Energy Supply Carnage: Last Man Standing?

A very traditional business strategy, in sectors where for some reason corporate survival is by no means assured, is "last man standing". Just hang on while competitors go under or vacate the field, in the hope of cleaning up when there's nobody else left and the benefits of monopoly can be reaped.  Well, for a few years at least - until the competition authorities eventually forget how worried they once were.

The UK energy residential supply sector has offered the prospect of this for many years.  The comfortable days of the 'Big 6' - when the barriers to entry were so high that new entrants rarely stayed the course - were always likely to be under threat at some point, with chaotic fallout.  So what were those barriers?  

• Competence: gas may be a relatively easy business to participate in, but electricity is fiendishly difficult, in several dimensions, as many an apparently competent energy player has found to their cost (Shell, BP, Total, Statoil, Conoco, ...)
• Branding & trust (a.k.a. inertia): people were fairly well accustomed to, and comfortable with, buying from "the electricity board" (not realising the concept was otiose from the mid 90's, with the restructuring of the industry and the separation of the supply side from "the wires") 
• Low margins:  the business might have been comfortable for long-term incumbents, but fortunes were not readily made - indeed, once the market settled down after the initial upheavals of sector restructuring, there was always at least one of the Big 6 thinking seriously about jacking it in
• Capital adequacy:  at very least, in order to be able to hedge the commodity price risk (a very necessary requirement in circumstances of volatile wholesale prices), a basic minimum credit standing is required

This all speaks to energy supply being the preserve of relatively large, competent, well-financed companies.  Was a market of "only" six suppliers necessarily non-competitive?  There are many other sectors where six, competing properly, would be considered pretty good.  To be fair, it can be argued that the Big 6 'competed' in a rather nominal fashion, and did little actively to shake up the significant degree of customer inertia: but the acid test - the trajectory of prices for end-consumers - was broadly favourable, and had been ever since the market opened up.

The picture began to change about a decade ago when a number of aspects came together to facilitate participation by players with quite different business models.

• government and regulators were very keen indeed on seeing new entrants, and proved willing to ignore the kind of arrant dross that was applying for supply licences (interspersed with a handful of genuine and properly-financed innovators).
• for the same "reason" (presumably), Ofgem simply hasn't enforced its own rules on smaller players, e.g. the requirement to provide a telephone call-centre service to customers. 
• one of the major barriers to entry - the need for complex systems (again, particularly for the electricity side) ceased to be an issue with the advent of decent-quality off-the-peg supplier software packages at reasonable prices. 
• wholesale prices: they started on a multi-year trend of slowly falling.  This facilitates the "Northern Rock" trick: sell long (e.g. one-year contracts at fixed price), buy short (on the spot market, where because of the falling price-trend, it'll be cheaper than when you made the sale).  Buying spot requires minimal credit; which is, errrr, handy for companies that have almost none...
• the "flipping" model: price comparison firms that offered to switch customers "automatically" (i.e. passively, on the customer's part) onto the cheapest available tariff.  A supplier with next-to-zero marketing capabilty could thereby "buy" as much market share as it wanted, simply by pitching its prices accordingly.
• some of the social-policy costs levied on suppliers only apply to the larger players.

This helps explain how an inadequate company might be able to get into the energy supply game.  But why would they want to?  There is no single motive, but alongside some perfectly creditable intentions, others of them are very bad.

• genuine, albeit speculative profitability of the "Northern Rock" model - for just as long as wholesale prices continue to fall AND the supplier isn't going to the trouble and expense of hedging against the possibility of rising prices (not least, because it doesn't have the credit standing to do so! - see above).
• positive cashflow: notwithstanding various unavoidable start-up costs and system overheads, with a customer base once established the supplier is able to get ahead of supply-cost outgoings via (a) direct debit charges and "estimate"-based payments, i.e. borrowing its customers money; and (b) collecting, as it is required to do, ever-increasing "green" levies, which do not need forwarding to the relevant authorities until several months later (if indeed they are ever paid out at all) - another cheap source of "finance". 
• ease of syphoning off this cash: small players with no public profile nor recognisable corporate governance can readily and quietly play tricks like borrowing from Related Parties at outrageously high interest rates, "investing" in Related Party ventures, and paying Related Parties for extremely costly "software services" and "consultancy".  How do I know about this stuff?  Because sometimes it's as plain as day in their annual reports!  (That's for the supply firms that aren't so small, they don't have to file full accounts ...)  Where were the authorities in all this?  Evidently, neither Ofgem nor government could give a stuff.    

Until now, of course, when they are dropping like flies.  In the meantime, the Big 6 has ceased to exist!  SSE and National Power have exited: we are left with E.on (German), Scottish Power (Iberdola of Spain), good old Centrica, and of course EDF, probably only still in the game to give it political cover for its UK nuclear machinations.  True, Ovo and Octopus have stepped up to the plate: but then, so had Bulb - until last month ...

