Cheapest retail tariffs may threaten health of UK gas and electricity market

Sources at several UK gas and electricity suppliers have expressed concerns over the viability of the cheapest tariffs currently available in the retail market in light of recent rises in wholesale commodity costs. Liquidity in the wholesale market could be at stake, should the retail-sector suffer from bankruptcy, they have warned.

According to trade body EnergyUK, the number of suppliers offering gas and electricity tariffs has increased from 27 to 44 within in the last two years.

The increase in independent suppliers has helped preserve liquidity in the wholesale market following the departure of a suite of financial institutions in 2013 and 2014, as falling prices and regulatory upheaval deterred speculative activity (see EDEM 7 January 2014).

However, a gradual shift of customers away from the biggest six vertically integrated utilities to a growing base of independent suppliers has increased demand from physical purchasers of gas and electricity in the wholesale markets.

‘Unable to wash their face’

Good Energy’s director of trading and origination Mark Meyrick told ICIS: “It appears that there are a lot of retail offerings out there that unable to wash their face at current [commodity] price levels.”

“This could be a real risk to smaller suppliers’ viability going forward because, if a company’s loss leader tariff turns into an insolvency, the rest of us potentially end up paying for it via the settlement system,” he added.

Far curve wholesale gas and electricity prices sank to record lows in January this year, trading off bearish sentiment from a near-13-year low on the Brent crude oil benchmark contract. A milder-than-average winter also restricted gas and power demand below typical winter levels, allowing gas to remain in storage and sending bearish signals to forward wholesale gas and electricity contracts.

Since mid-April, both the NBP natural gas and UK power markets have staged a prolonged recovery, aided by some value returning to the oil benchmark, but also bullish currency movements and some supply risk.

The cost of gas delivered for this winter has increased by 42% at the NBP hub since 15 April while the value of electricity for the period has increased by 29% during that time, according to ICIS data.

‘Volatile market’

Another trader from an energy-to-business supplier said: “There are some new entrants that think they can make money by keeping prices fixed not realising there is a very volatile market sitting behind the scenes.”

“We track every change in the industry – EMR [electricity market reform] costs, FIT [feed-in-tariff] costs – it all has to be factored in,” he added.

“I just wonder if the new guys do that or even know about some of these charges. BSUoS [balancing services use of system] has become wildly erratic because of National Grid balancing measures.”

Currently 12 companies are offering annual household tariffs below £800 in the market, according to latest data compiled by EnergyUK.

The average of the cheapest ten tariffs in the market dropped from £798 in early January to £744 in mid-June, although this has increased again to £763 in recent weeks. However, the number of tariffs below £900 has increased from 32 in early January to 49, according to the latest EnergyUK data collected on 11 July.

According to one source, current commodity and network costs amount to more than £800 excluding additional green subsidies that are usually accounted for by suppliers in the end-user bill. This indicates that any tariff offered under £800 could struggle to break even.

Commercial strategy

However, companies that hedged the majority of their commodity costs before the recent recovery could benefit from the ability to offer cheaper tariffs, according to another trader at an independent supplier.

“If you’ve got a lot of your hedging away [during the first quarter] then even at the bottom of the market you could be profitable,” he said. “It just depends on your hedging approach.”

“That said, some of these tariffs are clearly not profitable,” he added. “Either these suppliers have some sort of fixed or variable kicker they’ll hope to roll their customers on to after the first year to recover losses or they’re going for grow-the-base-and-sell [approach] or they’re simply just not operating a sustainable long-term business strategy.”

“It’ll be interesting to see how long this can be sustained, especially with the Rough [storage] outage driving prices back up.”

Industry sources are also concerned by plans proposed by the energy regulator Ofgem to activate a levy known as the ‘industry arrangement’ where suppliers of last resort (SoLRs) are appointed or volunteer to take on the customers of a bankrupted competitor.

A consultation , launched last month and closing at the end of this week, proposes allowing Ofgem to use the levy in support of a SoLR when it settles the credit owed to customers of the failed supplier. This levy is added to the distribution use of system charges paid by gas transporters and electricity distributors.

When asked about concerns that tariffs are not reflective of recent rises in wholesale commodity costs, EnergyUK said it did not comment on the pricing and costs of its members or other suppliers.

Ofgem also refrained from commenting on the concerns. “In a competitive energy market, the prices suppliers set for customers are its own commercial decision,” a spokeswoman said. henry.evans@icis.com