Like all dot-to-dot pictures, it is only when the dots are joined together that a true picture emerges. There are several stories in the energy retail space, which when looked at together, form a worrying view of a rapidly emerging picture- one characterised by large cracks:
1) SSE results and the risk to the SSE/Npower merger: With this week’s ‘disappointing’ interim results, SSE confirmed that it is retrenching its core business back into networks and renewables, whilst continuing to try very hard to off load its problem child, now interestingly titled ‘energy services’ rather than the more traditional ‘retail business’. With customer losses reported by SSE at 446,000 and Npower at 530,000 it should be no surprise that the merger is looking increasingly hard to make work, not least with the well known challenges and costs associated with business and system integration. At the same time, with the introduction of the price cap, one of the key levers for managing risk, namely price, has been taken away- made worse by the recent increases in the wholesale market, which will potentially make the price cap out of the money almost as soon as it is introduced.
All of the Big 6 are working hard to re-invent themselves in the new market, but with customer losses continuing to accrue and the ability to improve profitability restricted to cost reduction, it is a difficult place to be. Cost reduction plans are being announced and implemented, but as always, the loss of people, particularly knowledgeable ones often results in detriment to customer service standards of delivery. It is a hard line to walk.
2) RO and FIT mutualisation: For most people this will mean nothing- but it is a major story in understanding the retail market. To simplify, the level of cash that suppliers are obliged to pay into the RO and FIT funds in order to pay out to renewable generators has, for the first time, fallen below the minimum level. What does this mean in practice?
Firstly, some suppliers do not have enough free cash to meet their obligations, needing it instead (if available) to fund increasingly constrained working capital. With the potential fines and licence implications, no business would choose to fail to meet their obligations.
Secondly, recycling of funds back to all suppliers will be less than they were expecting as the shortfall is spread around suppliers in proportion to their market share. An already difficult cash position will become worse for all suppliers- and there is no means of recovering the deficit as prices are capped based on forward views of RO and FIT obligations. Suppliers (still in business) will just have to suck up the deficit caused by those not able to pay.
3) Wholesale prices: Going into winter, wholesale power and gas prices are pretty aggressive and have been consistently rising. As OFGEM admitted last week when confirming the price cap, it is likely that the price cap will go up again at the first opportunity, due to prevailing wholesale conditions. Historically, any well run retail business would have the ability to manage its commodity risk in real time, but with the introduction of price caps, there is the potential for at least a three month lag between wholesale cost movement and price cap limits being adjusted. The ability to manage this risk is being severely curtailed, and in an uncertain period, made worse by the impact of Brexit, it means very difficult times for even the best run energy retailer. For those small suppliers who lack substantial capital backing, the ability to manage the wholesale risk is further constrained, and anyone over exposed to short term market price movements will undoubtedly suffer, and potentially not survive the winter.
4) Access to markets: Aggregators and renewable generators have lobbied hard and successfully to improve access to balancing markets for a broader range of businesses without having to utilise the services of a supplier to access the markets for them. Whilst at a holistic level, this makes a lot of sense, one of the consequences is that is cauterising supply business ability to utilise additional profit streams from their position as market access ‘controllers’. Another risk management tool is effectively being removed from those operating in the supply space.
Four new entrant suppliers have gone out of business since July 2018, with the supplier of last resort process being put into active use more than ever before. However, the pressure of winter prices, price caps and RO/FIT mutualisation is likely to tip more over the edge, and the industry commentator tom toms are working overtime to this effect.
The key point here, is that whilst the bottom end is being squeezed, so is the top. Making money in energy retail, even for the Big 6 is no longer a given. The business models which are likely to sustain are those which are not incumbered with legacy issues, have adequate funding to weather the storms and most importantly have differentiated propositions focused on more than supply. There are an increasing number of suppliers who have these characteristics, but whether there are enough who have the capacity to grow quickly to pick up the fall out from elsewhere is yet to be seen.
Whilst, the media take great glee in bashing the sector, there is a growing and real risk that businesses withdraw from the market, voluntarily or as a result of failure, simply because the constraints imposed on them prohibitively restrict their ability to manage business risks.
Time will tell, to see whether cracks in the supply market can be shored up, but whilst government and media hype are driving price caps, central action needs to be taken soon to mitigate some of the issues constraining cash and profit generation, before we start seeing major market disruption in the energy retail space. Winter 2018 could be a watershed period- hopefully OFGEM are ready for it