At least some of the current survivors will be hedged through to April-ish, when the prevailing energy price cap is scheduled to end (see earlier posts).  Of course, nobody will be making any positive plans whatever until the government has shown its hand on replacing the cap.  If it gets this wrong, chaos ensues, probably followed by de facto nationalisation in some shape or other (like the banks in 2009). 

But there must at least be the chance that Centrica's unwavering 25-year strategy of positioning itself to be the Last Man Standing finally pays off.  And a Happy New Year to all concerned!

ND

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 

Corporate Software Madness, Part 94

A periodic discussion point around C@W is the hash that apparently capable companies (and governments...) make of software procurement and installation.  The amounts of $$$ that unscrupulous and rapacious consultancies - "system integrators" - make from these suckers is quite astonishing; and  frequently with crap end-results to boot.  They advise their clients to spend far too much; they pocket the lion's share (often leaving the software vendor grovelling in the dirt); and their implementation skills & project management are deficient.  Yet still it goes on - year after year.

So I snorted loudy, but was not unduly amazed, upon reading this announcement - possibly the biggest triumph of optimism over experience I've ever seen:

E.ON enlists software company SAP to digitalise its power grid and customer service in a 2-year project, the heads of the two companies, Johannes Teyssen (E.ON) and Christian Klein (SAP) said in an interview. In total, E.ON is investing several hundred million euros in the digitalisation of its network and sales division and a “high double-digit million euro amount” in the cooperation with SAP, Teyssen said...

A story.  Many years ago I worked for an energy company that knew what it was doing.  When gas trading started in the UK we knew, from our US experience, exactly what was needed for deal-capture and processing which, in the early days of trading (with modest deal-flow) was not a massive software requirement.  We turned loose two of our own employees who were versed in MS Access, and they designed and delivered a wholly workable system in 6 weeks flat.  Cost?  Bugger-all, seeing that Access was conveniently on everyone's PC already, licensed as part of the Office suite.  Just two guys' time, and a round of training for front, middle and back office staff.

Shortly thereafter I was invited to expensive lunch by a competitor.  As always, the reason only came up at coffee.  We are outgrowing our gas trading spreadsheets, he said, and we know we need some proper software.  Our 'Big 4' consultantcy has advised us to budget £6m - does that sound about right?

I let him carry on in his state of blissful stupidity.  Reprehensible, I know.  Well, it was their money - and a nice lunch.  Their project took nearly a year.  You may safely bet the consultancy spent the full budget for them.

Now, about E.ON's high double-digit million euro amount.  "... in cooperation ..." ?!  €99m buys one f*** of a lot of "cooperation" in my book.  All so wearily familiar.  Still, I suppose they'll claim it as a necessary outlay to the German network regulator.  Add it to the Energiewende bill - it's small beer in that context. 

*   *   *   *   *

Footnote:   Further to my recent note on Centrica trying to flog off its LNG portfolio:  "Centrica resumes talks on potential sale of North Sea oil and gas venture Spirit Energy (Bloomberg).  The company is in discussions with 'a number of parties' regarding a sale of its controlling stake in Spirit Energy.  The stake could be worth $1.8-1.9bn."  Maybe that LNG sale isn't going so well.

ND

The Politics of German Gas

Round the back for the dodgy deal

A brief history, plus some other bits and pieces you won't read about in the meejah and might find helpful in forming a view on Germany's and Gazprom's shenanigans and Nordstream 2

(1) Firstly, it's also about oil - not just gas.  The Eastern and mittel-euro countries, including Germany, have long relied heavily on Russia for oil products (indeed, those countries nearest to Russia are almost wholly dependent).  Of course, oil as a commodity is very liquid - in both senses: and both senses are equally important.  (i) Market liquidity means there is a universally-accepted benchmark for pricing;  and (ii) literal physical liquidity makes transportation and delivery much easier than for (e.g.) gas, the latter being dependent on inflexible infrastructure.  Both factors make it much more difficult for Russia to stiff their european oil clients than it is for them to play games with gas: everyone knows what the market price of oil is; and it's not difficult to obtain the stuff, and transport it, from anywhere (albeit perhaps inefficiently).

Those factors combine to make the situation almost the converse to gas, because oil is easy to steal, and to fence.  There is a strong tradition of truckloads of misappropriated Russian oil being sold at discounted prices in eastern and central Europe by highly organised criminals (a bit like ISIS oil to Turkey a while back - and indeed mafia oil in New York City!)  In several EU countries, if they were being honest, what they lose on the gas price, they (well, some of their *businessmen*) gain on the oil.  I'm guessing we won't see an EC inquiry into that anytime soon.  (See also Raedwald passim.)

