Last week, a couple of smaller energy companies went bust. I’ve been around a couple of businesses that have failed, and it’s never a good thing. It’s easy to trot out the capitalist line that company failures are an important part of the efficiency of the capitalist system but frankly it’s often a very difficult and stressful time for the people involved. Bluntly, losing your job because your entire company disappears can be a very stressful and difficult experience. Sometimes many employees also have no warning that it’s coming. I encourage you to think about what the personal impact would be of having your salary/work stop cold with little warning. Now, think about that happening if you were already under financial stress and pressure. This isn’t a blog about financial literacy and helping people to plan for emergencies, but I want to recognise the human cost of these situations before we get into economics, regulation, game theory, and similar. I hope that the employees at those companies are able to navigate the current period successfully.
Here’s what I wanted to look at: how the energy market works -- or doesn’t. Here’s a simple summary. Energy provision, in my simple non-economist view, is what my A-level economics teacher (shout-out to Mr Reid, who was one of the most entertaining and informative men I’ve ever listened to) used to call a ‘natural monopoly’. There’s one network/system for delivering the product, it is the same product no matter who delivers it (at least in the way the customer experiences it), and in essence we have a bunch of billing/marketing/customer service companies layered over the top of a uniform product and single delivery system (which is itself split up into multiple companies, but that’s another story again).
All of which means that when you change suppliers, the lights still go on, and the energy still comes through on the same wires and pipes. Nothing really changes except who adds up and sends you a bill. It’s really not like buying a new car.
The Thatcher government deregulated the energy sector in the 1990s. There were further reforms, importantly the introduction of a ‘price cap’ under Theresa May’s regime. Ofgem (the regulator), is responsible for setting the cap, which is the maximum amount that a company can charge on a default variable tariff. The fixed rate deals, and certain green tariffs, are exempt. These caps are set every 6 months, and have been rising of late.
However, the actual underlying wholesale price of energy - which is what providers actually pay for the energy that they sell to us as consumers, has also been rising - more quickly, and more steeply than expected. So there’s now a small gap - or no gap at all - between the price of the ‘raw materials’ paid by providers, and the maximum amount they can charge. Worse still, they may have customers on low fixed-rate contracts, which have become less profitable, or worse still, completely unprofitable. This is especially challenging if the provider doesn’t operate sophisticated hedging of their forward exposure to wholesale price changes (yes, some suppliers contract to supply customers at a price they can’t guarantee they will be able to meet profitability).
As a result of all this, some suppliers get into trouble. There is a process for moving customers to another supplier, which is managed by Ofgem, but the new supplier doesn’t have to honour the tariffs that the bankrupt firm’s customer were on, so customers can end up paying more when they are moved to a new supplier. (Although, in a situation like there is right now, there isn’t a great deal of difference between suppliers in pricing terms, because there isn’t much wiggle room between costs and the cap on revenues.)
So here’s the irony: right now, the price cap - that many said wouldn’t help the customer - is actually really helping the customer, because it’s making it extremely hard for any energy company to make much money at all. In the short term prices are lower than they otherwise might be without the cap, so people are paying less.
This lack of room to make profit is an interesting point in political terms, because there didn’t use to be any profit made out of energy provision, back pre-Thatcher/Lawson. (I should note that Ofgem as an operation is independent - leadership is appointed by the Secretary of State, but their role is to protect customers.) And then we return to that capitalist question of whether failure of businesses in a regulated market is a good or a bad thing - and whether a regulated market being squeezed is a good thing. Generally speaking, profit in competitive markets leads to investment, and investment, if well directed, leads to better outcomes for consumers. Better outcomes for consumers - better billing systems, better customer service, fewer mistakes which lead to endless calls to call centres, or call centres that actually work - those are clearly good things. Those are things that people are willing to pay for - at least, I’d pay to avoid a call to a call centre, all things being equal...
I’m not sure there’s an easy answer to this. Squeeze the industry until it fails and re-nationalise it? How will we get the innovation required to deliver the complex transition to sustainable energy and micro-generation that is required to solve our environmental challenges? Is that fair for investors who believed that the regulatory environment would be stable? Temporarily squeeze out some of the many suppliers until more efficient suppliers only exist? Is that fair, or right for competition? Immediately get back to raising the price cap aggressively, enabling more suppliers to play pricing games that exploit customers, but that allow headroom for future investment? Whichever way the regulator and the government choose to move, there’s a need for consumers to watch out, and be aware, because it can be quite easy to find yourself with the wrong provider, on the wrong plan, and just getting it wrong.
If only there was a product that had my best interests at heart, that could do all of this stuff for me...
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