A webinar held by Utility Week for BT sought to establish just how bad things in the market are for the big guys (and smaller suppliers), and how much of an impact political pressures such as the price cap and Brexit are having. Hardman and Co utilities analyst Nigel Hawkins said he expects to see “major change” in the energy supply market over the next five to six years, as the big six begin to reposition themselves.
For some time now, these companies have been reporting large customer losses. For example, SSE recently announced it had lost 160,000 customers in the three months to December 2018. It finished 2018 with 5.88 million customer accounts in Great Britain compared with 6.45 million a year previously.
Npower reported in November 2018 that it had lost half a million customer accounts since the beginning of 2018. Even the largest supplier in the market, British Gas, has suffered the effects of tough market conditions, reporting a loss of 372,000 domestic energy supply accounts in the four months to the end of October 2018.
Hawkins suggests most of the big six have become less interested in pursuing the retail side of their businesses. “Currently, of the big six, four are overseas-owned and, frankly, the two German ones – RWE and Eon – are far more interested in their generation assets in mainland Europe rather than the UK,” he says . “Iberdrola’s interests are in its superb investments in renewable energy, which after 10-15 years are really bearing fruit. With regard to EDF, it’s effectively privatised but run by the French government, which owns well over 80 per cent of the shares, and EDF’s agenda really is nuclear in France.”
Increased competition and tough market conditions have prompted some larger retailers – such as SSE and Npower – to look again at the retail side of their businesses. In November 2017, these two companies announced plans to merge their retail arms to form a new “independent” retail energy company.
The proposal prompted concern from some in the market, who thought it would mean the big six becoming the “big five” – and a further stifling of competition. However, despite being approved by the Competition and Markets Authority in October 2018, the merger plans fell through just two months later. The two companies blamed “adverse developments” in the retail market and “regulatory interventions”.
Hawkins says: “SSE has been pretty honest and said it makes far more money out of networks and regulation on distribution and transmission in Scotland. That’s its priority, as it indicated when it tried to deal with its retail business via the failed Innogy deal relatively recently.”
Peter Siggins – energy and utilities expert at PA Consulting – also foresees big changes ahead, but he remains “relatively positive” about the market. “There’s certainly a lot happening in terms of the competitive landscape, but in general I would see that as healthy rather than unhealthy competition. Albeit with the spate of recent failures there are things to be improved.”
Brexit uncertainty
At the forefront of every business’s mind at the moment is Brexit, which is making everything uncertain. At a recent Utility Week roundtable held in association with Oracle, attendees expressed concern that the Brexit conundrum was having a bigger effect on their businesses than was originally anticipated.
Siggins suggests Brexit per se will ultimately herald an increase in retail prices. “I’m not familiar enough with interconnector agreements or the detail of it to know precisely what the impact could be, but in broader terms we know Brexit introduces a lot of uncertainty, and with the foreign players in particular in the UK market, who knows what impact any sort of Brexit might have – whether it’s a soft Brexit, hard Brexit or whatever.”
Hawkins agrees that the uncertainty brought about by Brexit is having an effect on utilities, but only to a certain extent. “With regard to the electricity sector, there’s only one company that’s really directly affected and that’s National Grid. They’ve got some really quite big investments on European connections, both to France and Holland and elsewhere.”
However, the effect of Brexit is “nothing” compared with the outcome of the regulatory review in 2021, which will be “absolutely pivotal” in National Grid’s share price going forward, he suggests. “For National Grid, that transcends what may or may not happen with Brexit.”
Price cap
The energy price cap, brought in by Ofgem on 1 January, has been a challenge for retailers large and small. “The introduction of the price cap is a bit of a blunt instrument, and in the context of the recent price rises, it does introduce complexities,” says Siggins.
All six of the largest energy companies have increased the price of their standard variable tariffs by at least 10 per cent this year. Eon was the first to announce a rise in line with the new level of the price cap on 11 January, closely followed by EDF, which raised its prices on 12 January, Npower on 13 January, British Gas and Scottish Power on 19 February, and SSE on 21 February. Co-op Energy and Ebico have both also announced price hikes of at least 10 per cent.
Siggins suggests the introduction of the cap is likely to have some “unintended consequences” in terms of how the competitive market works. “For the smaller retail players, it does mean there are implications in terms of hedging strategies. When you look at the make-up of the retail price offsetting in terms of looking at operating costs there’s not much to be had there, so it is going to continue to create difficulties.”
However, he adds, in this area the behaviour of the regulator will be “really important”. “We’ve already seen they’ve announced an increase in the price cap. Maybe there is a forecast it will come back down, but I think it’s a case of how the regulator operates in tandem with the wholesale market to make sure there’s a fair deal for customers, but also that they’re not putting the retailers in a riskier situation than they should be.”
Small supplier struggles
As the price cap begins to bite, it’s not just the big six being affected by political and market strain. At the other end of the scale, small suppliers are also suffering. Fifteen suppliers have gone out of business over the past few years – with the highest concentration in 2018.
