Wednesday, 1 December 2021

With dumb energy ministers like this ...

Minister says price cap not to blame for supplier failures:   Suppliers which have gone out of business as a result of the recent escalation in gas costs cannot blame the price cap because they should have been adequately hedged, the energy minister has argued. Appearing at the House of Lords Industry and Regulators Committee, Greg Hands said suppliers who were properly prepared have “clearly been in a much better position to ride out the big increases in global gas prices.”

OK, we haven't yet seen the full transcript and maybe Hands said something more nuanced later on.  Maybe ...

Here's the thing, Greg.  

(a) Just hedging volatile wholesale prices alone is hard enough for very small suppliers that have been stupid enough to sell forward at fixed price - which is of course what a very large % of residential gas and electricity customers (the ones that are active in the buying market) expect from their supplier.  

Why?  Because in order for the supplier to fix its own prices in the wholesale markets, effectively entering a forward contract (i.e. a financial derivative), it is getting into two-way credit risk.  Will it still be around to pay up if prices subsequently collapse?  That's the consideration from the point of the other party to the hedging agreement.  Of course, the small supplier should equally be worried about whether that other party itself will still be around to perform, should prices subsequently soar.  But that 'other party' will probably be at least three orders of magnitude bigger than the dodgy little twat-company that is the "small supplier" in Ofgem-regulated Britain: so not an issue the tiddler need worry about in practice.  And on the other side, well, who's going to extend the latter any credit?  So they can't actually afford to hedge much at all.  When they sell at fixed prices, in other words, they are taking a purely speculative punt on what the spot price will be at the time they must make delivery ('Northern Rock syndrome').

(b)  But it gets worse.  Suppliers don't just need to think about fluctuating commodity prices; the government has forced them to provide a price cap.  As eny fule kno, a price cap is essentially a Call Option, in the jargon of financial derivatives; and while (for the provider) hedging a price cap that's out of the money is relatively simple, albeit an advanced technical exercise, the cap that the government forced on suppliers was always fairly close to being at-the-money - a vastly more difficult and sophisticated, costly, dynamic hedging challenge.  (It's deeply in-the-money now! - which of course means wipe-out for the unhedged...)

But we are not talking players who are remotely capable of mastering sophisticated derivatives challenges - we are talking a bunch of opportunistic, under-resourced minnows, some of whom have extremely dodgy business models and that should never have been licensed in the firstplace!

So, Mr Hands, while you may fairly expect the Centricas and EDFs and Eons of this world (and maybe the Ovos and Octopuses ... maybe?) to have their shit together, you should be looking squarely at Ofgem for the rest.   Licensing players with no capital, but then imposing a tight-fitting cap, is a sure recipe for what's happening right now.

ND 

19 comments:

Don Cox said...

Attempts by governments to control prices of specific goods always end in tears.

All a government can do is vary interest rates and the amount of money they print, in the hope of limiting inflation.

Don Cox

DJK said...

A Conservative government should know better than to expect a free market to operate with a price cap.

dearieme said...

It's deeply offensive to use "dumb" in the American sense of 'stupid'. I hope actual dumb people find some way to cancel you.

Anonymous said...

Whilst on this subject, I noticed a headline in the news that the Govt has given Bulb 1.7 billion to keep trading.

When a supplier goes bust, does the government pay one of the other providers to become a supplier of last resort?

As any payments made by consumers are protected, are the government essentially paying two lots of costs to the new supplier - one to the new supplier to take on the additional customers and then again to cover the amounts already paid by consumers, so that they don't lose out?

Nick Drew said...

Bulb has been put in "Special Administration", anon. This is a first - so nobody knows exactly what happens next - including the government, I should guess. But one shouldn't say "given £££ to Bulb" - it's a budget for keeping the wheels spinning while they decide.

