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What has caused the Energy Market Crisis and what does it mean for the energy retail market?

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Matthew Olney's picture
Content Manager Dyball Associates

Content Manager for Dyball Associates who writes and creates articles on the latest Energy News, top tips, infographics and videos.

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  • Oct 4, 2021
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jjIt’s an unprecedented time in the retail energy market and times are tough for many businesses and suppliers operating within it. We take a look at what has caused the current crisis.

The Danger Signs 

There’s been plenty of discussions and blaming taking place in the media in recent weeks about who and/or what is responsible for the current crisis.

If you believe the mainstream media, the events we are experiencing were unforeseen and to an extent they’re right. No one predicted with certainty what was going to happen. However, now that we have assessed the situation further it is clear to see that warning signs for the current crisis were evident as far back as early 2020.

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The Covid-19 Pandemic

The first sign that something unprecedented was happening in the energy sector was the sudden plunge in wholesale energy prices caused by a slump in demand as a result of the way governments reacted to the Covid-19 pandemic.

Heavy industry, manufacturing and many businesses were forced to either halt operating or reduce production massively during the lockdowns. Millions of workers were furloughed.

As a consequence, energy demand fell sharply with wholesale prices plunging to record lows. We covered the fall in oil and gas prices in our 2020 Energy Price Forecast.

Winter 2020/21

Then there was the winter of 2020/21 that dragged on far longer than forecast. Freezing cold temperatures and snowfall persisted well into March putting immense pressure on demand for gas to heat the nation’s homes. Despite this rise in demand, prices remained low; initially.

The government then declared a national lockdown, one that was only supposed to have lasted a few weeks but dragged on for months. It was this that masked what was to come for wholesale prices.

Naturally, many energy suppliers took advantage of the situation and lowered their prices. A move that would leave them massively exposed to the inevitable spike in prices to come.

We could argue that such a move was short-sighted, that they were asking for trouble, but when we consider that the energy regulator and consumer groups had been consistently demanding that suppliers do all they could to support struggling consumers they weren’t exactly encouraged to raise or maintain their energy bill prices.

The decline in business energy use during the lockdowns weighed heavily on energy suppliers with many experiencing big hits to their finances.

Geopolitical issues

In the background and rarely mentioned in the mainstream media were the stirrings of geopolitical factors that have played a role in the current crisis.

Russia, sensing an opportunity to put pressure on its rivals in the European Union to authorise the start of gas flows via the controversial Nord Stream 2 pipeline used its state-owned energy giant Gazprom to restrict the supply of gas in the aftermath of the harsh winter.

The pipeline designed to deliver Russian gas directly to Germany via the Baltic Sea has caused controversy in eastern Europe as it will bypass both Ukraine and Poland.

Ukraine whose relations with Russia are at historical lows following Putin’s invasion and annexation of Crimea has seen the two nations engaged in a bitter conflict.

Ukraine’s gas giant Naftogaz accused Gazprom of deliberately withholding gas supplies to Europe and of blocking the gas transmission system of Ukraine from other Russian companies, effectively blocking exports from Asia that could be used for Europe and the UK.

Surging demand in Asia

Ironically the place where the Covid-19 virus originated is also the place that has proved to be a key factor in the current gas price surge.

China’s post-Covid economic recovery has been ravenous and when combined with increased demand across Asia and Europe demand and prices skyrocketed.

China’s insatiable demand for energy will continue to play a major role in the global energy market for the foreseeable future as currently, it is experiencing blackouts across the country due to lack of supply.

According to S&P Hlobal Platts, China’s demand for gas is likely to rise to 360 billion cubic metres this year, up from the 332 bcm in 2020.

Gas producing countries such as Qatar have stepped up their supply to China, at the expense of shipments going to Europe.

The surge in demand also combined with the harsh cold winter of 2020 that led to depleted gas reserves across Europe and the UK (more on that later). As a result, gas prices quadrupled in 2021 taking the market by surprise and putting immense pressure on energy supply companies.

An unprepared UK

Another key factor in the crisis we are experiencing today is down to the lack of preparedness of the UK itself.

For decades successive governments have been warned that the UK’s energy supply is insecure.

The over-reliance on fossil fuel and gas-powered plants has left the country exposed to commodity prices swings.