What does this gas-flow map remind Germans of?

(2) Gas and Germany:  it's fairly well-known that back in the late 1970s / early 1980s the USA made strenuous but unsuccessful diplomatic efforts to prevent Germany, France, Italy et al from buying Russian gas at all.   This was the era of Cruise, Pershing & 'Star Wars', after all.  But Germany (which in those days was more than pulling its weight in NATO) had already decided it was a strategic move, and went for it in a big way.  An exceptionally strong *commercial* relationship was forged between the predecessor of Gazprom (then called SoyuzGazExport) and Ruhrgas, a classic German entity of very complex ownership (including Shell, Exxon and BP) and extremely strong *connections* to the German government.  Ruhrgas was eventually bought by E.on in 2003 - mysteriously the EC competition authorities did not prevent it and E.on has continued in the tradition of being *very close* to both their own government and Gazprom.  No surprises there.

When the eastern countries complain that Germany has cut a preferential deal with Gazprom, they (and the European Commission) choose not to highlight the very substantial amounts of what we might call soft finance Ruhrgas and E.on have provided to Gazprom over the decades (obviously, at governmental behest, to say the least).  Whether Germany Inc as a whole has made a net return on this colossal *investment* in financial terms - cheaper gas in return for soft finance - I couldn't begin to guess.  Maybe they've received a "most-favoured-nation" discount, and maybe some of the eastern countries have been handed a "punishment premium".  Frankly, though, if Germany Inc has made an overall financial loss I wouldn't be surprised.   Because Germany sees it all as strategic.  And, as we know (see recently the Deutsche Einheit) Germany can be willing to pay a high price for what it sees as a strategic geo-political imperative.  

(3)  Overall / rest-of-Europe:  putting Ukraine to one side, Gazprom has generally been a very reliable supplier in political terms, i.e. they have kept the gas flowing westwards even sometimes at the expense of cutting off their own citizens in situations of shortage.  The reason is easy: hard currency revenues (trade was always better than fighting).  As I've mentioned here several times before, it's always been Holland that has been seen as a politically unreliable supplier: they'd always interrupt exports if there was a problem, in order to supply their own citizens in preference.
 

Not entirely reliable

(Incidentally, Gazprom hasn't been particularly reliable in engineering terms - in fact, their system is notoriously primitive.   But their big Europe customers understand this well, and have invested in huge gas storage facilities to tide them over the inevitable occasional hiccup; and everyone's too polite to talk about it much.)

Now Germany's dealings with Gazprom have been conducted more-or-less at state level; and while one can describe it as highly corrupt, you could also say it's just high politics (- like BAe and Saudi Arabia).  And on the western end of that relationship it's mostly a matter of plumb sinecures taken by Herr Schröder and the like - galling, but hardly the worst thing anyone's ever done, nor even remotely furtive.  But in other countries ... well, let's just say that in the case of certain large Mediterranean clients of Gazprom's, the hanky-panky has been rather more venal.

Ever meddlesome

(4)  The 'Energy Union':   I've written before of my disgust at the acquis-grab that is the European Energy Union.   Suffice here to say that for the eastern EU members, right from the start this has all been about getting the EC to deal with Gazprom on their behalves, urged on by the ever-meddlesome Mandelson, needless to say.  (The EC has actually been promising all countries everything they want in the energy space, in order to extend the acquis.)   Given that the timing of the Energy Union initiative coincided with the height of the Ukranian nonsense, the EC documentation contains some of the most undiplomatic anti-Russian sentiments you'll ever read from a non-Trumpian civil servant, so it's clear the easterners have been making the running and holding the pen.  Germany, though, blithely ignores all this crap and motors on with Nordstream 2 unaffected.

Let's see how it all pans out.  One of those easterners is presumably leaking the Competition enquiry stuff (which was almost forgotten, so quiet had things gone) in order to sabotage Nordstream 2 at a fairly critical juncture.  The Danes are nervous of approving their leg of the new Baltic pipeline, but will probably roll over.  The Finns have already rolled over (well, where do we think they get their oil and gas?)  Yes, it's power-politics all the way.  Think the worse of Germany for it?  They'll be the judge of their own strategic interests.

ND

When the Big 6 becomes Big 5

Over the years we've often suggested that the way government and regulators cheerfully beat up on the big 6 energy suppliers isn't terribly clever.  It's very handy for them to have big corporates to do their daft bidding in energy and climate-change policy; but simultaneously allowing them to be popular whipping-boys, and loading them up with onerous social and policy-delivery obligations, is inviting them ultimately to jack their hands in and step away from the table altogether.

