Has the GB energy retail model past its sell by date?
Why do we think this?
A 6-fold increase in input costs would challenge any business and it would depend on several factors whether they could sustain the increase. Three of these factors are the business’s reserves, its hedging strategy and its ability to raise prices. All 3 call into doubt the UK energy retail model.
The UK’s encouragement to bring in competition to challenge the “big 6” has, to date, worked well. Smaller retailers account for around 30% of the market, npower and SSE have left the market with companies like Ovo and Octopus going from strength to strength. However, you have to ask how sustainable are lower prices, especially when retailers have control over only 55% of what they can charge (with taxes and network charges making up the balance)? Despite lower costs-to-serve delivered by new platforms and tax advantages for very small retailers, margins are extremely tight and lower prices involve higher risks, especially when input costs rise, which is where hedging comes in.
Hedging incurs costs and there is a strong temptation to conserve funds on this. As a smaller player it is also harder to arrange hedging in the first place. This is where several of the smaller energy retailers have come unstuck.
When prices do rise, then at some point these have to be passed on to customers, but here the UK government has instituted a price cap. This is designed to stop retailers from exploiting those who do not switch but in this situation, is making the business model loss-making and therefore unsustainable. In fact, margins have been so low even before the gas price rise that many retailers were already loss-making or barely making a profit.
In addition, what this might also impact is the willingness for organisations to invest in energy retail in Britain – it is too high risk. This is likely to return the market to where it started with a small number of large incumbents. Additionally, it may also mean that investment in other elements of the UK’s energy market will be harder to get slowing down the energy transition and putting an even greater pressure on the government to fund the “green recovery”.
In our view, the current energy retail business model is dead. Ofgem’s figures for Sep 2021 for a dual fuel energy bill shows the average margin to be minus 0.93% and this is before the current price hikes. So, what could replace it? Are there less risky models to be considered that could re-invigorate the market and investment?
An alternative?
This is what Traxis Energy is working on. We believe in three things:
1. Decarbonisation is making the energy market increasingly fragmented. Distributed energy offers opportunities for retail but focusing on individual elements in isolation – such as heat pumps - will not work. We need a wholistic approach, and nowhere more importantly than from the end-users’ perspective.
2. The parts of the puzzle are all there. Several trials and pilots have proven the technology. We do not need more legislation – what we need is for business to grasp the nettle, collaborate and start working together to build new value chains.
3. The key element is a viable commercial model that will attract investment. This is about understanding the value chain, collaborating to share value equitably for the benefit of all through building a market and finding bridgeheads to the mass market - the best early opportunities - such as new build and major refurbishments.
We believe local distributed energy holds considerable potential for solving the current problem with retail. It can also help start to address the concern DNOs have about the resilience of the local distribution systems with the growth in ev ownership and as severe weather incidents increase. Therefore, with our partners we are developing a Distributed Energy Service Company model as a new approach that combines energy retail, investment in homes and local businesses, and local grid strengthening, and that makes investment in retail energy more attractive.
What we are doing now...
We strongly believe this is a viable model right now and to prove this we are putting together a collaborative project under Ofgem’s £450m Strategic Innovation Fund – or SIF for short. If you are interested in finding out more or joining the consortium call Simon Anderson on 07968763148 - there is nothing better than talking direct – emails just get lost these days!
Author: Simon Anderson