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?
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.