The last few years have been difficult times for UK Utility companies. Changes such as Brexit negotiations, no new subsidies in the renewables sector, and talks of nationalising key parts of the UK Energy sector, have dented investor confidence – and seen stock prices impacted. Today another part of the changing market environment, the Energy Cap bill, was debated in parliament, with cross-party support for legislation claiming to fix a “broken” energy system that “rips off” consumers. Is this the final nail in the traditional utility coffin, or the push that the industry needs to move away from incumbent positions to more rapidly shift to bundled energy management solutions?
While the proposed energy price caps will result in a significant reshaping of the market, and impact profits, key players are not waiting for the changes to come into place before reacting. We are already seeing suppliers moving away from standard variable tariff (SVT) products, such as British Gas’ announcement last November. We expect to see this trend continue with a move toward shorter term fixed and tracker tariffs to minimize commodity risk and more effectively price for prevailing market conditions. While this will start the transition away from SVT products, how the cap on pricing will be administered is still unclear, so further change is inevitable as the bill moves into law.
Historic apathy
One thing that is clear, is that this move by the government in support of price caps indicates a policy shift away from market choice towards direct intervention. This approach seems driven in part by the historic apathy of UK energy customers: despite the highest switching rates since 2010 only 15.8 percent of households compared prices and switched supplier in 2017. This apathy tends to undermine the ability of competition to bring down prices over time. Thus, the government intends to force down rates by legislating lower ones.
From a regulatory standpoint, this is going to create more complexity. With green tariffs exempt and a large number of vulnerable customers already operating under a cap of their own, managing the cap is not going to be straight forward with decisions required on both switching approach and tariff design. It will also be interesting to see how the regulator manages time of use tariffs under the cap, as that could make a far bigger impact on both pricing and open the door to some of the market changes necessary to support more effective energy management across the industry.
This policy shift is already creating an impact. Customer activity in the market has improved with switching increasing significantly in the past few months. 400K customers switched supplier in January, a 14% increase on 2017. This is likely as a consequence of media coverage of the SVT changes and increased communication from suppliers. With a potential shift to shorter term fixed and variable tariffs, consumers are going to need to engage more with their suppliers. From a customer standpoint, this is going to get more invasive for less return as the savings they will see are likely to be smaller and more dependent on broader market dynamics. However, increasing the levels of engagement could create the demand for, and opportunities to sell bundles (from energy management to full connected home) of products to drive customer value.
Depressing margins
From an operational perspective, efficiency is going to be the key moving forwards. More products for shorter periods of time will make things like customer communication and administration more complex and time consuming so the cost of administering these new tariffs will increase. This is going to make it more difficult for smaller players and more costly for all providers, further depressing margins.
The risk profile is also going to change. With SVT disappearing, managing elements like commodity risk are going to be increasingly important. Developing tariffs that minimise exposure and energy trading approaches that offer some protection will be key to delivery.
More significantly, proposed price caps may reduce the number of competitors in the market. Some large suppliers are already confronting losses, such as EDF Energy and npower which were in the red in 2016, and would see even further erosion following the imposition of a cap. We have already seen some changes in the market with smaller players disappearing, some new players such as Shell and BP taking positions, and even larger providers such as SSE and npower considering their options. By constraining prices in the market, this series of caps will give a competitive advantage to suppliers with low operational costs, who can eke out profits even in a restricted pricing environment. For some smaller power suppliers, the only option may be consolidating to increase scale and provide capital for investment in digital systems that can reduce customer services costs.
What’s the bottom line? The government has concluded that customer choice has not driven down prices as hoped, so it’s designing a protectionist customer approach. Reduced choice in energy retail seems the inevitable outcome in the short term, but the Price Cap bill may usher in some of the broader market changes that are needed to drive longer term energy market performance.