Will soaring wholesale costs take us back to a ‘big six’?

After a bruising week for the energy retail market, in which wholesale power prices hit dramatic new heights, more than 500,000 customers saw their supplier exit the market and a major price comparison website was forced to suspend its energy services, the real fear is that we have yet to see the worst. Adam John looks at where the energy retail sector goes from here.

It was a stark illustration of how turbulent the energy retail sector has become. This morning (17 September) visitors to Compare the Market looking to switch their energy supplier were informed these services had been halted because retailers were limiting the tariffs on offer.

Across other price comparison sites (PCWs) the pickings were slim, as suppliers rushed to protect themselves against an increasing hostile environment of soaring wholesale power prices – which are now eight times higher than the average for 2019.

There is a real sense that after a lull of market exits in 2020, we could be witnessing a new wave of failures. The most pessimistic predictions suggest that from a peak of more than 70 suppliers in 2017/18, the market could shrink back to a handful of large players once again.

In 2019 a record nine suppliers exited the market, a number which looks set to be easily surpassed in 2021, with seven suppliers having exited already. Four of those unfortunate retailers exited within a week of each other and the latest at the time of writing, People’s Energy and Utility Point, left well over half a million customers to be acquired by a supplier of last resort (SoLR).

At a time when wholesale prices are rocketing, further mutualisation of renewables obligation payments seems likely and suppliers are bound by a price cap, who would want to take on almost 600,000 more customers? Could we even see Ofgem forcing a supplier to become a SoLR?

For some, the only suitable contenders for such a significant number of accounts are the large players who have deep pockets and those that are vertically integrated.

SoLR is not an easy process as suppliers have to incorporate complex systems into their own, made even more difficult if a company exits the market in a disorderly fashion. Furthermore, many customers will be coming across on loss-making tariffs, compounding an already volatile situation with the rising wholesale prices.

Rik Smith is a former energy expert at Uswitch who now works for a property lettings platform. Smith believes the latest two SoLR opportunities could be a chance for legacy suppliers to regain some lost ground.

Speaking in a personal capacity, he says: “The larger, vertically integrated suppliers are best for taking on such a large number of customers just because they’ve got deep pockets. They are going to be the ones who can fund it because they are not going to get money back from Ofgem for some months, they have to have billions of pounds available to front the wholesale costs or at least a good slice of it.

“They will probably enter into it with the expectations that they will lose around half of them within months, which is difficult to judge. They will also probably be the ones that have done this before and have got a good relationship with Ofgem.

“They could rebuild a big wedge of customers. Given the PCWs have slowed down enormously, their churn will have reduced as well. They will be seeing it as an opportunity to regain market share and win back customers they have lost. It’s a pretty tough sell though, these people are price hunters, they have come from PCWs and autoswitchers.”

The fact many of these customers who now find themselves without a supplier are also autoswitch customers only exacerbates matters for the new SoLR. Both People’s Energy and Utility Point are known to have had worked closely with autoswitching service Look After My Bills, and one industry insider says as many as 50 per cent of the customers now facing the SoLR process were acquired by autoswitching.

Companies who are signed up with autoswitching services will see a significant number of customers on their cheapest tariffs and not many on their more premium offers. These suppliers then have to price low in order to keep customers or see them disappear.

Additionally, this makes rescuing these customers when a supplier goes under an unattractive proposition as they will be price driven and will quickly move on to cheaper deals.

Vertical integration – the only way?

Vertical integration has not always had a good press over the past decade, with concerns raised that it hampered competition in the market. While some companies such as Eon began decoupling its generation business, others such as SSE (with its business arm) continue to see vertical integration as a viable model.

Jeff Hardy, a senior research fellow at the Grantham Institute for Climate Change and the Environment at Imperial College London, believes vertical integration to be an asset, especially considering the steep rise in prices.

Says Hardy: “Big, vertically integrated companies probably have got some risk mitigation because they will have bought a lot of their fuel in advance, and will have those power purchase agreements.

“What’s going on at the moment is a perfect storm. You have several things happening, exceptionally high gas prices globally, low wind and a number of nuclear power stations offline and interconnector issues. All of those things combine, and none are going away immediately.”

Hardy believes there are both advantages and disadvantages to being vertically integrated.

He continues: “An advantage is exactly what’s happening now, you have got a little bit more control of where you get your electricity from which means you are less exposed to the fluctuations in global markets because you can sort yourself out in advance with forward contracts. However, if you are vertically integrated and you’ve taken past bets on particular technologies, such as coal, that does not look like a very good bet now.