It has also been clear that not all of the Big 6 necessarily have the financial stamina for the long haul, never mind the stomach for it.  Margins in the residential sector are lousy, and the risks are great.  Hanging on in there as a 'last-man-standing' strategy isn't a work of commercial genius.  (Though, since most of the suppliers are still engineer-heavy at the top, and with truly dreadful track-records on both customer service and, perhaps counterintuitively, IT - trust me on that latter, I've dealt with all of them - commercial genius isn't necessarily to be expected.)

Three years ago we noted that RWE / NPower / Innogy (pick you prefered brand-name) was occupying the bed closest to the door, and so it has proved.  They and SSE have had enough, and intend to merge their portfolios of residential energy customers and float them off.

Having reduced the competition at the big end of the sector by one sixth, will the government be inclined to think again, and cut them some slack?  I doubt it.  May seems determined on some kind of price cap.  Ofgem is ecstatic abut how many tiny new entrants there are in the residential sector, notwithstanding their very patchy performance, inherent financal weakness, and parasitic dependence on the Big 6 keeping the main show on the road.  (One of the canniest decisions Sadiq Khan has made was stepping back from a manifesto promise to set up a publicly-owned, fully-fledged London energy supplier.)

In all this mess, then, it's little surprise to see NPower and SSE look for an exit strategy.  Of the rest:  Centrica is, after all these years, still a remarkable survivor as a UK inde.  It had shrewd and genuinely commercial management from the day it de-merged from the old BG 20 years ago.  We've had issues with them over the years (check the Centrica thread from the tags below) but they're OK.  EDF's continuing to play the game is of course 100% strategic for the French based on making sure nothing prejudices Hinkley.   Right up until they decide that game's not worth the candle, either.  On paper, EDF is bust already if you factor in all their nuclear liabilities.  But the French government won't let them go under.  (Check the EDF tag too, for various C@W stories over the years - starting with this pivotal one from 10 years ago which explains plenty.)

That leaves E.on and Iberdrola (Scottish Power).  Neither are as strong corporately as they were when the turned up in the UK; and I can't see the UK being strategic for the Spanish.  E.on are corporately sharp, mostly clear-sighted, and can be quite decisive when it comes to restructuring.   But, EDF's special circumstances apart, they are the strongest of the lot.

Newby tiddlers notwithstanding, the landscape hasn't changed much for a decade, i.e. since EDF came to town in a big way.  I couldn't begin to guess what it will look like in 5 years.  But I can tell you electricity prices will be higher.

ND 

Russia: the Bear-Baiting Continues ...

... unabated, as one might say.  I have just returned from an outing across France and Germany to report that while all eyes are on Greece, something else very interesting is afoot.  Until a year ago the biggest civil actions the world has ever seen were (a) that being pursued against the German government by the three German nuclear power operators (E.on, RWE + Vattenfall), for damages in respect of Merkel's precipitate post-Fukushima closure of their plants.  That one weighs in at around EUR 12 billion, and is perhaps a story for another day.   (b) The BP oil spill ($18 billion, as we now know).

However, these were relegated to the second division by the extraordinary award against the Russian government of $50 billion last July, in favour of Yukos shareholders claiming that Russia destroyed their oil company illegally.

I don't recall this making monster headlines at the time (CU covered it here), but that might change.  Because all across Europe, law firms are diligently working up practical plans to seize Russian state assets - and last month the tip of this iceberg was sighted.  In all the Greek excitement, I certainly didn't spot it.

Apparently this is all very real and maybe even imminent.  There may be trouble ahead ...  oh, and that EC investigation on Gazprom rumbles on.    The countries of the Orthodox faiths must think us western europeans have got it in for them.

A good job the Chinese have problems of their own.  More nervous days in Mariupol though, I'd suggest.

ND

Gazprom, Spinning

As oil prices tank ($67 today!), heads must be spinning at our old friend Gazprom, where they still insist on indexing their prices to that of oil.  But they still aren't quite there with the spin management yet.  Here's an amusing presentation for energy & geo-politics buffs, entitled Gazprom for European Market: Reliable Supply in a Changing Environment.

Naturally enough in a presentation on Europe the first slide is about new sales of gas to China, with the claim that these 'are not going to compete with LNG import on Chinese market'.  Well of course not.  A major new source of supply isn't going to have any effect on the international wholesale market, and certainly not on prices.  No Sir.

And so it goes on, a Kremlinologist's delight.  'Major suppliers to Europe have similar contracts' (a subtle one, this, attacking the new federast notion that Europe should buy its gas centrally - and they are right, Europe shouldn't).   'The price of Russian gas are fully competitive and are subject renegotiate' (sic) - well yes, but oil indexation + 'subject renegotiate' is a ludicrously inefficient way of doing things.  'European customers are perfectly protected by long-term oil-indexed contracts against any form on monopoly abuse of power' - an attack on the ongoing EC investigation into Gazrom's behaviour, plus a slide making cryptic, tangled (and wrong-headed) critique of pricing via gas indexation.  Tell that to Eastern European buyers.

