This article was originally published on 30 March 2020 in Energy Spectrum Issue 708
The last month has seen many of life’s certainties shaken as the country has had to contend with stemming the danger of Covid-19. Even if they have so far avoided the illness, everyone at home and work has been affected. The government has tried to stop the spread of the virus while maintaining as far as possible the economy.
In the electricity and gas sectors there have been specific initiatives from the likes of BEIS, Ofgem, Elexon, Energy UK. But, as we discuss in this week’s Energy Perspective, through the retail market we fear that, without urgent and active policy intervention, Covid-19 is about to force the whole energy industry into uncharted and unpleasant territory.
The last period of significant economic dislocation was the credit crunch of 2007-09. Looking back from an energy perspective, disruption was patchy. Supplies kept flowing and the economic downturn collapsed oil-driven wholesale gas and power prices giving what some described as the equivalent of a tax cut. There was considerable dislocation in the business markets where the “credit crunch” caused supplier exits and diminished suppliers’ willingness to contract with many customers.
The current prognosis is that Covid-19 is likely to cause bigger immediate social and economic dislocation and have deeper long-term consequences. Last week we hosted a webinar where, as well as discussing the immediate impacts of the lockdown on the energy system, we highlighted some of the consequences we foresee and outlined—and raised some concerns on—the government’s relief package.
The mood music is not improved by news of Gnergy falling into supplier of last resort (SoLR)—its customers transferring to Bulb—and the administration of Better Energy. Both exits were unrelated to the current situation, with Gnergy struggling to pay its 2018-19 Renewables Obligation (RO) bill and Better Energy, a gas-only supplier, that shed its customers rather than become DCC compliant. But Gnergy’s exit emphasises that the late summer payment deadline for the 2019-20 RO will loom even larger than usual over the retail market.
Immediate financial consequences
The consequences of the government decisions on Covid-19 have been particularly quick to filter through to the retail energy market. We have picked up anecdotal evidence, including:
- Large business customers either failing to pay their bills in entirety or asking for “payment holidays” that have already started.
- Microbusiness shutting up shop and being unable to pay their bills.
- Households cancelling direct debits, asking for payment holidays, seeking emergency prepayment top ups or simply running out of money.
Unfortunately, these events are occurring at the end of winter when domestic suppliers’ cash balances are near their lowest reflecting fixed monthly direct debit payment profiles.
All the above are signs of the lives of people and businesses being turned upside down. From an energy commercial perspective, they are all visiting themselves on the least-well capitalised part of the market, a lot of which is now in a struggle to conserve its cash. This week will see its March billing cycle commence, while the struggles to collect February’s dues continue.
The expectation, particularly in the business market, is that March’s billing cycle will be much more difficult and this will trigger a significant upheaval in suppliers.
But for now, the market is functioning—albeit with a seizing up of the TPI-led business market last week—and the energy is continuing to flow. There are signs of demand changes, some of which it is already being suggested could be long term. Higher domestic consumption has been reported, for example by Octopus Energy with a slide in larger non-domestic demand highlighted by Electralink. Overall, the latter effect has been much more significant than the former. We estimate year-on-year power demand down 11% and as much as 20% at the morning peak even after adjusting for embedded generation (see Figure 1). Lags in settlement and a lack of meter reads for small sites may mean that these effects take time to come through, also upping the pressure on microbusiness suppliers relative to domestic as initially small business are settled in the wholesale market based on estimated annual consumptions.
Thus far National Grid ESO has responded with a straight bat referring to the “potential for gas to make up less of the mix of electricity” … although it “will still need to be called … to manage key properties of electricity, such as inertia and frequency, so any change may be negligible”. More eyes than usual will scan the demand forecasts it will post in its 2020 Summer Outlook.
Reaction of wholesale prices
Compounded by a tussle for supply promoted by Saudi Arabia, oil markets have also crashed taking other energy and commodity prices with them. Low European power demand has encouraged exports to Great Britain, further squeezing a generation market already accommodating high solar and wind volumes. British wholesale gas and power prices through to next winter have slumped, with power imbalance prices barely scraping over £10/MWh and discounting even day-ahead prices significantly.
Painful for generators, at first glance this looks like a benefit to suppliers as their major cost should be much cheaper. Unfortunately, this is not the whole story: a sustained wholesale price crash will increase significantly suppliers’ mark-to-market trading costs. Such conditions may well test suppliers’ balance sheets to their limits. Sliding demand may also compound this if suppliers are left with stranded volumes they cannot sell on.
One of the areas we see long-term consequences already from Covid-19 driven demand falls is in non-energy charges. This is because the charging bases relied on for networks and policy subsidies will be that much smaller in the round, and consumption patterns altered between households and businesses. We expect disturbance to price caps from summer 2020 onwards. Likewise, there is the potential for new challenges in electricity system balancing if demand remains low and more synchronous generation is squeezed off the buzzbars.
