Industrial and commercial customers are far closer to the wholesale market than household consumers, James Clarke, vice president trading at Smartest Energy, explains. “When we contract with them, it is all about: ‘What is the market price today?’ There is a level of transparency there that probably there is not in the domestic market.”
Smartest Energy, which has been active in I&C retail since 2008, finds that customers increasingly choose contracts that follow the wholesale price rather than long-term fixed rates.
The domestic market is “quite opaque” by comparison, he says. “There is always the general perception that they all want to average in their domestic portfolios. Nobody wants to be an outlier. They all want to put their prices up together. Do they really want to trigger competitive responses from each other, or are they happier keeping their share?”
Labour leader Ed Miliband propelled transparency and competition up the political agenda in September when he pledged to freeze household energy prices for 20 months if elected. That, and break up the major vertically integrated energy companies. The shock announcement was born out of a conviction, difficult to prove, that the big six are ripping people off. Yet like all the policy interventions promised or threatened by government and opposition, it ripples through the whole market. And the view from the trading screens of Smartest Energy is very different.
“It is not particularly helpful if the market gets embroiled in what are essentially domestic problems,” says Colin Prestwich, head of regulatory affairs at Smartest Energy. “The market we work in is very competitive.”
The company has fared well in that competition, nearly doubling its turnover in five years to hit £1 billion in 2012. Pre-tax profit margins have been modest but steady at 1 or 2 per cent across that period.
The low profit margins in big six retail businesses and higher margins in generation have fuelled suspicions of dodgy accounting and cross-subsidy. Prestwich does not subscribe to “conspiracy theories”. He says: “The big six are generally set up with their trading experts in the generation department precisely because the generation is the most flexible. It just makes sense that those areas of the business are looking for more opportunities to make money. The retail businesses are not as flexible with their portfolio, so they are price takers.”
It may not be a conspiracy, but Prestwich does see vertical integration as a problem when it comes to liquidity, because internal trades leave less available for the market. The volume of trades in the UK power market is just three or four times the physical product, around one-third the churn of Scandinavia’s Nordpool. That makes it hard for small players to hedge, in particular.
Smartest Energy is in favour of a self-supply restriction to force trades into the open. It would “effectively split the big six” and be “a fairly easy change within the industry”, says Prestwich. Ofgem’s answer to the problem, a licence condition, is “a step in the right direction” but will not fully address the issue.
On the aggregation side of Smartest Energy’s business, there is Electricity Market Reform (EMR) to contend with. The company was founded in 2001 as a buyer of power generated by the independent sector, from lone community wind turbines to industrial combined heat and power engines. It now claims to cover 30 per cent of the UK’s embedded renewable capacity, across 614 sites.
Under EMR, renewable generators will get support through contracts for difference with a “strike price”, in place of the Renewables Obligation. The market “reference price” will be topped up to a rate set for each technology. That changes the nature of power purchase agreements (PPAs) and the renewables lobby has raised concerns that small players could struggle to access the market. They say renewable generators will not actually attain the reference price, because they sell through PPAs at an increasing discount.
As a business that helps small generators sell their power, Smartest Energy does not see this as a problem and argues that heavier discounting is an inevitable trend. “The problem is that this guaranteed strike price has raised expectations,” says Prestwich. “The wind generators will start to see, as time goes on, a greater discount, and that would happen with or without EMR.”
Clarke explains: “Increasing generation from wind will mean that low price and wind generation will become more coincident. Over time, their generation will be worth less because they are generating most when prices are low.” In other words, at times when your wind turbine is generating most, it is likely others will be too. The marginal cost of wind generation is close to zero and a glut of wind power suppresses the wholesale price. Over any given period, wind generators are likely to earn less than the average wholesale price for their power.
“There are different risks associated with the PPAs under EMR because they are not the same structure as under the Renewables Obligation, but there has always been a discount to reflect risk,” says Clarke. “Any hedge is going to require a risk premium and a margin. These are not charitable endeavours.”
Aside from a self-supply restriction, Prestwich would like to see as little intervention in the market as possible. He says: “We are on a bit of a road to intervention that is difficult to stop, but we are firm believers in competitive markets.”