Ordinarily, (i.e. the dozens of other bankruptcies we've seen) Ofgem auctions the customer-base of the defunct co and another supplier picks it up, theoretically preserving (e.g.) customers' credit balances etc. Some costs that the new supplier might incur in this process are allowable and they are passed through to *ahem* all of us, on our bills.

In purely functional terms it's mostly worked well. Of course, allowing the easy default option of socialising the costs is fraught with moral hazard, and has been mercilessly exploited by chancers and some outright charlatans who've set up "supply companies" so small, they don't even have to file full accounts. Total delinquency on Ofgem's part.

Anonymous said...

Can't see why you're so dismissive of Mr Hands. From the Wikipedia page

"He worked on trading floors in derivatives at the City of London and New York City until 1997."

Seems he may be better qualified to comment. Perhaps you'd like to comment

Nick Drew said...

Then he should think about the crap the civil servants give him before reading it out

actually, he probably knows all too well, but the search is on for ways of deflecting blame from his Government's price cap (see Don Cox and DJK above)

Anonymous said...

There is a bigger problem coming with the water companies.

Uniquely you can turn off power supplies to domestic non-payers but you can't do it for water so debt levels rise. In addition, the new owners of water companies sensing the government is vulnerable have loaded the utilities with debt (to pay dividends) and are waiting for bailouts when it all goes ....

Can't hedge water can you?

Nick Drew said...

anon @ 5:49 - a very interesting contribution: any links?

On the matter of blackmail by owners, there's a very interesting standoff taking place in electricity - the US owners of Calon (Calon is a random collection of 3 large gas-fired power stations) are attempting the same right now

https://www.msn.com/en-gb/money/other/bid-to-fire-up-power-stations-to-ease-energy-crisis-strangled-with-red-tape/ar-AARjraA

Beal Bank, the US owner, bought them, ran 'em very poorly, mothballed 'em down a couple of years ago, and has been playing brinkmanship with them sporadically ever since

Elby the Beserk said...

Baker on the radio this am. Annual bill for gas for baking - £135,000. Gas price increases will increase that to around £500,000 pa. So he'll close. As will many other bakers.

Beyond stupid, evil in reality. Cold kills far more people than heat. Many on pre-payment meters, which are horribly priced, will be choosing between cooking and keeping warm. On a planet where there is more enough fuel to warm everyone.

Matt said...

Perhaps the idiot government will allow fracking to make us self sufficient in gas for the next 100 years.

I realise it's "allowed" now - what I mean it remove the de-facto eco-loon limit of tremors amounting to footsteps.

lilith said...

Go long on pitchforks

CityUnslicker said...

Not only do the Government have no answer to the predictable ofgem mess, they are also not addressing the medium term issue here about how we ever lower the energy costs again.

The only thing worse will be putting Ed Miliband in charge!

Jan said...

OT and sorry to hijack the thread but this little gem may amuse:

an anagram of: delta omicron is media control

andrew said...

Omicron b -> No crimbo

andrew said...

... unless you are a friend of boris, in which case partaay

Elby the Beserk said...

DJK said...
A Conservative government should know better than to expect a free market to operate with a price cap.
11:55 am
=====================================

Quite. However whatever political hue this government may be, it is not a Conservative one. Anything but.

Elby the Beserk said...

Anonymous said...
Whilst on this subject, I noticed a headline in the news that the Govt has given Bulb 1.7 billion to keep trading.
1:36 pm
========================================

The taxpayer, actually. You and I. That's who is paying. Dig deep, comrades, we're nowhere near the end of them emptying all our bank accounts; I would see the taxpayer now as an ATM for government, with no overdraft limit.

DJK said...

> whatever political hue this government may be, it is not a Conservative one. Anything but

No, it's not. I'm starting to think that a Keir Starmer led government might actually be more conservative. Boris is breaking way too many promises, and ignoring too many rules that are expected to apply to other people. And that is before considering the general air of incompetence and cluelessness attached to this government, plus of course the many non-Conservative policies.