Gas & electricity suppliers fail as energy intensive users suffer

The last few weeks have seen unprecedented upheavals in energy markets. A global shortage of gas has seen gas prices trading at record highs, while a period of low wind output added further stress to high electricity prices.

10 electricity suppliers went bust in August and September, with more on the brink. The Government claims this is a result of poor management, and that there will be no bailouts. At the same time, energy intensive industries are threatening factory closures as input costs become unaffordable.

So what's going on, whose fault is it, and what should be done about it?

There is a global shortage of gas. During the pandemic, demand fell significantly, as production fell in response. However, last winter was colder than average across the northern hemisphere, meaning that gas inventories were significantly depleted.

As the global markets recovered from covid, demand began to grow at a faster pace than production was ramped up. This was exacerbated by upstream maintenance work which had been deferred from 2020 due to the pandemic. The result has been slower storage injections than normal, and a global gas shortage. Lack of storage in Asia, and relatively inelastic gas demand has seen Asian LNG prices soar as buyers seek to outbid the European markets, while European hub prices hit record levels.

There is a tendency to blame the Government for the UK's dependence on imports and lack of storage, but it is doubtful that either would have made a significant difference. The past few years have seen a benign environment for gas and the major imbalance due to the pandemic could not reasonably have been predicted. Had the Government provided the ￡1 billion or so needed to fix the problems at Rough and keep it open, gas prices (or taxes) would have needed to be higher to cover the costs. At some point, that strategy would be more expensive than paying high gas prices during times of market tightness.

The time these arguments have weight is when we cannot secure gas supplies at any price, but that is not currently the case. As almost half of Britain's gas comes from its own production and close to 30% comes via pipeline from Norway, the bulk of our gas supplies are quite secure. Norway has agreed to increase flows to the UK, boosting supplies further.

It's easy to criticise just-in-time supply chains when problems arise, but problems are actually rare, and arguably, there would have been no market shock had covid not happened. So the question isat what point is it reasonable to invest in just-in-case capacity?

But those are really questions for another day. The real issue is what should the Government do now. The Government has been smugly pointing to the retail price cap as protecting consumers from high market prices, but this is not what the cap was intended to do. It was intended as a temporary measure to prevent suppliers earning excess profits until the market became more competitive. Unfortunately, since its introduction, the number of suppliers has fallen by a third, so competition has hardly been improved.

And when suppliers are unable to pass costs on to consumers, they inevitably get into financial difficulties. This is predictable and has happened in other markets with price caps. So smaller, less well capitalised suppliers are going bust, while larger suppliers increasingly need to borrow in order to cover the mis-match between wholesale prices and capped retail prices. And every month that goes by makes the problem worse as old fixed price deals end and customers roll onto the capped variable tariffs which now represent the best value in the market. Even where they hedged their forward purchases they would not have anticipated being unable to recover those market costs, and historically hedging was more appropriate for fixed price deals.

Domestic consumers suffer because supplier failures cost money. Customers of failed suppliers are likely to immediately move onto more expensive tariffs because their fixed price deals are not carried over to the SOLR, while the cost of reimbursing credit balances can be shared among other suppliers and their customers.

Business consumers suffer because suppliers are now trying to recover some of the losses they are making on their domestic portfolios from business consumers. At least one supplier is refusing to honour fixed price contracts held by its business customers.

The Government needs to remove the price cap and restore order to the supply sector. But households do need relief from the high prices. This can be achieved in two ways: moving green levies which account for 23% of electricity bills into general taxation, and providing VAT relief for the duration of the winter.

For business consumers the green levies should be deferred, and recovered over a longer period of time, for example beginning next summer once global gas markets begin to return to balance.

Continuing to ignore the problem risks further chaos, and the complete failure of the primary objective of privatisation: the introduction of consumer choice. If all but the largest suppliers fail this winter, consumers will be left with the same old problem: a handful of suppliers and little choice. And how likely would they be to trust any future new entrants when their cheap deals, along with those new entrants, could disappear overnight.