The speedy reconsolidation of the energy supplier market was predictable and possibly structurally inevitable but, we are only at the end of the beginning. There still remain significant questions on who else is going to fall victim and who, ultimately, will foot the bill. Commentators have been asking what happens if one of the big players fail. Will the Supplier of Last Resort process be robust enough? Will the Special Administration Regime ever get used and if it does is it fit for purpose or is it “light touch” nationalisation? There has been irreparable damage to the ecosystem that relied on these energy suppliers, and there is of course the question of what will happen to the consumer this winter?
The energy retail sector has always been at the mercy of the markets and has been fighting off challenges for a while. This has now culminated in the current energy crisis. There are a number of reasons for the current crisis including an increase in global demand following the relaxation of lockdown restrictions, reduced storage capacity and issues with a major grid interconnector. The wholesale price of natural gas is at an all-time high having more than doubled in price since the beginning of 2021. The situation is considerably worse in the UK with it being reported that energy costs in the UK are triple that in counterpart European countries.
Whilst the current wholesale prices are a contributing factor, the previous relaxed entry requirements and monitoring are also a cause. Ofgem’s previous policy encouraged new energy upstarts to join the market by dropping the barriers to entry. The plan was to diversify the energy market by creating competition for the Big Six (British Gas, SSE, EDF Energy, EON UK, npower and Scottish Power). In many ways this worked, but the new supplier entrants tended to have a business model which did not consist of hedging arrangements and preferred to buy their wholesale energy on the spot. This worked when the wholesale price was low as it meant these companies were selling energy to customers at a higher price than they were buying it. When the wholesale price spikes however, that business model does not work as Ofgem’s price cap limits a supplier’s ability to pass on the actual cost of supply to customers. The Big Six buy their energy in advance and seek to insulate themselves against rises in the price of wholesale energy by having appropriate hedging arrangements in place.
The first casualties to fall victim to the crisis have been the smaller energy supply companies - fourteen energy companies have ceased trading in recent months with the likes of GOTO, Pure Planet, Igloo, Avro and Green having entered administration. In total, over two million customers who were supplied energy by these insolvent energy companies have been transferred across to new suppliers by the market regulator, Ofgem, through the ‘Supplier of Last Resort’ process. Ofgem’s primary concern is customer focused and struggling energy companies either go through the ‘Supplier of Last Resort’ process or, if all else fails, appoint a special administrator. To date, a special administrator has not been appointed although this may change if one of the bigger supplier finds itself in difficulty. We have discussed the regulatory regime when energy suppliers face financial distress in detail in our previous article, click here to read more.
In an industry that relies on hedging, energy companies who are appointed as a ‘Supplier of Last Resort’ may become increasingly reluctant to take on additional customers, mostly because they may be required to buy energy at wholesale prices to provide supply to the additional customer basis they have acquired and which might not be covered by their current hedging arrangements, but also because of the associated costs of assets/infrastructure/data that will be required to service the additional customers. This places an extra layer of strain on the very companies which are being relied on to carry the industry. So far the government has been reluctant to intervene and provide any support.
There has been and we think there will continue to be an influx of energy suppliers, in varying stages of distress, and many might be looking at seeking finance in the current market. Any funding arrangement will be determined by the overall financial strength of the individual energy supplier in light of its customer book, supply terms, forecast, brand strength and balance sheet. The term and quantum of suppliers’ hedging arrangements will also be a key factor in any decision making process for both directors and lenders. Forecasting is integral in the energy market but the fact remains that it is not possible to accurately predict how prices will fluctuate going forward especially as the market shows no sign of stabilising. Even energy companies who are not yet struggling will need to start considering what their future looks like – do they have the margin to weather the storm or seek new financing arrangements to see them through these troubled times, or do they close out their business.