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UK Energy Markets- Where’s the money?

In announcing its results yesterday, E.ON’s press statement used a phrase which made me smile. In reporting the UK’s poor Customer Solutions results (an eye watering fall in EBIT from £148m to £59m), the explanation was attributed to the ‘special situation in the UK’. Centrica, in providing a quarterly update, reported a £70m loss attributable to the impact of the price cap- which they would probably agree was pretty special. SSE’s turn comes next week, and follows its February announcement that it is assessing the future of SSE Energy Services, which remains held for disposal- we wait with bated breath to see if they have found someone to buy their ailing business.

So not great for the Big 6. Much of their decline in performance is attributed to the growth of new entrants, several of whom with innovation, agility and the advantage of not being weighed down by legacy issues and brand connotations are rapidly building market share. However, even here it is not so rosy, pressure is being heaped on principally through the impact of competition and having to pick up uncontrollable costs relating to the failure of other new entrants. The greater issue though is that even the fastest growing, are carrying significant retained losses from investment in prior years, primarily as a result of the cost of getting established. Three of the apparently most successful, Bulb, Octopus and Ovo reported retained losses in their last financial statements of between £13 and £26m. With single digit margins and the need for continued investment to keep ahead of the game, they will need a lot more customers, welcome injections of capital from new investors, and sheer grit to weather the current storm.

The generation market has also taken a battering in the last twelve months. What had been a reliable market for several years, with embedded benefits, ROCs and FITs underpinning investment returns, no longer exists. The suspension of the Capacity Market for most, just added insult to injury. We have therefore seen a material decline in investment in recent months, and where investment is getting away, increasingly complex models reliant on stacked revenues (riddled with uncertainty) and the need to take punts with increasing amounts of merchant risk.

Aggregators, the relatively new kids on the block, are also finding life challenging. Whilst it is clear that there will be increasing value in the flexibility markets, whether through the ESO, DSOs or Balancing markets, the successful growth of these markets has inevitably resulted in falling prices. Whilst a positive sign that the market is working, it is providing challenges for aggregators, who again need to recover their set up costs and investment in technology before making profits. There are few who are yet in the black.

So the closer a business is to the customer and the regulator, the higher the risk and the harder it is to make money in today’s market.

Interestingly, where money and investment appears to have migrated is to the ‘middle layer’ or supply chain. If you are a provider of services to the regulated market, whether it be providing pre-packaged licences and technology to suppliers, metering services, meters themselves, or to a lesser extent outsourced customer services, there are two primary benefits. The first, is that the businesses are providing regulated services, required by suppliers to operate in compliance with their licences, and the second is that the businesses are at arms length from the regulator. They are protected from any price or profit intervention, but due to relatively low levels of competition, able to make the market. Genius- a great model, and hats off to those who have made it happen- but it doesn’t feel right, in terms of the risk and reward balance.

Lastly the absolute bastion of low risk, high value returns lies in the industry bodies themselves. ‘Allowable’ revenues almost always seem to support plush offices in prime locations and employee numbers appear to be able to continue to grow with few constraints. It can catch in the throat for those working at the ‘grubby’ end when visiting ‘the industry’.

So why are there still so many people ploughing on at the tough end?

Whilst money and margins are hard to come by today, belief, entrepreneurship, bloody mindedness and an underlying excitement helps people turn up for work every day. Businesses working at the sharp end are typically characterised by energy, humour, fun and hard work. People are buying into the leaders, the promise and the belief that work today will deliver returns tomorrow. It may be tough- but it’s still a great place to be. Fundamentally, consumers (of whom there are many) will continue to need to buy energy, whether self generated, stored or supplied directly – and that certainty in an uncertain market provides opportunity for all.

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