A shade of Evergrande in UK’s energy crisis

Barely a week goes by without a UK electricity and gas supplier being toppled by soaring commodity prices. Millions of British customers face an unsettling wait to learn if their power provider will survive, who’ll take over their contract, and whether their energy bills will increase. Britain’s energy regulator Ofgem — the Office of Gas and Electricity Management — has written to those companies still standing demanding urgent information on their finances.
Alas, after studying some of their recent published accounts, the responses to Ofgem are reassuring. Even before energy prices skyrocketed, many suppliers were loss-making and had liabilities far in excess of their few assets.
To be sure, government-mandated price caps make life tough for energy retailers as they can’t easily adjust tariffs to reflect their costs. For small suppliers that want to fully protect themselves against commodity price swings, such hedging can be prohibitively expensive. Yet the foundations of this extraordinary crisis were a lack of financial resiliency, light-touch regulation and unsustainable pricing practices that left the industry unprepared for its Black Swan moment. “Rising electricity and gas prices pushed suppliers over the edge but weren’t the root cause,” says Investec utilities analyst Martin Young.
This tale of inadequate capital buffers and “moral hazard” will be familiar to students of previous crises. And its resolution will be similar too: a bonfire of the energy suppliers, in which the small fry are consumed by better capitalised entities. Big suppliers will get even bigger. Injecting more competition into a market once dominated by the “Big 6” energy companies like British Gas (owned by Centrica Plc) and EDF Energy (Electricite de France SA) was well intended and achieved some success.
The market share of legacy suppliers has dropped to around 70% and new entrants helped spur innovations in clean-power tariffs, online services and smart-meters, aiding energy efficiency and the decarbonisation drive. Providers were forced to become more efficient and, at least in some cases, customer service improved. Well-funded entrants like Ovo Energy Ltd and Octopus Energy Ltd, which received a $600 million investment from Al Gore’s Generation Investment Management LLP last month, have achieved scale economies, in part by absorbing rivals. Ovo took over SSE Plc’s retail arm in 2019 while Octopus has taken on more than half a million customers from the failure of Avro Energy.
But because licenses and software were cheap to come by, there’s been a proliferation of less resilient players. At the peak in 2018, there were 70 companies supplying energy to British consumers. That number has since fallen to fewer than 40 and many more exits and failures are expected before winter’s end. Perhaps there’s such a thing as too much competition.
The new entrants expanded rapidly because it was their best hope of generating cash. As we’ve seen in the airline industry and now with Chinese property developer Evergrande, getting customers to pay in advance is a cheap source of funding. The energy suppliers held up to 1.4 billion pounds ($1.9 billion) of excess customer cash, or around 65 pounds per household, Ofgem estimated in March, and they weren’t required to ringfence that money.

—Bloomberg