“If you have got a gas plant and operated it for the last six months then I suspect you are doing very well indeed because it’s been around 40 per cent of power for quite some time and is still very important for heating.

“But looking forwards, what is an optimal mix of plant to have in an increasingly zero carbon power system? That’s where you might end up being quite exposed if gas keeps getting pushed out. Once we hit 40GW of wind in the 2030s, which is a 10-point plan commitment, then there are going to be plenty of days where you have got an entire system which is almost renewable driven.”

For some a good hedging strategy, rather than being vertically integrated, is key to a successful retail business. Ultimately this means that small suppliers who have historically benefited from low energy prices and by not hedging are now facing the full brunt of rising wholesale costs.

Keith Maclean, managing director of Providence Policy, says: “We are now seeing the imbalance in the system is driving prices to almost unheard of levels. Those companies who have not hedged and who in the past by not being hedged had an advantage because the price went down with time, are now facing the opposite problem as prices go up. They have got commitments to their consumers and they run the risk of not being able to afford to buy either the power or gas in order to serve those customers.

“That’s at a time when they are already going to be under strain from having to make their renewables obligation, feed-in-tariff and other payments, this is traditionally the time of year when Ofgem calls in the money and some go bust. This year looks a bit more extreme still in terms of the peaks both with gas and electricity.”

Ultimately, there are indications that the energy retail market is about to turn back the clock and consolidate around several ‘big X’ suppliers. If the trend of soaring wholesale costs continues, and there are smaller retailers who have failed to hedge correctly, it may well be the only players resilient enough are those vertically integrated and/or with deep pockets.

One expert sees this as a handful of larger players with a smattering of more niche energy brands such as Good Energy, a supplier dedicated to developing green generation, and app-based Pure Planet.

“I think what we will end up with is two types of large supplier, those that are asset or financed backed, I see that as around 7-8 suppliers. Then we will have the differentiated suppliers beyond that, the likes of Good Energy, Ecotricity and Pure Planet, players that have a USP.

“They don’t need to be big, they probably never will be big, but they have a way to speak to the market through their models.”

Whatever happens eventually, there will be a growing sense of dread within the offices of the energy regulator over the coming weeks and months. As such, attention will be turn towards what the sector can do in the meantime to battle the price spikes.

At Utility Week’s recent Consumer Vulnerability & Debt Conference Ofgem’s head of retail market policy, Meghna Tewari, was asked what protections the regulator could offer retailers while guarding the public against excessive bill shocks.

“It is something that is being thought about internally”, she replied, adding: “Our chief executive has been out there talking about the pressure on the industry and also the challenge of maintaining market integrity. It’s a key point of discussion internally. I’m sure whatever we think will be made public in the next few weeks.”

One industry leader suggested the price cap leaves the market in a “challenging position”, and that a good way of reducing consumer bills would be to look into energy efficiency.

Michael Lewis, chief executive of Eon UK, said: “The current situation of rising energy bills is nothing to do with the effectiveness or competitiveness of the energy retail market, we are already in a challenging position since the advent of the price cap on suppliers and the industry in aggregate has been loss-making.

“The price cap on suppliers doesn’t affect global commodity prices or the price paid to generators and that’s where the current price pressures are coming from.”

He added: “We know this is a concern for consumers and we need to consider both short term and long term solutions to help people reduce their energy use and cut their bills.

“Energy efficiency is still the most effective way to reduce bills and we must have a joined-up approach to improving millions of homes around the country.”

Furthermore, Lewis said he believed certain policy costs on energy bills should be shifted to general taxation.

He explained how around a quarter of an average domestic electricity bill is additional charges to pay for government policies, compared to about two per cent of the gas bill.

Lewis labelled this as “regressive” in that the poorest in society use proportionately more of their income to pay for these so-called hidden ‘taxes’ which disadvantages electricity over gas, setting back the need to prioritise cleaner forms of heating to reach net zero.

“Simply put, we should take those charges off the electricity bill and into general taxation so these costs are funded more progressively and we level the playing field on the cost of cleaner heating. Then we can also start to apply something like a carbon tax on gas on a ‘polluter pays’ principle. A carbon tax is factored into electricity generation price anyway but there’s no carbon tax on gas when it’s used in homes,” said Lewis.