Entomologists should make a bee-line for the UK energy supply sector – its members have been falling like flies of late, battered by the surge in gas prices.
At the time of writing – and the figure may well rise further – some 27 energy suppliers have folded since last August. A remarkable attrition rate.
Few would argue that the policy of encouraging competition in a difficult sector has been anything but a shambles, presided over by Ofgem. It appears that every man Jack could set up such a business – and many did – without having access to anything like the requisite financial backing.
In 2014, the Big Six boasted of a market share of over 90%. Five years later, this share had eroded to 70% as the six companies focussed on more pressing financial issues or, in the case of SSE, exiting the supply market altogether.
For the UK energy supply market, it was quite a transformation; in reality, though, it was a house built on sand.
Of course, the surge in spot prices for gas – up from 40p per therm in April 2021 to around 450p shortly before Christmas – is unprecedented; it dwarfs the five-fold OPEC-driven oil price increases in the 1970s.
For energy suppliers, the imposition of the energy price cap in 2019 locked many into offering seemingly attractively-priced deals that they can no longer honour without incurring substantial losses.
Former energy regulator at Ofgem’s predecessor, OFFER, Professor Stephen Littlechild, highlighted the key policy error. He stated: “It is the price cap, rather than the unprecedented wholesale price increases, which are causing such havoc in the market.”
In his trenchant criticism of the price cap, he argued that it had “compromised or invalidated their (new energy suppliers) business models”.
Financial resilience
The lack of substantial financial backing for many new entrants has been crucial. While Octopus, to name one, enjoys very substantial backing from its parent, Octopus Group, many others have been unable to fund their losses and have folded. The former’s web-site goes gang-busters in highlighting this valuable financial buffer.
Curiously, there are many parallels from the financial crisis of 2008/09. Its first major victim was Northern Rock, notorious for its 125% mortgage offer. Suddenly, the credit markets, on whom Northern Rock had relied, dried up: the Northern Rock dream was over.
Subsequently, many building societies also went under. And, in an echo of the energy supply crisis over a decade later, the one very solvent player, Nationwide, fielded many calls from the Treasury – as no doubt, Centrica does today from Ofgem – asking whether they would be prepared to take on the latest sector casualty.
As the cost-of-living issue has rocketed up the political agenda, politicians are now panicking about both gas supplies and energy price increases.
The UK’s gas storage levels are dangerously low – the risk of insufficient gas supplies remains a real one.
On the electricity front, the gas input cost of CCGT plants, which currently generate around 35% of UK output, is very considerable. Inevitably, the price of gas-generated electricity will rise sharply.
With coal-fired plants being mostly decommissioned, along with problems aplenty in the nuclear sector, generating options are very limited.
While renewable generation output has risen in recent years, its contribution to the grid on cold windless winter evenings is inevitably limited.
All in all, it is a right old mess in terms of both energy supply and cost. The warm weather so far this winter may be sufficient to prevent widespread disruption.
But these major failings cannot be overcome by easy short-term fixes.
A new paradigm
Questions are also being asked about how the long-term UK supply market will evolve.
After over 30 years of operation, the UK mobile telecoms sector may provide a clue. Currently, the leading quartet account for around two-thirds of the UK market.
British Telecom’s EE leads the field, at 22%, with the overseas-owned O2 on 19%. The UK’s Vodafone has a 15% share whilst the Hong Kong-owned Three has 10%.
In time, the domestic energy supply market might end up with a similar profile.
The Big Six has now frayed, with a big tick going to SSE for exiting the supply market in January 2020 – its share price has moved up by almost 10% subsequently, mainly due to the underlying valuation of its core regulated networks and renewable generation businesses.
Of the remaining Big Six players, Centrica’s position offers by far the most scope. These days, it is anything but long on gas: its cornerstone Morecambe Bay Hub is well past its production peak. And Centrica is currently engaged in selling Sprint Energy’s Norwegian assets sale for around £800 million.
Centrica’s shocking share price performance – down 80% since 2013 – highlights its plight. Importantly, its net debt has plunged to just £93 million, giving it real scope to invest in recovering its heavily eroded share of the UK energy supply market.
Centrica’s new mantra is ‘Fixing the Basics’, a throwback to John Major’s ill-fated ‘Back to Basics’ campaign – but one that is eminently sensible.
Through the Supplier of Last Resort (SOLR) mechanism, Centrica has recently hoovered up over 400,000 disenfranchised energy consumers via Neon Reef (30,000), Social Energy (5,500), Zebra Power (14,800), Bluegreen Energy (5,900) and People’s Energy (350,000).
More will certainly follow, as Centrica seeks to re-establish its former market status as King Gas.
Of the other Big Six players, the two German suppliers, Eon and RWE, have undergone major structural change of late, including the absorption of Innogy into the former.
