Poor regulation, not price cap, to blame for energy market mayhem

The cost of failed regulation in the energy market is mounting.

Keeping Bulb’s customers supplied with gas and electricity this winter will require a £1.7bn loan from the government to cover the defunct company’s working capital until April. That’s more than £1,000 for each of its 1.7m households, or about £60 per UK home.

Whether or not that money is ultimately lost depends on what can be recovered in the Bulb special administration process, in effect a form of government ownership, and what type of hedging the company did, in a market where regulator Ofgem reckons it costs £700 more than the current energy price cap to supply an unhedged customer at wholesale prices.

That isn’t the end of it, of course, for UK consumers. Bulb was too large to be handled by the supplier of last resort system that has cleared up over 20 failures since August by parcelling off customers to stronger suppliers. The cost there could be north of £2bn, reckons Martin Young at Investec, which will partly be passed on to bill payers via the industry levy.

This is policy failure on a vast scale, whereby the risk taken through flimsy, supplier-in-a-box business models ends up with consumers and the taxpayer. But those simply blaming the energy price cap have got it wrong.

Bulb wasn’t a “tease and squeeze” merchant, attracting customers with low fixed rates before flipping them close to the price cap. It had one variable tariff. But it had grown very quickly and was perennially lossmaking, thinly-capitalised and in effect sold energy at cost. Its gross margin in the year to March 2019 was 1 per cent.

Its position had looked precarious for some time. The going-concern statement in its March 2020 accounts implied it was reliant on a letter from parent company Simple Energy Limited (which only holds Bulb) guaranteeing support for another 12 months.

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

The reality is Bulb probably didn’t have the balance sheet to follow the paint-by-numbers template provided by the regulator for protection consistent with the assumptions in the price cap. It wasn’t required to do so and it’s not clear how much it did hedge.

The price cap isn’t perfect: Ofgem has already started canvassing opinion on incorporating some extra costs into it and updating it more frequently than six-monthly when needed.

But the absence of a cap arguably wouldn’t have saved some of the undercapitalised, unprofitable, unhedged businesses that have fallen victim to a massive rise in power prices. A company would have had to jack up prices so high relative to competitors that had smoothed market exposure it would have bled customers, said one industry executive.

The government now rightly says its priority is to “protect consumers, not companies”. The politics of surging wholesale prices in an uncapped world would be ugly for the industry. Indeed, the conversation about how much bills must rise by next April, and how to mitigate that, is a looming political challenge.

The mistake was capping retail prices while allowing companies chasing growth at any cost to take huge amounts of commodity price risk that was in effect backstopped by the state. Recent moves in power prices would have probably meant some failures under most regimes, reckons Peter Atherton, a sector consultant. But the politics of energy mean ultimately “the government is the supplier of last resort — always has been, always will be”, he said.

A regulatory environment that priced in that risk to the taxpayer would have policed existing rules more vigorously. It would have set a much higher bar for new entrants, much earlier. And it would have set tougher requirements on hedging wholesale price risk.


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