Where do we stand
Presently we see: a retail sector already displaying fragility with 26 supplier exits since start of 2018 and coming to terms with domestic price caps; strongly-rated network companies on the cusp of new price controls; and a generation sector striving to meet the challenge of subsidy-free renewables. Such is Covid-19, that all will be directly or indirectly impacted by the factors we have discussed above.
Supplier working capital requirements will rise if customers are not paying bills, particularly if costs they are liable for (and generally collect from consumers) are maintained. While interest rates remain low, credit margins will rise if general defaults on bank facilities economy-wide occur, and the availability of capital may reduce. If there are widespread supplier failures the industry safety net—Ofgem’s SoLR—will merely redistribute credit default costs on to remaining suppliers, opening up the domino risk of further failures perhaps beyond the retail market itself.
What is being done?
Many voluntary actions have been undertaken by suppliers and others to aid consumers in distress. Energy UK is actively co-ordinating responses reaching into the highest levels of government and out to the industry. There are also the macro-economic support measures set in place by the Treasury, in particular:
- The Covid Corporate Finance Facility (CCFF) provides unsecured loans of one-year maturity and £1mn minimum. CCFF is aimed at larger, good credit-rated (importantly, prior to Covid-19) companies with large short-term financing requirements that are making a “material contribution” to economic activity in the UK.
- The Coronavirus Business Interruption Loan Scheme (CBILS) offers bank loans, unsecured below £250,000, normally secured above that level up to a maximum of £5mn for repayment over three to six years. CBILS is aimed at businesses up to £45mn turnover as at March 2020.
The schemes have been widely welcomed but are not yet in full flow, and how banks approach the finer details is still not clear or consistent. On CCFF it is not clear what “material contribution” to the UK economy means and so how many energy companies it will apply to. Also not all companies are credit rated (so will be relying on banks or agencies to make judgements on a niche industry quickly) and, given the retail sector has had significant financial challenges since 2018, it is difficult to assess how many companies would pass the “robust prior to Covid” test.
Energy retail needs specific help now
Several credible proposals, especially co-ordinated through Energy UK, have emerged seeking to address the problems faced in the retail sector. They face a Treasury apparently sceptical of individual sector solutions. We believe schemes designed for “normal” businesses are not necessarily best placed to energy suppliers that operate in a regulated market and perform several critical roles with regard to consumers and funding policy objectives (like renewables and energy efficiency). But we also need to keep in mind the purpose of any relief package: it should be to minimise distress to vulnerable business and domestic consumers. Positive side effects should be ensuring sufficient of the energy industry remains robust to aid economic recovery and help deliver net zero after Covid-19.
It so happens that the first brunt of Covid-19 is being borne by the sector of the energy industry that has the least financial resilience. Relief is needed most urgently here, but it does not necessarily need to be applied directly. Using government loans to pay consumer bills—as has been proposed for both domestics and microbusinesses—is one option. Temporarily relaxing credit requirements—to free up working capital—and regulatory forbearance on obligations/costs and limit charge shocks have also been tabled but will be incremental rather than transformational. An example here could be for the relaxation of BSC rules so that BSC supplier charges for 2020 are deferred to later.
The idea of a “payment holiday” is also not new for the network companies. They voluntarily offered rebates to suppliers during December 2013 political crisis over rising fuel bills of around £5/customer. While the companies implemented the rebate in different ways, all collected the money by treating it as under-recovery in their price controls. Perhaps they could be persuaded to take similar action again, given RIIO-2 decisions are looming and showing a desire “to be seen to be doing the right thing”.
Another option is perhaps government loans to network companies and levy collecting bodies to fund costs normally recovered by levies or charges on suppliers, who then pass through these costs to bills. While this may be more complex than loans to suppliers, it would have the merit in ensuring these counterparties are paid promptly, lowering their exposure to supplier default and hopefully reducing the scope for those defaults to occur. Suppliers could use slack cut from not having to pay these bills immediately to support distressed customers through granting payment holidays and other bill relief and then repair their balance sheets. They could repay the money through adjusted charges over time, once the current situation is alleviated. In turn, the network companies and levy collecting bodies could then repay the government loans.
Operationally regulatory and policy schemes in place now or due to be introduced should have a level-headed appraisal of their delivery. Examples include installations of smart meters and measures under the Energy Company Obligation, but also the new processes and systems to deliver faster switching and new electricity network charging arrangements.
Whatever is decided, action is needed now if the energy retail sector as it is currently constituted is to play a meaningful role in delivering net zero.