And the rather sinister 'After midstream business is dead, nobody is taking responsibility for supplies structuring'.  Midstream dead !  This is a bit harsh - whoever do they mean ?  Would that be, errr, Eon and RWE ?

ND

"UK Blocks Russian Deal" - Interesting

The issue of sanctions against Russia over Ukraine has gone a bit quiet of late:  they don't play at all well in Germany (I wonder how they are being circumvented ?) - and then there are those assault ships sitting in a French dockyard ...

Anyhow, in a rather passive manner the UK seems to have played the game with a straight bat by denying Mikhail Fridman a 'comfort letter' re: his planned acquisition of RWE's North Sea assets - something else that may not sit well with our German friends.

RWE, it will be recalled (click on label), along with its fellow German mega-utilities is right up a gum-tree, courtesy of Berlin's demented energy policies - wildly, infeasibly green + anti nuke.  They will all be making big asset sales in an attempt to steady the balance sheets: and RWE is in the bed nearest the door.  They need the dosh, and now we've stopped it.

This is the thanks Germany gets for letting the Hinkley Point nonsense go through the EC?!

EDF Radioactive Turd

But on that front, there is someone else with a mighty beef: the French have let EDF's CEO go !  Just hours after his Hinkley triumph.  Not green enough, they say.  Of course he's not:  FFS, he's the bright orange, glow-in-the-dark head of EDF !  Le Turd Radioactif lui-même !

Couldn't happen to a nicer chap:  I laughed until I stopped.  In this country he would have been given a peerage.  Perhaps Cameron will.

ND

Meanwhile, at the German end of Gazprom's Pipelines

We have noted here several times that RWE of Germany, one of the 'Big 6' UK power and gas players (in its local guises as NPower and Innogy) is a prime candidate for the bed closest to the door.  Iberdrola of Spain (= Scottish Power) is the other, but seems to have stabilised itself of late.

News from the bedside is not encouraging. 

A surge in [German] solar and wind capacity undercut the profitability of its power plants and triggered nearly 5 billion euros in write-downs. The company said on Tuesday it had swung to a net loss of 2.76 billion euros from a profit of 1.31 billion a year earlier, its first net loss since 1949.

This is one of the companies the UK government is increasingly beating up on for supposed overpricing, while simultaneously passing round the hat for vast investments towards its demented dirigiste energy plans.  Perhaps someone in Whitehall will realise that the three components in this puzzle - pressure on revenues, expectations of huge capital investments, and a sickly balance sheet - do not readily snap together into a neat jig-saw. 

It won't just be HMG's plans that feel the draught as the door opens for RWE to be wheeled away to intensive care.  As with its German sibling Eon, RWE's share register is dominated by Stadtwerke, who rely on the hitherto healthy dividends for provision of municipal services.  In mighty Essen for example (home to both RWE and Eon-Ruhrgas) the city elders are being forced to contemplate savings such as closing large chunks of the tram network as dividend income falls.

'Utility death spiral' is one of the more dramatic descriptions of what's going on.  This, Ed Davey and Ed Miliband, is the real world.  You can probably persist with your delusional energy policies for a little while longer.  Maybe till after the Election.  

Probably.

ND

'Big 6' Fragmenting? HMG Beware

For some time now I have been suggesting that if the government continues to beat up on the hated 'Big 6' energy suppliers, it may wake up to find only 5, with RWE and Scottish Power (Iberdrola of Spain) probably the weakest hands.  E.on has its problems too: and while the others (Centrica, SSE and EDF) all probably have sufficient UK energy market ballast to stick around and play 'last man standing', even Centrica has been known to make dark hints.

The beating these guys take isn't just non-stop public floggings in front of fatuous parliamentary committee hearings or in the media.  Nor is it even the fines that Ofgem periodically boxes their ears with (they probably deserve them).  It's also the extraordinary burden of social obligations and 'green' policy objectives they must comply with, because under current and future energy policy they are the vehicle through which government raises billions, soon to be tens of billions for its inane interventions in the energy markets.  No wonder the barriers to entry in the sector are considered well-nigh insurmountable.  General taxation would be the honest (and progressive) way of doing this but they find levies on unavoidable energy bills a more expedient approach.

And now RWE has sold off a large chunk of its UK supply portfolio.  Of course this is being spun as creating a 'Big 7', hence better for competition: but this shouldn't fool anyone.  RWE is a sickly beast, having taken even worse beatings at the hands of German energy policy, and desperately hanging on (like E.on) for massive compo they are suing the German government for in respect of the half-baked, summary closures of their nukes.