Instead of updating and building more nuclear power stations to keep up with demand the governments of the last two decades have allowed the current stations to age resulting in unplanned outages required for maintenance.

An over-reliance on imports has played its part with the fire at a French electricity interconnector further highlighting the risks. The closure of the interconnector only added to the upward pressure on energy costs.

The current government’s obsession with wind power has been exposed with the technology proving unreliable during the least windy months since the 1960's that made most wind farms effectively useless at the time of greatest need. 

This situation is only set to get worse as the government pushes ahead with its green agenda, closes all of the remaining coal power stations and the nation’s nuclear fleet set to close at the end of the decade.

Bad debt

Energy suppliers have also had to deal with the rising amount of bad debt caused by the pandemic. Last year even the largest suppliers voiced their concerns over the impacts of the lockdowns and the increasing number of households defaulting on their energy bill payments.

To make matters tougher for suppliers was the Ofgem mandate that no supplier could pursue debt with them being banned from chasing unpaid bills until only recently.

The shortfall from bill payers has weighed heavily on many energy supplier bank balances and is likely to have played a part in many of the exits from the market witnessed in recent weeks.

Bad business practices

There’s no denying that some of the energy suppliers that have exited the market were poorly run and engaged in bad business practices.

A focus on undercutting the competition resulted in smaller suppliers offering the cheapest tariffs on the market as they attempted to entice customers, but it also left them massively exposed to the sudden surge in wholesale prices.

Poor customer service and inaccurate energy billing have long been an issue in the market and too many suppliers have been poorly run, often by inexperienced people seeking to make cash quickly. The smaller suppliers cannot take all the blame for what has occurred as even some of the largest have declared that they too are in financial difficulty. 

Regulatory failures

Perhaps the biggest culprit in recent events is the energy regulator itself. It is Ofgem who is responsible for the scrutiny of Supplier Licence applications. It sets the rules and regulations that suppliers must abide by.

Many in the industry have been warning that the rules need to be tightened up over market entry but for too long those warnings fell on deaf ears. Whilst it has announced tougher rules, it’s too little too late. Such rules should have been in place from the start, the fact they were not is why the industry is in the state it is in today.

The energy price cap has effectively hamstrung energy companies into selling energy at a loss and prevented suppliers from raising bills to cover their costs.

Ofgem boss Jonathan Brearley admitted recently that the current energy cap (£1,277 for a dual fuel household with average energy consumption) limits the ability of companies to pass on higher wholesale costs to retail customers, and that it is likely to rise again when it is reset in April 2022 after a 12% rise due to take effect at the end of this month.

The boss of the UK's fifth-largest energy provider, Scottish Power, said the government was essentially asking larger providers to weaken their financial position by shouldering billions in an additional cost to provide these customers with energy that costs more to buy than they are allowed to sell it for under a government-imposed retail price cap.

The future?

The current crisis is the perfect storm of issues, and it can be argued that under such circumstances any market would come under strain, but it also highlights the fundamental flaws in the way the market functions.

When the current crisis abates those companies that have survived the storm will be faced with a new reality, one where there will be far fewer energy suppliers, where competition is reduced and one where laws, rules and regulations will need to be changed and tightened to prevent such an event from happening again. 

 

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Rafael Herzberg's picture
Rafael Herzberg on Oct 5, 2021

Hi Matthew,

Very interesting overview of the energy outlook. Thanks for sharing!

I am an energy consultant (based in São Paulo, Brazil) and most my clients are/were deregulated energy users including industrial, commercial and institutional ones. 

There is a common perception to lock power deals (as well as other energy sources) basically aiming a short/medium terms. 

My advice is always to - as much as possible - lock long term deals so that there is little exposure to what happens in the short term. History tells us that there are always "bumps". It is part of of life!

I like the idea that the client is contracted for most of its needs for the long run and uses the spot (short term)  just to trade differences. This enables a predictable, acceptable and consistent business plan to happen.

Additionally I urge my clients to consider having a portfolio of sources. To diversify risks and potentially arbitraging costs. 

I consider this as a very interesting and fascinating challenge for the C level, Board Members and even Managers. It is as well a super opportunity to make a difference and potentially make your company way more competitive in its respective market.
 

 

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