Energy Retail: Time for a new model
If nothing else, the current gas price crisis, and the consequent failure of multiple suppliers must now catalyse a fundamental review of the energy retail market model which has been in place since privatisation in 1998.
The politically acceptable view of the current situation is that all those new entrants who have failed were badly run- so it’s right that they have been allowed to fail. This is undoubtedly true of a few, but deeply insulting for many, who were desperately trying to offer customers something different, socially acceptable and progressive whilst operating in a regulatory strait jacket. It feels like we’ve lived through a very bad experiment if the outcome of all of this is that we end up back where we started at privatisation, with 6-10 suppliers sharing and dominating the market in a pseudo regulated oligopoly.
At the root, which has come sharply into focus, is the fact that you cannot control or beat a commodity price, and particularly one which is driven by a worldwide market. Suppliers cannot, and never have been able to, fundamentally differentiate themselves on price.
Anyone exposed to the risk of rapid and unexpected market movements needs access to short term cash. With the best will in the world, in energy retail, however good your hedging, there is never certainty on customer numbers or demand until the point of delivery. A sudden cold snap, for example, and heating being turned on can have a big impact on demand. Last minute balancing in short term markets is a function of running an energy supplier- and exposure is limited only by the quality of forecasts and perfect hedging. With eye watering prices (peaking at almost £2,000 MwH) in the last few weeks, and lack of liquidity in the traded markets, deep pockets of cash to sustain the shock of imbalance has applied to all suppliers, not just the small. The large suppliers, for now, have deep enough pockets and cash reserves to weather the storm.
But small, and undercapitalised suppliers cannot survive these shocks- and never will be able to.
So how do we develop a properly competitive retail market which enables innovation, particularly in relation to zero carbon objectives, but also protects vulnerable and fuel poor customers?
Generally, the trouble with companies of scale is that they lack the agility or chutzpah to deliver innovation at speed. Most new innovations in the retail market in the last few years have originated from the smaller players- and got to market quicker, because of their size. We will not get the necessary behavioural change and transition to the apocryphal ‘energy as a service’ world by relying on a few large monolithic players. The capital and social demands of change can be driven by energy retailers with the development of new products and services offered to their customers, but it needs to be done at pace with innovation as an essential catalyst. There is no lack of ideas in how to do this.
Protecting vulnerable and fuel poor customers has always been an important priority for the Regulator and Suppliers, and this mustn’t change, particularly now when prices are going up so steeply. But the demands, needs and behaviours of these customers are very different from those on whom the energy transition depends. The ability to afford the heat and light in a home is the only real priority for this important group of customers, and they need as much protection as the market can give.
So, we have some fundamental incompatibility baked into the market design and need to think more radically to create a fit for purpose market.
With the price cap, and despite all its flaws, we effectively now have a ‘national’ tariff. With rising prices, it is no surprise that all suppliers are converging around that tariff and price comparison websites have lost their raison d’etre.
But perhaps this is part of the answer- a hybrid nationalised/private model. The nationalised bit would be a standard tariff, which is set and underpinned by the regulator on behalf of the government. The tariff could be set dynamically, say monthly, and adjusted to recover the changing cost of commodity and imbalance. Potentially, prepayment customers and fuel poor could have a separate discounted tariff which avoided some of the socialised costs associated with investment incentives. The private part of the model would cover everything else. Suppliers would continue to bill and manage the customer experience, but without bearing the commodity risk. This would then enable the true development of new products, services and business models which genuinely create differentiation and accelerate the transition to a net zero world. In this scenario, it is easy to see successful new entrants emerging who are focused on dynamic management of heating, or transport or energy efficiency- selling energy solutions rather than just the commodity. This is what most suppliers are trying to move to today- but the crippling demands of commodity management do not allow the bandwidth or free cash to deliver at pace.
This might not be the perfect answer and undoubtedly needs more thought. But having lived through the market experiment to date and understanding the challenges that face us going forward- I am in doubt that we need to rip up the current market design if we are to achieve our net zero ambitions. I know that my frustration at the state of the retail market is shared by many, not least all the hundreds of bruised employees and leaders who have worked so hard and are now looking for new jobs. It is time to create something very different.