Companies have sold chunks of portfolio before, but earlier sales were part of of the baleful consolidation process which, coupled with the restoration of vertical-integration-via-acquisition that we've slated here before, is how we got to the 'Big 6' stasis everyone seems to despise.

In many respects we already had a Big 7 because GdF of France has quietly assembled a UK portfolio of power generation assets and industrial customers making it bigger than Scottish Power in most aspects other than residential customers (of which it doesn't have any).  And Gazprom (yes, Gazprom) already takes the #8 position.  But there ain't much scope for small players in this market (and why should there be?), notwithstanding that gas retailing (to industrial customers) is a relatively straightforward proposition (not electricity, though - nor residential sales).  From time to time a fresh new hopeful joins the fray, for example Co-op Energy (!).  Good luck to them all.

So - let's see how Utility Warehouse, the proud new owners of 770,000 of RWE's best UK customers, make out in this bracing environment.

And watch out for further retrenchment, by RWE and others.  That's a warning for HMG as well as a comment for investors:  how much investment towards their mad, hundred-billion-pound energy schemes can they expect from these guys when their balance sheets are under such pressure ?

ND

Energy Policy: Omnibus Post

(Catalysed by comments from Timbo, BQ and BE in last week's Climate Crisis thread here.  Several of the topics below have been covered in C@W before over the years but I don't have time just now to do all the links.  Maybe later ...)

For most of the time we are all capable of sailing serenely on in ignorance of how fundamentally our world-views differ from those of others; but once in a while the chasm is illuminated by a bolt from the blue.

One such event happened last week, when Miliband launched his 'energy price freeze' policy.  I and many others in the 'sphere and MSM alike immediately clapped our hands to our heads and proclaimed, that's it ! - he's completely lost it, and shot himself in the vitals on prime-time TV to boot.  We clearly thought the lunacy of it would be obvious to all.

But not a bit of it, because the reaction of other commentators was: a price freeze - so what ?  No big deal, even if it's not something we particularly applaud; and anyhow, the energy companies had it coming. 

In other words, there is no general consensus or shared understanding on some pretty basic energy market concepts.  So here are some responses to the interesting exchanges between Timbo, BE and BQ.  I'm going to focus on short- / medium-term, (say, out to 15 years hence) because the really long-term stuff is unknowable, thanks to technology shifts we can barely guess at.  (In which latter category I place Timbo's fascinating comments on electricity storage, the Holy Grail of energy policy which would transform the landscape.)

The paramount fundamental is that electricity has staggering high 'utility value', i.e. people (in developed economies) will pay almost any price to get it.  Second only to food, for most people.  (Water comes third because you can generally makes your own arrangements, up to a point.)  By this standard, as Timbo wrote, "...how cheap the grid is.  It's dirt cheap".  And when people will pay almost any price ... things can go horribly wrong.

Notwithstanding various developments in micro- and distributed-generation, and predictions of more to come, the kind of electricity and energy we all want - permanently available, in bulk, almost everywhere we go, and relatively cheap - requires centralised 'organisation' (grids, despatch and balancing systems), if not actually 20th-century style centralised generation.  And this isn't just power for domestic use, schools and hospitals: as BQ said, "you can't run a blast furnace on wood".  The saintly George Moonbat tried very hard to run a self-sufficient smallholding in Wales, and just about managed OK for a couple of years until he had a bad winter - after which he suddenly became a convert to nuclear power.

It used to be thought (and still is, in some dark quarters) that only centralised ownership, or at least centralised control, could deliver the goods: but this was comprehensively disproved in the UK and other regions with the advent of full bilateral (self-despatching) markets at the beginning of this century, which not only confounded the statists dirigistes by working at all, they worked better, and reduced electricity costs as their proponents (incl. yours truly) said they would.  Even the Labour Party still signs up for this, (see Caroline Flint on Brillo's Sunday programme: and the changes that brought it about in in the UK 2001 were put through Parliament by Mandelson) so dissenters are up against it politically.

But there are problems.  Firstly, bilateral market structures, though basically robust, are vulnerable to large-scale interference by the heavy-handed and dull-witted.  This includes many politicians and almost all civil servants.  In particular, there is a limit to how much ill-considered (indeed, sometimes actually infeasible) 'decarbonisation' policy can be loaded onto a market framework without it buckling.   Of course, in this country the rot started under Miliband lui-même when in power - oh the irony - but has been further perpetrated here by t'Coalition (and on an even more manic scale in Germany).  

(As an aside, the chronic state of our Heath-Robinson energy policy makes it very easy for any politician to score a few easy and populist points against it.  That Miliband is the first one to do so on a grand scale, is just hilarious.)

