Blame to spare in UK energy supplier debacle

Price cap was part of the problem, but lack of hedging and oversight also contributed

When the UK introduced a cap on household energy prices in 2019, the idea was to protect consumers from predatory suppliers charging above the odds for gas and electricity. Now, the shoe is on the other foot, with suppliers blaming the cap for driving more than 20 firms out of business when wholesale energy prices surged 250% in August and September.

They have a point. The cap sets the maximum amount a supplier can charge a retail customer on a variable tariff for their gas and electricity annually and is reset twice a year to take account of market prices.

When wholesale prices for gas and electricity jumped above the cap, suppliers were unable to pass on the costs of sourcing energy to customers. This has been the case in gas since April, and while prices have retraced in recent weeks, no end to the situation appears in sight.

But it’s not all the cap’s fault. Some of the blame lies with the suppliers themselves.

Going by the annual reports of the energy suppliers, few saw the cap as a problem until wholesale energy prices began to explode.

Firms offering variable tariffs largely assumed they would be able to adjust retail prices to match what they were paying for energy in the wholesale market. Those that hedged only did so out to a maximum of six months, meaning they were only protected for a short period of time once prices went above the cap.

Few saw the cap as a problem until wholesale energy prices began to explode

This begs a number of questions. First, why did suppliers sit on their hands while prices were racing towards the cap? Some may have run into credit limit issues, or had difficulty devising and executing a hedging strategy when prices were moving rapidly. But Risk.net’s conversations with market participants uncovered no real evidence of a change in supplier behaviour leading up to the point when the cap was breached.

Second, was no-one checking to see if these firms were prudently managing their risks? Actually, no. The UK energy regulator, Ofgem, has a mandate to protect consumers, not to oversee energy suppliers. From a risk management perspective, UK energy suppliers were largely left to their own devices  

Then, there’s the structure of the retail energy supply market. Ofgem encouraged new entrants into the market to break the stranglehold of the so-called big six energy firms, and made it easy for retail customers to switch between suppliers, meaning competition is intense.

That means prices are low, which is great for customers. But it also left suppliers operating with razor thin margins. That may have contributed to some being unable to hedge as much as they would have liked because they simply couldn’t afford it – or because they wanted to keep their market share and gambled on the market retracing.

When these firms collapsed, the so-called big six energy suppliers scooped up many of their customers, who may now see higher tariffs. So at the end of the day, the market is heading back more or less to where it started – with higher prices and a concentration of suppliers.

It’s not clear how or when this crisis will end and more pain is tipped to be on the way. But when the situation does calm, all those involved need to have a serious think about how risk management is applied in this sector.