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.