The second point is that those bilateral market structures are relatively new and by no means perfected, even before they started to be messed with.  In particular, (a) liquidity in some parts of the power markets, here and elsewhere, left quite a lot to be desired.  Liquidity, for those who don't have an instinct for it (this includes many politicians and almost all civil servants ...) is absolutely vital for markets to deliver for consumers. Ofgem, which had this forcibly brought to their attention nearly a decade ago, has been farting around ineffectually on the issue ever since.

(b) A related point: the state of competition is unsatisfactory.  There is no reason why the current UK  'supply' set-up - 6 massive players plus a host of lesser ones - shouldn't make for a competitive market.  It is, in fact, more competitive than many people give it credit for.  But there's a damaging, mutually reinforcing effect at work:  unsatisfactory wholesale liquidity makes suppliers migrate towards vertical integration (i.e., becoming generators as well), which further reduces liquidity ... etc etc.  

[To illustrate: Centrica set out in 1996 intending to be a capital-S Specialised Supplier (of gas and power), with no power generation at all and limited gas production of its own (the 'merchant', or 'Enron' model).  But over the years, they found liquidity in the wholesale markets less than satisfactory.  So they have slowly become more and more vertically integrated, to the point where now they have about 75% cover for their supply obligations from their own 'upstream' assets (power plants, gas fields and some large long-term purchases).  This means that, where once they were trading in the wholesale markets for almost all their needs, they are now only trading for 25% (net) of their needs, plus some spec trading etc.]

Two dreadful policy decisions have gravely exacerbated this situation.  The first was to allow large-scale vertical integration by acquisition.  This was of course re-integration, because throughout the whole of the 1990's, Ofgas and Offer (the worthy predecessors of Ofgem) had been preoccupied with breaking up the old verticals (themselves the products of the two big privatisations of the 1980s).  The worst examples of vertical integration by acquisition were (1) Powergen's purchase of Eastern Electricity and other UK assets, followed by E.on's subsequent purchases of both Powergen here and Ruhrgas in Germany; (2) EDF's purchase of British Energy.  These should have been stopped by UK and EC regulators - not because vertical integration is intrinsically wicked, but because the markets weren't sufficiently liquid at the time.  (In fact, truly liquid markets make vertical integration a very dubious commercial proposition - which is the virtuous-circle side of the liquidity picture.  We are stuck with the vicious circle.) 

The second disaster for the liquidity/competition downward spiral is the manner in which decarbonisation is being pursued.  In the UK this means the ridiculous 'Electricity Market Reforms', which - take it from me - undermine liquidity still further, even as ministers and Ofgem continue to pay lip-service to the need for better liquidity.  It's hugely perverse, because several critical aspects of EMR are wholly dependent on there being deeply liquid markets in existence.  They will fail miserably, and piecemeal government interventions of the most grotesque kind will result - the civil servants can hardly contain their excitement at the prospect.  And they will probably keep the lights on, because we can and will pay (see above) - almost any price.

Which brings us back to Miliband's 'price freeze'.  I've banged on too long already to dissect this in detail.  Suffice to repeat: it's bonkers, it's a cheap populist shot, and will have negative consequences far outweighing any limited relief it may deliver to consumers.  Interestingly, in answer to Brillo's questions Caroline Flint (who, it must be said, was quite well briefed) quickly mentioned the really significant new Labour policy, which is to re-introduce something akin to the 'Pool market' (i.e. an end to the bilateral / self-despatch system) which was how things were run here in the 1990's.  It wasn't a disaster, but it was definitely very inefficient.  And - oh, how these things go full circle - it was dreamed up by Oliver sh*t-for-brains Letwin ! (Who still hankers after it, I can tell you, as do civil servants and all the old CEGB dinosaurs.)

Is that enough to be going on with ?   (Too much ! - Ed)

ND

Small Electricity Suppliers Have No Right To An Easy Life

Ofgem, whose uselessness over the past decade is a disgrace to the excellent work done by its predecessors Ofgas and Offer in the 1990's, is at it again. 

Britain's big six energy companies will face fines unless they open up the electricity market to competition from smaller rivals, under proposals by the regulator designed to "break the stranglehold" of the biggest suppliers.  (DTel)

The details of this are less dramatic than one might imagine: they intend to 'force' the biggest 8 generators (not just the 'Big 6') to become market makers in the forward market out to 2 years.  Since liquidity in the 2-year energy forwards is pretty unsatisfactory - and since that, in turn, is pretty damaging - no one can be happy with the status quo.  Ofgem have been farting around worrying aimlessly about energy liquidity for 8 years now and the only positive development has been the advent of hedge fund and PE money since around 2006 - mostly in the gas sector because electricity trading is fiendishly difficult.  On the downside, banks have been progressively scaling back their commodities trading altogether.