However, the long-term energy investment requirements in Germany, with the Green Party now in the coalition government and nuclear power plants being closed down, are such that the focus of both must surely be on Germany.
EDF is facing immense challenges on many fronts: massive over-runs on new nuclear-build; almost 20% of its nuclear fleet currently being off-line; and a much unwanted political intervention from its 84% government owner compelling EDF to sell more electricity at knock-down prices.
Furthermore, with net debt of €41 billion, it is no surprise that its share price is now around 10% of its peak in 2007.
Hinkley Point C aside, it seems clear that EDF’s focus will be increasingly on France.
Iberdrola, whose share rating has heavily out-performed its struggling rivals due to its expanding renewable energy capacity, will understandably give priority to that division, despite its other businesses in Scotland and via SP Manweb.
From disruptors to consolidators
From the collapsed pile of new energy suppliers, a few companies may well emerge as sector consolidators.
Certainly, Ovo Energy has enough customers to do so – 4.5 million in total, 3.5 million of which were bought from SSE. But, despite revenues of around £4 billion per year, Ovo is still heavily loss-making.
Ovo’s co-founder and effective owner, with a 67% stake, is Stephen Fitzpatrick. Undoubtedly, he will have been buoyed by the 20% stake acquired by Mitsubishi in 2019, which placed an imputed £1 billion valuation on Ovo. Recent market developments suggest that its current value lies well below that figure.
In 2016, Fitzpatrick founded the US-quoted Vertical Aerospace, which deploys Vertical Take-off and Landing Technology (VTOL). Whether that activity absorbs more of his time – and attention – in the future remains to be seen.
The thriving Octopus Group is another obvious consolidator. In five years, it has signed up three million customers and its Kraken platform is highly regarded. The UK and Germany are its key European markets and it has some involvement in both Australia, via Origin Energy, and in Japan, via Tokyo Gas.
Crucially, its financial backing, via Octopus Group, is very robust. Indeed, one of the group’s former funds, Octopus Renewables and Infrastructure, has a quoted value of over £600 million.
In terms of market share, First Utility – now Shell Energy – has done well. It has one colossal advantage in being owned by Shell, with a market value of over £140 billion. It reputedly paid around $200 million for the business.
For many years, Shell has talked up its green aspirations, but cash returns are modest. It is still highly dependent upon its exploration and production returns, the weakness of which caused its historic 67% dividend cut in 2020 – its first reduction since WW2.
With the electric vehicle market potential being talked up, along with its re-charging requirements, there are various scenarios that could lead to far greater UK retail involvement beyond its existing petrol station forecourt operations.
Shell is more likely to become a major investor in offshore wind as a consortium member. The Energy White Paper in 2020 projected a quadrupling, from around 10GW to 40GW, of UK offshore wind capacity by 2030 – a highly ambitious target.
Similar criteria apply to BP, which under new Chief Executive, Bernard Looney, is very keen to burnish its green credentials, especially in the developing EV market.
BP withdrew from its only exposure to the UK retail market when Pure Planet ceased trading last year. However, that does not necessarily spell the end of its interest in the sector. BP certainly has strong aspirations to be less dependent on exploration and production, and specifically, the quest to identify rich oil seams, many of which are in highly unsuitable locations.
BP, too, may well invest further in offshore wind generation projects; along with Shell, it was an aggressive bidder in Scotland’s recent offshore leasing round.
Following National Grid’s unexpected £7.8 billion acquisition of Western Power Distribution last year, it is reasonable to ask whether it may go further and invest in the UK energy supply market. However, this seems unlikely.
After all, National Grid has a raft of other challenges to address, in terms of the power requirements of the long-term EV rollout, a very large investment programme and pivotal price regulation issues (R110-ED2) with Ofgem – a key driver of its finances.
In the meantime, the temporarily nationalised Bulb’s future remains unresolved. Its finances are so distressed that the quoted Sequoia Economic Infrastructure has – temporarily at least – written off £55 million of its senior debt.
Bulb may either be absorbed by an existing player – perhaps as part of sector consolidation – or simply exit the stage.
The most plausible outcome for the future of the UK energy supply market is a new four-pillar structure led by Centrica securing a much-enhanced market share under a far higher price cap. The other participants would be the foreign-owned Big Six members – winding down their UK involvement – Ovo/Octopus and Big Oil.
Such a scenario would not be dissimilar to the restructured UK mobile telecoms market.
Ofgem stated its mission – “as (being) the independent regulator, we have a crucial part to play in making sure that energy markets are working in the interest of consumers”.
Given scarce gas supplies, soaring energy prices and a flurry of collapsing suppliers, Ofgem is falling well short of meeting its obligations.
UK energy supply has been – and continues to be – a sorry saga.
Nigel Hawkins (nigelhawkins1010@aol.com) is Utilities analyst at Hardman and Co.