Gas market crisis: the implications for energy companies

It has been an extraordinary time for energy markets. Natural gas prices have soared. The UK derives a significant share of its electricity from gas, so there has been a secondary impact on electricity prices. Energy price caps mean that not all these price rises can be passed on to consumers, creating problems for energy companies. Some have been pushed into insolvency as problems have worsened.

A number of factors have conspired to create a rapid rise in prices. These are partly global: concerns over supplies from Russia, but there are also problems with storage volumes after low levels of gas were retained over the summer.

There are also domestic factors: a fire shut down one of the UK’s most important supply cables from France, at a time when supply was already constrained. The cable will continue to be out of action through the crucial winter period.

Implications

The problem for energy companies is that standard variable tariffs (SVTs) have a price cap that is set twice a year. While this will be set at higher levels to reflect higher gas prices, it won’t fully reflect the increases. This will create a financial crunch for many energy firms.

Energy firms that offer fixed tariffs with inadequate hedging in place will be in a particularly tough position. They are likely to see a direct impact on their cash flow and in extreme examples, this will lead to insolvencies. This is unlikely to be confined to the smallest suppliers, and may also impact mid-tier suppliers. At the time of writing, nine suppliers – including Avro, Utility Point and People’s Energy – have already failed, leaving over 1.7 million domestic customers to be switched to another supplier through Ofgem’s Supplier of Last Resort (SoLR) process.

Supplier of last resort?

There may be an opportunity for more stable suppliers to bid for customer books from failed suppliers through the SoLR process. Energy firms bid on factors including service levels, the prices they’ll charge, honouring commitments the previous supplier made and making good credit balances. However, these firms will need to buy the energy for these failed suppliers at today’s prices, but can only charge those standard variable tariff customers at the price cap level – a potentially loss-making way to acquire new customers, if they switch to another supplier after winter.

Ofgem is likely to need to top up any lost cash from a fund it has established for failed suppliers. However, this comes with a sting in its tail. The fund is recharged back proportionally across all suppliers – so even mid-tier suppliers will be hit with significant one-off bills from Ofgem next year to fund these losses across the sector.

Government support

There has been debate over whether the Government will step in to bail out failing suppliers. However, the Government has robust systems in place to protect customers, so it is unlikely that it sees the failure of individual suppliers as significant. When the Government opened up energy markets, it set the barriers to entry low to increase competition – as a result, supplier failures and market consolidation is to be expected.

The need for renewables

The recent turmoil in energy markets highlights the need for a more secure energy mix and in particular, it pushes the case for greater use of renewables. This is already happening: the Government has put support in place for businesses to build extra renewable energy capacity. For example, in the most recent round of its renewable energy support scheme, it has allocated £200m for offshore wind, including £24m ringfenced for floating offshore wind projects. Ultimately, UK energy markets will only achieve real resilience with greater domestic renewables production.

Considerations for energy firms

This is a precarious moment for directors of energy firms. They need to be careful about their responsibilities in a tough environment, and need to consider implications of wrongful trading. However, opportunities may also emerge – for new customers and for merger and acquisition activity.

At Smith & Williamson, we can help energy companies wherever they need it. That may be supporting with insolvency considerations, alongside cash management and getting funding into energy suppliers, or Supplier of Last Resort bids for those more stable suppliers looking to grow. We can also help with the tax implications on restructuring, investment or M&A. We have considerable experience, so please don’t hesitate to get in touch.

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication

Smith & Williamson LLP Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities

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DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Smith & Williamson Investment Management LLP
Authorised and regulated by the Financial Conduct Authority
Smith & Williamson Investment Management LLP is part of the Tilney Smith & Williamson group.
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