One could almost feel sorry for the big six energy suppliers. In recent years, the giants who make up around 80 per cent of the UK’s gas and electricity supply markets – British Gas (owned by Centrica (CNA), EDF, E.ON, RWE NPower, Scottish Power and SSE (SSE) – have been targeted by political rhetoric around the cost of default price plans, known as the standard variable tariff (SVT), and moves from regulators and government to increase the level of competition in the market. This has led to a significant number of customer losses, with no clear end in sight.
These regulatory challenges aren't likely to abate any time soon, but it's not yet clear just how severe the impact will be on those currently leading the market. The first thing to remember is that the big six aren’t quite as big as they used to be. Where once they were vertically integrated companies covering the generation, transmission and supply of energy, this is less and less the case. In recent years, Centrica has shied away from its exploration and production business to focus on its customer-facing businesses – with mixed success – while SSE and RWE are proposing to exit the household energy supply sector altogether.
The threat of a price cap
Talk of price controls on energy is nothing new. Former Labour leader Ed Miliband floated the idea of a cap back in 2013 before making it a pledge in his 2015 Labour manifesto. The Competition and Markets Authority (CMA) also carried out a two-year investigation into energy prices that concluded in mid 2016. The investigation decided to limit a cap to a transitional arrangement for those on prepayment meters and forced companies to hand over details of customers who had been on the SVT for more than three years. These were then put on an Ofgem database to encourage rivals to approach customers with cheaper deals.
However, in April last year, the threat of a wider-ranging cap reemerged, with then-secretary of state for work and pensions Damian Green promising “a lot about energy prices” in the Conservative manifesto. In the event the manifesto proposed an independent review into the cost of energy, culminating in draft legislation imposing an absolute cap on SVT prices until the end of 2020, with the potential for extensions until the end of 2023. The Conservative manifesto going into the last election said the now-government’s ambition was for the UK to have "the lowest energy costs in Europe, both for households and businesses”. A comparison of energy bills across the EU carried out by the Centre for Policy Studies indicated people in the UK paid the third-lowest average energy price in Europe, including taxes and levies. Even so, further government action is possible.
The big six have not sat idly by in the face of disruption. Late last year, SSE announced it would look to spin out its household energy supply business. The division would be merged with NPower, the big six supplier owned by RWe via its subsidiary Innogy. This would effectively withdraw the two parent companies from the household energy supply market, although SSE shareholders would retain a 65.6 per cent share of the new group. Market regulator Ofgem said that they "would advise relevant authorities if [it] were concerned that a merger would not be in consumers’ interests”, so it's unclear whether it will go ahead and, if it does, how quickly, but the message is clear: household energy is no longer an attractive place to be.
Centrica took a different tack, announcing a raft of policy changes it would adopt and suggestions for changes government could make, such as abolishing the SVT, introducing fixed-term default tariffs and proposing the government fund energy policy costs through general taxation rather than bills.
Increasing competition
Measures to increase the level of competition in the market have also taken a toll. The number of gas and electricity suppliers has increased sharply in recent years, from 11 in December 2007 to 60 in June 2017 – the most recent figures. As competition has increased, the market share of the big six has slipped. Collectively, they went from controlling 99 per cent of the gas supply market in the second quarter of 2012 to 80 per cent in the same period of 2017, while in electricity supply they went from 100 per cent to 82 per cent during the same period.
In its recent policy proposals, Centrica highlighted the advantages enjoyed by smaller energy supply companies, which are not subject to the same policy costs as their larger rivals. For example, the Energy Company Obligation, which is intended to help reduce carbon emissions and fuel poverty, only applies to suppliers with more than 250,000 domestic customers, or who provide more than 400 GWh of electricity or 2,000 GWh of gas.
Centrica’s policy proposals said: “Some customers are being made to pay more for these costs, whilst others are exempt. This is driving price distortions in the energy market and also creating advantages for some suppliers to undercut others.”
Richard Howard, head of research at Aurora Energy Research, noted that any supplier with more than 1 per cent market share was likely to be subject to the obligation, but added that there was a long tail of smaller suppliers who would not be subject to increased costs.
While they may not enjoy any obvious policy advantages over their smaller rivals, the big six do still retain the benefits of scale. They can typically borrow money at a cheaper rate and tend to be more diversified. SSE, for example, has a sizeable portfolio of generation assets and a networks division, whereas smaller suppliers are more likely to be ‘pure-play’ investments.
Even these, however, must be looked at closely. Smaller, more distributed forms of energy generation are becoming prevalent in the UK and elsewhere, threatening the supremacy of larger power stations.
Mr Howard said: “Distributed generation makes up roughly a quarter of all generation [in the UK] by now,” adding that smaller generators can often connect directly to distribution networks and avoid the costs of transmission – although Ofgem is looking to take action on this too. Energy companies are also taking action. Centrica has been investing heavily in its distributed energy and power division, while SSE has been trialling active network management technology to allow it to balance supply and demand more flexibly.
Increases in the number of private suppliers are not the only problem; local authorities are increasingly looking to set up their own energy supply companies in a bid to reduce costs for customers. Should they succeed, this will strengthen the case for publicly owned energy companies, as was laid out in the most recent Labour manifesto.
