisms to rebalance and smooth this are urgently needed.
• I’m not going to criticise the price cap as I believe some level of price regulation could have a valuable place in the market. However, it is striking that suppliers used to hedge up to three years out to help smooth out wholesale price fluctuations while now the good ones hedge to the cap, closer to six to 12 months out. Others don’t hedge at all, effectively gambling with customer credit balances on the wholesale markets as part of their ‘sell long, buy short’ strategy. This risk has to be designed out, both to prevent disproportionate risk taking with customer cash and to create more stability by encouraging longer term hedging.
• The role that energy suppliers need to play in driving the economy to net zero has suffered a monumental setback. For every day we watch suppliers fight for survival, we also watch our climate ambitions slip. Suppliers simply can’t innovate, secure net zero investment or forge long-term partnerships with customers to reduce the carbon footprint of their homes and businesses while they invest all their waking hours in surviving. This is a huge threat to our climate ambitions and the future generations who depend on us for immediate action, and places us in an awkward position as hosts of COP26 which is just around the corner.

These are painful observations, but it’s even more painful to accept that we simply we don’t have the solid foundations we need to make progress against our net-zero ambitions with confidence and at pace.

As I’ve highlighted before, a functioning market needs to allow space for suppliers to make a fair margin and controls to ensure only those who are fit and resourced to operate in the market are allowed to operate. Meanwhile market participants need space to innovate without fear that their costs and returns will be regulated away and the ability to create longer-term partnerships with customers to smooth the payback period of home investments. Plus, vulnerable customers can’t be asked to pay disproportionately for failures that are no fault of their own.

So let’s move on from the fractious conversations with all their frustrations and let’s focus hard on getting through this crisis with minimum damage to our treasured liberalised market, protecting the most vulnerable and focusing on delivering net zero.

And please – let’s make sure this can’t happen again.