Of course, the real issue is that in the '00s, Ofgem and the competition authorities (against their better judgement but under instruction from Gordon Brown) allowed dumb vertical integration to take hold once more in the electricity market, after the successful efforts of 15 years to break it up.  EDF being allowed to buy BE was the final straw in the structural undermining of liquidity, a point we made at the time. The European authorities, who ought to be a back-stop against this kind of thing, were equally supine.

What I don't understand is why anyone thinks small, under-capitalised electricity suppliers have a God-given right to thrive.  This is the most capital-intensive of industries - whether or not a player intends to back ts energy positions with physical assets (power plants, gas production or storage facilities etc).  Even if they intend to operate on a 'merchant' model - just buying wholesale to meet retail demand - huge quantities of risk capital are required to back the big, long-term deals that are required for that business model.  That is the lesson of 'asset-lite' Enron:  it's a game for big boys with a credit rating of at least A, preferably higher.

What's needed is real competition between ten or so properly-capitalised players. Boutique energy marketing outfits with no credit won't be able to transact 2-year hedges anyway - unless the new 'rules' force the Big 8 to take the credit risk, the merest featherbedding.  Along with the free ride that is currently given to windfarms in terms of not being charged the full cost of their intermittency, plus a heap of social obligations as regards 'poor' retail customers, and even more nonsense contained in the Energy Bill, the burdens being heaped on the big players will one day make some of them decide it's not worth the candle.  Obvious candidates for giving up in disgust are cash-strapped RWE of Germany (nPower) and Spanish Ibderdrola (Scottish Power).  It's not too much of a stretch to see E.ON having second thoughts as well.

See how we like it when Big 6 becomes Big 3, eh?  No amount of flaky, subsidised suppliers called 'Nice Clean Energy' or 'Friendly Power' will help us then.

ND

Ganging up on Gazprom

Here's an amusing turn of events.  At the end of last month, Russia - after 18 years of trying - was admitted to the WTO.

Welcome to the world of free trade !  Within days, the EC announced proceedings against Gazprom under Competition law, on three counts, focusing on Gazprom's activities in Eastern Europe:

• hindering the free flow of gas by use of 'no-resale' clauses in contracts;
• preventing diversification of supply by frustrating third-party access to, and development of, gas infrastructure;
• insisting on pricing gas using oil-indexed pricing formulae.

One hopes the EC doesn't waste too much of our money on their investigation and I can assist them in this regard.  On count 1, a cursory examination of the relevant contracts will do the trick: guilty as charged.  (And while you are at it, check the big gas sales contracts made by Algerian state company Sonatrach to France, Spain and Italy - you'll find the same there, too.)

On the second you may have a bit more trouble because there will be less of a paper-trail, and some of the European companies who could spill the beans are strongly inclined not to.  Nil desperandum, because to establish charge no.3 you need only read the collected public works of Gazprom speakers at energy conferences over the past 5 years.

Putin seems to be sweating a little over this (wonder why ?) and has rushed to hinder the process.  As well he might because there is no telling where this could eventually lead.  (Hint to EC: broaden your scope to Italy ...)

What has triggered this action ?  You may recall that, of the two big German energy companies that have been bleeding white from importing oil-indexed Russian gas, E.on - always much closer to Gazprom - settled earlier this year but RWE was hanging in for much bigger concessions, and they gave fair warning.  This is RWE's ace: they have made several large acquisitions in the Eastern European energy sector, thorough which they obtained all the paperwork necessary to prove the case.

ND

RWE, EDF and The Curse of the Ratings Agencies

Anyone notice that RWE has been downgraded ?  BBB+ is not a healthy place to be for a big energy utility laden with physical assets - it's only just over Investment Grade.  Even Enron was BBB+, for pity's sake !  It's no joke and RWE will need to reorient their strategy significantly.  Getting a better deal from Gazprom on their long-term contracts will only be a start.

They've been buffeted, of course, by the vagaries of Germany's energy policy - or complete absence of policy as my German friends aver; and are just that bit less able to take the punishment than fellow-sufferer E.on. Both pulled out of the fatuous game of 'new nukes for UK' earlier this year, for the very reason of trying to preserve their ratings.  E.on's time in the rating agencies' sights may come (again).

So what of EDF and its resolute programme for a few new UK nukes of its own ?  Dream on, Ed Davey - they know they'll be hit too if they stick their balance-sheet on the line for this lost cause, generous subsidies or no.  Their would-be 20% partner Centrica will be heading for the hills soon, and EDF are already casting around for replacements.  Rumbling on in the background is a dispute with Areva over who takes the hit on the monstrous EPR over-run costs; and if DECC gets a single new nuke out of them (at Hinkley in Somerset) it will be a miracle of the first order.  

Interestingly enough it's not nukes that EDF press releases emphasise !

Yeah, funny, that.

ND