As the domestic energy supply sector is predicted to begin making profits for the first time in five years, Ofgem has issued a warning that suppliers need to make sure they have sufficient capital reserves before paying dividends to their shareholders.
The industry regulator has called for a balance to be struck between the need to maintain a resilient consumer sector and the need to build a well-functioning and competitive market: one that offers a fair deal to consumers on price and delivers better service standards.
The news that the domestic energy supply sector has not, on average, made a profit for the last five years may be surprising to many. However, news stories about ‘energy companies’ making record profits often blur the lines between the companies that extract and commoditise natural gas or generate electricity – the generators – and those that buy this gas or electricity and sell it on to consumers – the suppliers.
As a result of the consumer price cap, and the fixed price deals that some suppliers have offered, suppliers need to hedge their exposure to the volatile wholesale markets. If they fail to do so, or if the companies they are hedging with fail, they will need to draw on financial reserves or else themselves become insolvent. This is, essentially, what happened to 29 energy suppliers between July 2021 and May 2022, and the enormous cost of these failures, around £2.7 billion, has led to Ofgem calling for suppliers that do not yet meet the new capital requirements to retain profits rather than pay out dividends.
So how can suppliers strike the balance between the need to maintain a resilient sector, build a well-functioning and competitive market that offers a fair deal to consumers on prices and deliver better service standards, whilst at the same time generating sufficient profit to keep their shareholders happy and willing to inject more capital into the market?
Suppliers need to have confidence in the price they will be paying for power and need to ensure they are hedging their prices in a variety of ways. Suppliers may own, or be owned by, generators, and are therefore able to balance any losses in their supply business against profits earned by this generation arm. Suppliers may also have entered into long term power purchase agreements with generators to protect themselves against spikes in the wholesale price of energy. Alternatively, suppliers may remove themselves from the volatile markets altogether, and facilitate a business’ need for secure and predictable energy costs by pairing them with a generator and collecting a predictable, long-term income stream to facilitate that service.
These are all ways the ‘supply’ part of the supplier’s business can be controlled. However, increasingly, the ‘demand’ side can impact on a supplier’s profitability also. The energy market is becoming more flexible, with domestic consumers increasingly having access to energy storage through heating systems, electric vehicles or batteries, or on-site generation such as solar panels and heat pumps. Suppliers are uniquely positioned to take advantage of this flexibility. By offering those consumers flexible contracts that give them the ability to purchase power at times when the wholesale price is cheapest, a supplier can save their customer money and take a cut of the savings as additional profit.
Suppliers have already demonstrated their ability to influence when consumers use electricity. Last winter, some suppliers took part in the National Grid Electricity System Operator’s Demand Flexibility Service. This service aimed to reduce short term spikes in national electricity demand by incentivising customers to reduce their demand at certain times. The service was successfully able to shift 2.2 GWh of electricity demand from peak times, reducing the need for expensive short-term generators and reducing overall costs for suppliers. If suppliers can encourage their customers to take advantage of cheaper, and often greener, electricity at other times of the year, this could be a massive opportunity to save customers money and increase profits.
Suppliers have long been squeezed between high wholesale prices and low customer spending power, and finding a way to make a profit can seem like an impossible task. However, there is increasingly an opportunity for suppliers to generate independent value from their unique position between generators and customers. By navigating the market and exploring ways to influence how and when customers consume energy, suppliers can save people money on their energy bills, and take a cut of that saving for themselves, ensuring that both shareholders and customers emerge as winners.