Thursday 9 January 2020

Tiny Energy Suppliers Going Bust

A couple of times recently we've mentioned the 2019 phenomenon of minnows in the energy supply business falling off the perch (to mix metaphors gaily) in their dozens.  It'll be continuing into 2020, believe me.   (1) How can this be?  And (2) does it matter a hoot?

(1) WTF?

For many years the bane of the residential* energy sector was the 'Big 6' oligopoly, of deserved ill repute.  The I&C (industrial & commercial) sector, by contrast, has long been well-populated with credible suppliers and ultra-competitive prices on offer for any buyer who knows their stuff.**

The difference is simple.  I&C customers are relatively easy to service.  Residential customers can be an absolute nightmare in several dimensions;^^  plus, the governent dumps all manner of social policy objectives onto residential suppliers.  And energy wholesale-market trading is a necessary part of the supply chain, but notoriously difficult - essentially a big-boys' game.  Traditionally, the only way it could all be made to work was by having critical mass of customer-base, vertical integration, economies of scale, pre-existing trading floors, risk-management & billing systems etc etc.  

Hence the Big 6: and even for them, profits were often not easily come by; whereas fines from the regulator for all manner of cock-ups were commonplace.  Oligopoly is never ideal (to put it mildly), and Ofgem + the government would regularly tear their collective hair over how new entrants could be encouraged into this difficult business.  From time to time someone like the Co-op with apparent natural advantages would dip a toe into the market, only to lose their shirts.

It's not hard to see, then, why Ofgem would actually be delighted when the number of players in the residential sector suddenly started to grow.  And grow ...   And some of them were really small ... how did this happen, in a space seemingly reserved for big boys?  The answer is in four parts.

(a)  A few years ago there was a sustained period of steadily declining wholesale prices.  Now Big-6-type players are fairly conservative & commercially responsible, and tend to buy (or hedge) forward for at least a decent chunk of the portfolio, certainly against those of their customers who are on fixed price tariffs.  In circumstances of falling prices, it's not difficult for a player who's short (i.e. has sold forward, but not bought forward) to undercut those Big-6ers, i.e. selling on the basis of price alone, then simply buying day-ahead in this falling market - which is the easiest form of trading.  Opportunistic players were encouraged into the market initially by the simplicity of this trick.

(b)  Also a few years ago there came onto the market some fairly competent software packages known as "supplier-in-a-box", meaning you could buy not only an off-the-peg company kit, but one complete with billing systems and all the necessary market interfaces, too.  Being standardised and commoditised thus, the software wasn't even very costly.  This dramatically lowered one of the previous barriers to entry, clearing a passage for tiddlers.

(c)  As the government layers on ever more "green levies" onto energy bills, someone has to collect them from us - and it is the suppliers.  But they don't have to pay them over immediately - indeed, as you'll have seen in the press, some didn't hand them over at all ! (more in Part 2)   So - a major contribution to working capital was gifted to suppliers.

But - isn't it still a major challenge to build up a customer base - when you're a minnow that nobody's heard of?  Even offering cheaper prices, surely it'll be an uphill struggle for NoName Energy to sell anything at all?  That's where the final piece of the warped jigsaw falls into place ...

(d)  The 'flipping' business model.  Up until a few years ago, price comparison sites listed companies' offers and invited you to select.  You probably weren't ever going to pick NoName Energy, however cheap they were.  But with a flipper site, you were being invited to let the algo choose & switch on your behalf.  Now, all NoName had to do was pitch low (or in some nefarious cases, slip the site a few quid in a brown envelope) and be given as much business as it could handle.  And with wholesale prices declining ...

You can, I think, see where all this is going  ...  even if Ofgem couldn't.   (to be continued)

*  Many use the term "domestic" but this wouldn't make sense to some of our non UK readers, for whom that word applied to energy customers means "in-country" (as opposed to "overseas").
** A surprising number of large companies that ought to know better get stuffed every year because of the crazy way they go about energy procurement; and many smaller ones get royally rogered.  But that's for yet another post ...
^^ E.g. on the coldest day in winter I might turn every heating appliance in my house up to max.  Or I might go skiing, and use no energy at all - & I don't have to notify anyone.  And I can swich suppliers at the drop of a hat.  I&C customers don't behave like that.


Anonymous said...

Hi ND - I always find your Energy posts very interesting.

How do these small time players match demand to procured supply?

I.e. Do they estimate what they'll need for each day and then do agreements with generators to supply that amount or do they do have to do this at a lower or higher level - per hour or per week/month?

What happens when demand comes in above procured amount, obviously customers don't just stop getting electricity but who then supplies and bills the supplier for this extra generation?

