What can we learn from other markets?

The last few months have shown in graphic detail the impact of wholesale energy market swings. As we watch from the US, with the recent memories of the ERCOT crisis of earlier this year still fresh in our minds, the latest recipient of a market altering change, is the United Kingdom, a market, until this year, of nearly 70 different Retail Energy Providers, but has lost over 20 in a matter of months, with more forecast to fail in the coming weeks.

What’s happened?

The UK operates a regulated but open market, having historically been nationalized, it moved to more of an Oligopoly model, with 6 major providers dominating the space. As regulations relaxed, new entrants entered the market and started to gobble up market share with aggressive pricing and better customer service. This marketing focused approach yielded massive growth, owning the customer satisfaction scores, and sweeping large swathes of the incumbent customer bases of the Big 6. It was all possible due to historically low energy prices and largely predictable wholesale pricing behavior. They often backed this up with a strong focus on Green Energy to capture the European interest in Climate Change issues.

That was all until 2021, after the Pandemic drove prices down in 2020 a combination of factors started to effect both Global and Local pricing. 

As the worlds factories awoke post pandemic, demand for Gas started to spike. A key provider in the region, Russia, started to have excess demand from both its European and Asian customers and the supply started to contract due to the excess demand. 

The UK is actually quite well equipped with production and supply, Norway its cross Sea neighbor being a key supplier of Gas, France across the narrow Dover Strait and its strong history in Nuclear electricity production and a cable linking the 2 countries, the UK itself a net producer of Natural Gas, with production in the North Sea and also its heavy investment in Wind Farms and Tidal Production. Backed up with extensive agreements to buy LNG shipped from the Middle East, shipped direct to shore. Gas was often but for the most inclement days, merely a back up. 

Then in a sequence of unprecedented events:

  1. An unusually cold preceding winter meant gas stocks were very low.
  2. Norway became supply constrained.
  3. One of the main interlinks cables from France to the UK caught fire and has been reduced to 50% provision until at least March 2022.
  4. The winds didn’t blow as much as normal, and the Gas facilities had to fire up.
  5. The demand for LNG from the Middle East went up exponentially.
  6. 2 of the main Gas electricity production facilities were offline due to delayed repairs caused by the pandemic.

Suddenly, the UK was faced with a situation of lack of supply of electricity, which it would have normally backed up with Gas production, for which it had to pay exponentially more for the Gas to feed the production facilities, which were largely offline anyway. 

The knock on impacts downstream have been immense, with US and Norwegian owned Fertilizer and Ammonia manufacturers in the UK shutting down due to the immense spike in Gas costs, meaning the UK was suddenly faced with a lack of CO2 production, meaning the entire food chain was being put at risk, with the UK Food and Drink Federation warning that Poultry, Pork and Frozen products disappearing from shelves in a matter of days if the CO2 issue was not resolved. This is due to CO2 being a key product in animal slaughter and maintaining longevity of shelf life post packing. Needless to say the UK Government has now been forced to step in to force the opening of these plants again to ensure the opening, on terms that whilst not public are clearly at a cost to the UK Tax Payer.

Which leads us to the Retail Energy Providers…

So what’s happened in the Retail Energy space?

It’s bloody, very bloody. In the past 2 weeks a number of the smaller providers (companies with less than 500k customers) have declared bankruptcy, one of the larger brands with in excess of 1.7 million customers has now filed for Special Administration (as noted by the CEO of one their competitors Ecotricity, Dale Vince, even before the price changes they had an exposure on “$273 million in losses and were in urgent need of debt rescheduling”), with customer sticker shock on bills, with customers who were paying monthly, seeing increases in monthly payments go up by 77%. This has lead to a 2 tier set of Retail Energy Providers. 

Those who Hedged and De-risked, and those who didn’t.

In the words of Mr Vince, Ecotricity is 90% hedged for 12 months with only minimal exposure on the outstanding 10%. The former big 6 and companies like Octopus and Ecotricity that have developed the sophisticated practises that de-risk such market anomalies, can ride this wave. The smaller or less sophisticated companies are massively exposed and their Book’s have become their liability, with extensive bankruptcies expected without government intervention. 

Octopus CEO, Greg Jackson has been brutal in his assessment of the behavior of some market entrants, in his Twitter thread he was forthright in his condemnation, https://twitter.com/g__j/status/1439884649833054210

However, there is a twist in this tale, the Energy Price Cap. Regulated by industry watchdog Ofgem, there is only so much a REP can charge a customer. Unlike ERCOT, where end customers experienced runaway bills, they are restricted on what they can charge the end customer. 

So, what of the Government and Ofgem, well they are citing their preferred path of “Supplier of Last Resort” where the bankruptcy of a player is ok, the customers are just transferred to another more robust player. With that loss of the player, the losses incurred on their balance sheet are transferred across the remaining players to absorb on their balance sheets. Painful. But part of the regulators rules. 

In addition, any potential acquirers of these customers is faced with the price cap, with many of these customers transferring with potential bad debt, and even worse fixed price contracts that have been baked in for the next 12 months which mean they immediately on acquisition, they become net negative on the P&L. It’s a lose, lose for the acquirer as the type of customer they acquire will have a high propensity of Churn but they are locked in on that price until they leave. 

So once again, the UK tax payer steps in to cover the cost, with huge Govt loans to REP’s to take on these liabilities. But with the overhead of running their own business and the knowledge these loans need to be repaid and likely little if any profit down the road.

Takeaways

Energy supply is ultimately about cold hard numbers, with careful management of your Book, maximising potential, but minimising risk. In a market like the UK the REP bears the burden, the customer is better protected, but we at V3 have always operated on the baseline principles of sound financial planning, modelling, prediction and protecting your interests. Combine that core capability with tested and effective marketing, means you can be the company that survives and thrives, no matter what the market throws at you.

Curious about leveraging emerging tech into your energy offerings? Get in touch!