Bad regulation, not price caps, to blame for the chaos in the energy market


The cost of failing regulation in the energy market is increasing.

Supplying gas and electricity to Bulb’s customers this winter will require a £ 1.7bn government loan to cover the working capital of the defunct company through April. That’s over £ 1,000 for each of its 1.7 million households, or around £ 60 per UK household.

Whether or not that money is ultimately lost depends on what can be clawed back in Bulb’s special administration process, in fact a form of government ownership, and what kind of hedging the company has made, in a market where regulator Ofgem estimates it costs £ 700 more than the current energy price cap to supply an uncovered customer at wholesale prices.

It is not over, of course, for UK consumers. The bulb was too big to handle by the supplier of last resort system which has solved more than 20 failures since August by dividing customers to stronger suppliers. The cost could be north of £ 2 billion, believes Martin Young at Investec, which will be partially passed on to billpayers via the sector tax.

This is a large-scale political failure, in which the risk taken through flimsy, out-of-the-box business models ends up with consumers and the taxpayer. But those who simply blame the cap on energy prices were wrong.

Bulb was not a ‘tease and squeeze’ merchant, luring customers with low fixed rates before tipping them near the price cap. There was a variable rate. But it had grown very rapidly and was perpetually in deficit, poorly capitalized, and in fact sold energy at cost. Its gross margin until March 2019 was 1%.

His situation had seemed precarious for some time. The statement of continuity in its March 2020 accounts implied that it was dependent on a letter from parent company Simple Energy Limited (which only owns Bulb) guaranteeing support for an additional 12 months.

It had a £ 55million loan facility (again guaranteed by its parent company). Compare that to Octopus Energy, which at the time had a similar number of customers, with its £ 340million of funding committed in its April 2020 accounts. wholesale provides details of a “strict and sophisticated” hedging policy, the word “hedging” doesn’t even appear in Bulb’s similar disclosure.

The reality is that Bulb probably didn’t have the track record to follow the paint-by-numbers model provided by the regulator for protection in line with the price cap assumptions. He did not have to do this and it is not known how much he covered.

The price cap is not perfect: Ofgem has already started soliciting opinion on incorporating some additional costs and updating it more frequently than every six months if necessary.

But the absence of a cap would arguably not have saved some of the undercapitalized, unprofitable and unhedged companies that have fallen victim to massive increases in electricity prices. A company should have raised prices so high relative to competitors who had smoothed market exposure that it would have bled customers, an industry executive said.

The government is now rightly saying that its priority is “to protect consumers, not businesses”. The policy of soaring wholesale prices in an uncapped world would be ugly for the industry. Indeed, the conversation about how much bills are due to rise by next April and how to mitigate that is an looming political challenge.

The mistake was to cap retail prices while allowing companies that seek growth at all costs to take enormous amounts of risk with commodity prices that were in fact supported by the state. Recent developments in electricity prices would likely have led to failures in most schemes, says Peter Atherton, industry consultant. But energy policy ultimately means that “government is the supplier of last resort – always has been, always will be,” he said.

A regulatory environment taking into account this risk for the taxpayer would have applied the existing rules more rigorously. It would have set the bar much higher for new entrants, much earlier. And that would have imposed more stringent requirements for hedging wholesale price risk.

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