It has become an all too common sight on our news feeds to read that yet another energy company has gone bust. The collapse of Colorado Energy and Pure Planet brings the total number of crumpled suppliers in the UK up to fourteen and it leaves the market in still a precarious position for many households – and ultimately the government. In Europe, things are little rosier. The rising costs have doubled European energy prices and the EU member-states are calling on the block to take further action.
The origin of this crisis is, naturally, related to the general inflationary trend we have been experiencing since the pandemic. After frequent disruption in supply chains due to lockdowns and social distancing, it is unsurprising that this would have a cost-push effect on prices. The Bank of England estimates current inflation for the UK is 3.2% and the ECB is currently grappling with price increases of 3% in the Eurozone. Futures prices for natural gas give us a good indication of how dramatic the increase has been as prices shot well above their 2018 high at the beginning of October and show no signs of climbing down. But this inflation in gas prices, although certainly a supply-side shock, also has its own specific causes.
A New Pricing Mechanism
The European countries have been steadily moving over to a different pricing mechanism when it comes to their gas market. Prior to 2005, Europe used oil indexation to calculate the price of Liquified Natural Gas (LNG). However, since the 2010s this has rapidly changed with European countries joining the US and UK in buying its gas on competitive markets, also known as gas-on-gas pricing (GOG). Essentially what this means is that LNG is traded on liberalised markets which are determined by supply and demand, rather than indexed to another commodity. Europe now prices at least 80% of its LNG with this mechanism.
GOG pricing is not a bad thing in and of itself. It provides flexibility and increases efficiency when it comes to buying and selling gas. However, pricing LNG in this way means that it is more subject to volatility in the market fluctuations as varying supply and demand would have immediate effects on price. This again would not be so much of a problem if suppliers and producers formed long term contracts in order to secure prices and supply for a given number of years, but since liberalisation, gas has been bought at its spot price or on short-term contracts, which are not ideal in a crisis situation
Furthermore, this revolution in GOG pricing in the wholesale market has not been accompanied by a similar change in the retail market. In the UK and Europe, it is typical for an energy company to sell a contracted “fixed” price to consumers for electric and gas over a period of time, usually between one to three years. This is a commitment for the energy company who locks in the prices for consumers and is unable to raise them if wholesale prices become intensely more volatile. As a result, an energy company who has grown rapidly with many of these commitments will encounter problems if the price of energy increases and, as we have seen in the UK, will have no choice but to go bust. This disjoint between the wholesale and the retail markets has played a major part in this crisis in the UK.
Causes of the Crisis
Crises do not come out of thin air and have many causes, and the gas shortage in Europe is no exception, so blaming it on one element or the other would fail to give the complete picture. First of all, it is important to note that Europe experienced an increased demand for LNG due to suffering a particularly cold winter in 2020. Naturally this sapped much of the gas reserves leading to a depletion for the following year. These reserves were subsequently not restocked during the summer. To add insult to injury, the UK closed its largest gas storage plant in 2017. These failures by both the UK and Europe would have been bad enough on their own, if it wasn’t for additional factors.
International reasons have exacerbated the crisis by a mixture of misfortune, ignorance, and possibly political cynicism. Asian buyers undercut European bids for American LNG leading to Europe losing out on important contracts which might have eased the current crisis. This, in effect, has left us reliant on our largest gas supplier, Russia, who are in no urgent hurry to help us out; Russia’s state-owned gas company Gazprom has been leaving Europe dry. Either for genuine reasons, such as issues related to the Nord Stream II pipeline and European regulators, or some political pressure from the Kremlin aimed at making Europe squirm, Russia’s inaction and apparent indifference has made Europe’s shortage worse than it should be. In addition, Algeria’s closing of its Maghreb pipeline from the 31st of October will contribute to an increasingly dire situation in Europe. These factors, combined with sensitivity of GOG pricing, have left Europe in a bit of a pickle.
The UK’s Messy Market
In the UK, the disaster of the energy market has been much more structural. With one of the world’s most deregulated markets for energy, it has left it incredibly exposed to volatility in market prices. The growth in smaller suppliers from 2017 has allowed for the UK to grow one of the most competitive markets for retail energy in the world, allowing for newcomers to wrench dominance away from the Big Six. Along with this growth in challenger companies, however, the rise in “cowboy” energy companies, who have taken advantage of customers with low prices, have emerged. Poor customer service and dubious practices have poisoned the market with suspicion, and many customers find themselves victims to predatory doorstep tactics of smaller suppliers trying to get a piece of the market. Moreover, many of the bigger companies have engaged in this behaviour too, leading to a general pessimism when it comes to finding a decent supplier.
However, UK energy companies going pop like a string of tripping Christmas lights is not a healthy outcome for a marketplace. Without mentioning the immediate effects of staff unemployment, financial loss, and customer uncertainty, the ultimate issue comes down to what to do with those customers who have suddenly found themselves without a supplier. So far, the answer has been for Ofgem (the UK’s energy regulator) to appoint a Supplier of Last Resort (SOLR) – often a larger and more solvent energy company – to take on the bust supplier’s customers. This has worked moderately well as a temporary measure and with sparse supplier busts, but we are starting to see the cracks.
Under the SOLR solution, Ofgem transfers the customer base of the bankrupt supplier to another. When a company absorbs those new customers, it takes on the company’s liabilities as well as assets. Unprofitable customers, customers in debt or who have just joined, become part of the larger company’s balance sheet and if too many companies start going bust, this can be increasingly saturating. This is what has happened in the UK today, with the bigger companies such as EDF and British Gas – as well as others – slowing their customer acquisitions to allow for some breathing room.
This is why Bulb Energy’s possible demise is a big risk for the market on the whole. With 1.7 million customers, the fallout from Bulb would mean a disaster for UK energy. As a medium-sized supplier, no single energy company would be able to amalgamate their customers onto their balance sheet. Even though OVO and Octopus have expressed interest in bidding for Bulb, it still leaves government intervention in the energy market as a possibility.
The entire Bulb affair exemplifies the main issue with the UK’s energy market: it is too competitive. Market forces have let suppliers become irresponsible, cutting corners and leaving customers in a lurch. They have made the crisis worse for the UK industry with increased risks of unemployed staff and a saturation of the SOLR. A reform of the energy market must begin by looking at much tighter regulation to ensure that a crisis couldn’t affect the UK in the same way again.
The Bottom Line
Ultimately, the real shame has been the need for Europe to switch on its coal power stations again. Once the champions of sustainability and green energy, and with the Next Generation EU programme striving to pave the way for wind and solar, it has now been left to the mercy of one of the dirtiest carbon emitters. LNG is not perfect, but it is certainly better than coal, producing at least half as much CO2. But it is clear that if our current renewable technologies have left us needing to turn to coal in the absence of gas, we need to start thinking about more stable and cleaner options such as nuclear energy, which France is already leading the way with. Let’s hope we come out of this crisis wiser and more pragmatic for our fight against climate change.
About the Author
David Tait is the founding editor of the La Konfederisto and has contributed a number of articles to the magazine. This post was originally published on his blog The Young Mazzinian.
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