Wholesale prices are set to soar this winter. Does this signal the death of small energy suppliers? Or will wider supply margins and hedging strategies be enough to save them?

Unsurprisingly, small energy suppliers are more vulnerable to fluctuating wholesale prices than their larger counterparts, and many will be quaking in their boots as prices rise this winter and threaten to send them the way of GB Energy Supply, which was forced to shut up shop last winter.

Even before the season has fully set in this year, UK electricity prices are around £7/MWh – 16 per cent – higher than they were last year. But small suppliers needn’t give up hope just yet.

Energy regulator Ofgem isn’t daunted by the threat of price hikes, saying it fully expects sufficient supply to meet the increases in demand throughout the winter. Oxford Energy consultant William Blyth is confident that energy prices will not spike as high as last year, as reserve margins are almost double what they were in 2016.

These wider supply margins allow the market some breathing room, as National Grid is less likely to have to pay extortionate prices to generators to provide power at short notice. This happened last September when power prices surged to record highs as several power plants were unexpectedly shut down and unusually warm weather for the month pushed up demand. As a result, the UK power market saw record high prices being paid for short-term electricity contracts, with National Grid accepting contracts at up to £1,500/MWh as it sought to balance the system. Low LNG prices should also shield the country from such seasonal upward pressure on prices, and dampen fluctuations.

To hedge or not to hedge?

On top of this, one method employed by many energy suppliers to protect themselves against price fluctuations is to hedge a proportion of their electricity purchases against future price rises. However, not all small players can afford such a strategy. Without easy access to the wholesale markets to forward buy their customers’ consumption profiles, they are hit by half-hourly imbalance charges imposed by the central wholesale trading market. These charges, as well as the increasingly volatile wholesale prices, has put pressure on suppliers offering fixed-price deals.

When wholesale prices shot up last year, they killed off small Preston-based supplier GB Energy Supply. The company said its failure was due to “swift and significant” increases in energy prices over recent months. The sudden increase followed a period of falling wholesale prices proved fatal for GB Energy, as it endeavoured to fulfil the rates it had guaranteed to customers, through fixed-price deals, when wholesale prices were lower. “As a small supplier,” chief executive Luke Watson wrote, in a letter to customers, “our inability to forward-buy energy to allow us to access the best possible wholesale prices, means that the position of the business has become untenable…”

The supplier had put up its prices to customers by 30 per cent, in a desperate attempt to save itself. However, market observers said the move was “too little too late”, and failed to save the supplier.

Electricity prices: day-ahead baseload contracts – monthly average

Source: ICIS, information correct as of October 2017

With around 54 independent suppliers now active in the UK market, it’s reasonable to suggest comparable firms could face similar challenges this winter.

There were eight new entrants in the first half of 2017, and it is these newest entrants which are most vulnerable to price fluctuations and to the impact of the “consolidation and shake out” that Blyth expects in the coming months. Other market commentators agree.

It’s difficult to second guess just how bumpy a ride the winter months will give suppliers from year to year. Cold snaps and unseasonably warm spells bring their own challenges (though cold is generally welcome to gas retailers as a source of beefed up revenues) and the chance of unexpected power plant shut downs is hard to predict.

With weather sages forecasting a particularly sharp winter for 2017/18 however, companies can make sure they are armed for strong demand. A comfy capacity margin should head off too much painful spot pricing for unhedged suppliers. But nonetheless these fiercely price competitive market players should consider whether their fixed-rate pricing strategies can endure another year of wholesale cost spikes, or risk following in the footsteps of GB Energy Supply.

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