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High energy prices squeeze UK suppliers

4 years ago
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High energy prices squeeze UK suppliers

A surge in energy prices in 2H21 has created significant risks for unhedged UK electricity and gas suppliers, with half of them going into administration, Fitch Ratings says.

However, the credit profiles of larger Fitch-rated utilities, such as EDF, Iberdrola (Scottish Power) and E.ON, are unaffected as energy supplies in the UK represent a small fraction of their revenues. UK energy networks are insulated by a cost pass-through mechanism.

Rapidly increasing average energy costs in the UK were detrimental for smaller unhedged electricity and gas suppliers. Half the UK’s energy suppliers have failed this year, reducing their total to 26 from 52. About four million domestic customers were affected.

Non-integrated and unhedged suppliers are exposed to wholesale electricity and gas price volatility as they sometimes purchase energy on the day, and have recently paid significantly higher prices than those allowed in the standard variable tariff (SVT) price cap set by UK regulator Ofgem, or prices set in their fixed contracts with customers.

Although Ofgem increased the SVT by GBP139 to GBP1,277 a year (effective from October), this does not apply to customers on fixed tariff contracts. The price cap is currently reviewed twice a year and limits standing charges and prices for each kilowatt hour (KWh) of gas and electricity, but does not cap a customer’s overall energy bill, which is also based on consumption volumes.

When a UK energy supplier ceases trading, Ofgem appoints a new supplier to replace it using the Supplier of Last Resort (SoLR) process. The new supplier may choose not to match the terms of the failed supplier’s contracts (for example, any contracts with a price fixed below the SVT).

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The SoLR mechanism also allows new suppliers to recover additional costs temporarily incurred when they replace failed suppliers. However, their existing hedging would not cover the increased number of customers on the SVT, exposing them to market price mismatches. We expect Ofgem to change supplier licence requirements and the SVT mechanism as this price shock exposed problems with the current setup.

The next SVT revision by Ofgem will become effective from 1 April 2022. It could lead to a further rise to incorporate increased costs of implementing the SoLR for multiple failed energy suppliers. Typically, full repayment of such costs takes place 12 to 15 months later, but Ofgem has adopted a temporary speedier claims regime recognising exceptional market conditions.

It approved SoLR-related claims of about GBP1.8 billion on 22 December (this amount is mostly based on the preliminary assessment of unrecoverable wholesale costs). This could increase further with second claims that new suppliers can submit six months after the appointment to include costs associated with the final assessment of unrecoverable wholesale costs, customers’ credit balances and administrative costs.

We expect the wholesale gas and electricity prices (the largest component of the SVT, at about 41%) to remain high until at least the end of the UK heating season, given low levels of natural gas in European storage facilities and limited supply response from key producers, including Russia.

However, prices are likely to moderate towards March-April 2022, easing pressures on energy suppliers. Larger, internationally diversified suppliers continue to offset pressures in the UK market with solid performance elsewhere.

We do not anticipate credit profiles of UK electricity and gas distribution networks being affected due to supplier failures and the SoLR implementation. Although networks are paying higher SoLR claims, they are reimbursed by customers through higher network charges. The accelerated SoLR claim recovery process also means there is no misalignment between SoLR payments and cost recovery for UK energy networks.

Source: fitchwire
Via: norvanreports
Tags: easing pressures on energy suppliersHigh energy prices squeeze UK suppliersUK electricity and gas distribution networks
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