The company I work for has swallowed the green blob so is big into long-term PPA's with various wind operators (and a solar), I understand if we use more than we've purchased we just pay market rate which is managed via npower and mitie - would these smaller companies also go for PPA's or do they tend to not look that far ahead and just chance the market?

Lord T said...

I've always said that if something can be screwed up then the government has a finger in the pie somewhere. Government policies and knee jerks can be better handled by larger companies as they have that bit of flex that when they want some 'social responsibility', for example, as part of their work big companies already have a bunch of useless SJWs ready to go. Small companies have to recruit a useless mouth to feed.

Anoneumouse said...

"royally rogered" is there a Dale Evans joke comming soon.

Nick Drew said...

Anoneumouse - that dates us both! (Hi ho!)

Lord T - spot on

Anon - thanks.

What follows is necessarily simplified. Basically, all wholesale market players are responsible for exact matching, supply with demand AND, as hinted in the post, suppliers don't have a very good handle on individual residential demand. But it's not as bad as it sounds; because you only need 100+ customers in the same general region to get the benefit of diversification / law of averages: and they have access to well-proven algorithms to predict average residential demand given the temperature / wind / cloud / postcode / what's on the TV etc etc. (A sudden drop in temperature can catch everyone by surprise, but even then, they are forecasting for only an hour or so forward, and there's a limit to how much things can change in an hour.)

As stated, the smaller companies have tended NOT to buy forward. So for a given day they go buying, firstly, into the day-ahead market, armed with a pretty good estimate of what they'll need: and they can (if they choose) then continuously update their position for the day in question, hour by hour as forecasts change, buying for shortfalls and selling surpluses via within-day trading instruments. (Many of them outsource this to a 'proper' trading house: it's not an easy game to play.) And then all over again for the next day.

(BTW, if they had bought forward, it would just make their requirement to trade day-ahead that much less. But (a) the precise balancing challenge within-day remains the same; and (b) they'd then be stuck with whatever forward price they'd agreed months before - maybe advantageous, but maybe not ...)

There will always be an imbalance, however small. Outside a fairly tight tolerance, this is settled for them automatically by the Grid (or maybe they use an outsourcing arrangement, where netting may be possible within a big portfolio being managed by the third party) - at prices designed to incentivise accuracy, i.e. "penal" prices. These are typically much worse for being short than for being long (for obvious reasons, although these days being long can also be awkward for the Grid when the wind is blowing strongly). So people tend to err on the side of being a tad long. In any event, no customer ever goes hungry; the Grid ensures that. Gas and electricity are essentially the same, except the tolerances are much greater for gas, and hence the S/D challenge much less strenuous - because gas balancing only needs to be on a daily basis rather than half-hourly (elec).

We'll talk about PPAs in Part 2.

Matt said...

@ Lord T

My thoughts exactly on the previous post that prompted this one. You can be sure when there are stupid rules/levies/requirement that the government has been involved.

Nessimmersion said...

Never forget that whenever there is a price difference, some idiot can be counted on to start squealing about "postcode lotteries" ans something must be done or snot fair etc etc.
One of the reasons to try different ways of doing things is to find out what works best, then move on.
Until govt started interfering with green levies etc, the UK was doing quite well in energy provision, it's the gov't finger on the scales that is screwing up rational energy provision.

estwdjhn said...

How do the suppliers know what thier customers demand is doing on an hourly basis? Mine can't possibly have any idea.

I'm on a conventional meter, which my supplier didn't bother to read (or provide any way for me to submit readings) for an extended (and currently unended) period (it's now over two years). My original supplier went bump about 6 months ago, my account was transferred to someone else (without any requests for meter readings, although I took the precaution of noting the readings anyway), then for about 4 months no-one bothered collecting any money from me.
I'm about to switch away from my new supplier (now they have started billing me), which is probably going to cause lots of fun and games (especially as my original, now broke, supplier mucked about with my direct debit and all sorts, but never sent me a single bill.)

If this is halfway to typical across the industry I'm not surprised that lots of the minnows have collapsed in heaps!

Nick Drew said...

@ How do the suppliers know what thier customers demand is doing on an hourly basis? Mine can't possibly have any idea

Of course not (the full-heat-or-skiing example already given).

But see my earlier comment above: "you only need 100+ customers in the same general region to get the benefit of diversification / law of averages: and they [suppliers] have access to well-proven algorithms to predict average residential demand given the temperature / wind / cloud / postcode / what's on the TV etc etc"

smart meters will actually only improve this forecasting aspect by a tiny amount (though there are other potential benefits) - because on average we really are very predictable indeed

Your example isn't rare: and some would argue it's yet another reason why it's a game for Big Boys, who can take a bit of crap in their stride. (But the water industry is much worse!)

Part 2 coming soon ...