These have been both large and small. Electraphase, which went out of business in August last year, had fewer than 100 customers, while Spark Energy (bought by Ovo in November last year) had 290,000 customers.
More suppliers are expected to follow as they are hit with wholesale price rises and burdened with renewable subsidies and taxes. Hawkins predicts that as consolidation happens over the next few years, the market will end up with a relatively small number of well-financed companies which have scalability and are better-able to deal with the risks they’re faced with – such as fluctuations in prices and demand. On 22 February, Ofgem announced that it had banned Solarplicity from taking on new customers. This is not necessarily an indication that the supplier will go out of business. However, it should be pointed out that Ofgem banned Economy Energy from taking on new customers due to poor customer service just before it ceased trading. And Iresa suffered the same fate last year.
The unprecedented collapse of smaller suppliers has led to calls for Ofgem to do more to vet prospective entrants to the market.
When a supplier goes out of business, and a trade sale is not feasible, Ofgem may need to appoint a “supplier of last resort”. This was originally brought in as a last resort mechanism, but has recently become commonplace, as the rate of suppliers going out of business has increased. At Utility Week’s Energy Customer Conference in Birmingham in mid-January, Ofgem’s director of conduct and enforcement, Anthony Pygram warned that the supplier of last resort mechanism is there to protect consumers, and not as an “insurance policy for dodgy business models”.
The regulator is currently in the process of reviewing its existing arrangements for supply market entry, exit and monitoring.
Although several new suppliers that entered the market over the last five years have managed to expand significantly – for instance Utilita, Ovo Energy and Bulb Energy – there are no suppliers, besides the big six, that have yet reached an individual 5 per cent market share.
One side effect of some smaller suppliers going out of business is that, through the supplier of last resort process, mid-tier suppliers have grown rapidly in size by taking on their customers, and so are inching ever closer to that 5 per cent mark.
As of June 2018, seven suppliers had a market share between 1 per cent and 5 per cent and 60 suppliers had market shares below 1 per cent. Ofgem says it still sees some barriers to expansion for medium and small suppliers. For example, there is currently a 250,000 customer account threshold – above this threshold suppliers must bear the costs of contributing to schemes such as the Energy Company Obligation and the Warm Home Discount.
However, these constraints have so far not prevented the continued erosion of the six largest suppliers’ market share.
Why the price cap?
The CMA investigation into the market found that 70 per cent of big six domestic customers were still on expensive default standard variable tariffs, despite the proportion falling in recent years.
In its State of the Market report, Ofgem said around 54 per cent of customers had been on a default tariff for more than three years. The difference between the average SVT price of the six large suppliers and the cheapest market tariff was on average £320 between June 2017 and June 2018.
In July 2018, parliament mandated Ofgem to introduce a temporary price cap on all SVTs. The cap came into force at the beginning of the year and was set at £1,137. On 7 February, Ofgem announced the cap would rise by £117 to £1,254 a year from April onwards. However, some analysts have predicted it will come back down again in October.
Energy market investigation
Back in 2014, despite some new entrants, the big six had 95 per cent of the market and there were concerns about a lack of competition and barriers preventing new suppliers from entering the energy market.
This led to Ofgem referring the entire energy sector to the Competition and Markets Authority (CMA) after an initial investigation found competition was not as healthy as it should be – particularly between the big six.
The CMA investigation lasted two years and was by the far the biggest of its kind since energy privatisation in the 1990s.
In July 2015 the CMA published its initial findings, which put forward around 20 proposed reforms aimed at boosting competition within the retail energy market and removing barriers to engagement for customers.
In June 2016 it published its final market reforms. These included 30 measures it hoped would drive down costs by increasing competition and helping more customers switch to better deals, while protecting vulnerable customers.
Since then, Ofgem has been implementing these remedies, and competition in the market has increased to the point where many of the more than 70 suppliers in the market are struggling to make money. Some are even being forced out of business.
Smart meters
Smart meters will have a positive effect on the market in the long run, according to PA Consulting’s Peter Siggins. “An increasing customer interest in not only energy consumption but where we’re buying it from, will mean we continue to see a positive transformation in the market,” he says.
The government-led initiative aims to deploy 50 million smart gas and electricity meters to every UK domestic property, and smart or advanced meters to smaller non-domestic premises.
This rollout is being led by energy suppliers, who are required to take what Ofgem refers to as “all reasonable steps” to roll out smart meters to all their customers by 2020.
Although it is widely agreed that smart meters will benefit consumers in the long run, the rollout has been plagued with major delays and setbacks.
Latest figures show that almost 12.8 million smart meters are currently in operation. However, most of these are first-generation SMETS1 meters, not all of which will be interoperable and could go dumb if the customer switches to another supplier. It is predicted that more than seven million more SMETS1 meters have been installed than were originally planned.