UK energy price cap increase helps suppliers pass on costs
The increase of the energy price cap by the UK energy regulator helps energy suppliers pass higher wholesale energy costs on to customers and mitigates the impact of record prices, Fitch Ratings says.
The magnitude of the price cap rise is in line with the country’s existing tariff-setting methodology and our expectations, and therefore we do not expect any rating implications for our energy utilities portfolio.
Ofgem yesterday announced that a 54% increase in the default tariff price cap to GBP1,971 from GBP1,277 would come into effect on 1 April 2022, with overall price caps covering about 22 million customers.
The UK government simultaneously announced an upfront GBP200 discount, to be repaid over five years, on domestic energy bills from October 2022. With the government meeting the cost of energy bill rebate, the discount will have a neutral impact on suppliers’ costs and working capital.
The current tariff rise is driven by a rapid increase in forward wholesale energy costs, which more than doubled over previous six months due to a combination of low renewables output and rising natural gas prices. Sharply increasing energy prices have been detrimental for smaller unhedged electricity and gas suppliers, with 29 of them failing since January 2021, affecting about 4.3 million domestic customers.
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Larger Fitch-rated utilities weathered wholesale price increases better due to integration into generation and hedging strategies in the case of integrated utilities, and a cost pass-through mechanism for distribution networks.
Larger suppliers took on customers from failed suppliers, including British Gas (about 729,000 acquired customers), EDF UK (580,000), E.ON (239,000) and Iberdrola via Scottish Power (70,000). This increased their customer bases and market shares, which had been eroded in previous years due to low barriers to entry in the UK energy supply market and intense competition.
We also expect Ofgem to tighten licensing requirements to prevent simultaneous failures of energy suppliers, which could benefit larger market participants. Despite these longer-term opportunities, larger suppliers still face short-term challenges in accepting new customers, such as working capital swings and the need to meet larger collateral requirements.
Network costs have been increased by about 39% as a result of the price cap revision, largely due to supplier of last resort (SoLR) levy costs. The latter are incurred by suppliers acting as SoLRs as they are taking on customers of failed suppliers and are paid by distribution networks and reimbursed via SoLR levy charges. They therefore have a neutral impact on rated electricity and gas networks.
SSE and Drax have no domestic customer supply business and are not affected by the price cap increase.
