Why are energy bills in the news and suppliers going bust?

• Gas prices are rising globally due to high demand post-pandemic, lack of gas storage across Europe, and politically driven by the withholding of fuel supplies from oil and gas giants like Russia
• These rising wholesale costs have driven many suppliers’ profits down – so that they are no longer making a profit and go into administration
• Energy bills are likely to go up again when the energy price cap is reviewed early next year
• In the longer-term two ways to isolate Britain from further volatility is to:
  • accelerate the transition away from fuels for energy
  • increase energy efficiency (decreasing the demand for gas).

In brief, gas bills in the UK are going up because the wholesale price of gas is increasing globally. This is the price that suppliers pay before adding network costs and other overheads. It’s around 4x more expensive than it normally is at this time of year.

Electricity bills are also rising in the UK, but less so compared to gas. This is because generation of electricity is increasingly from renewables (43% generation), meaning it is less reliant on gas (36% generation) and so subjected to less volatility. The UK has a target to decarbonise electricity completely by 2035, so cheaper renewables will continue to play a greater role in falling prices as time goes on.

This is not the first time energy costs have fluctuated in response to global markets. Historically, fossil fuels prices have been volatile, for example in summer 2008 oil prices were at record highs that weresharply followed by record lows when the financial crash hit. The nature of global commodities like gas, where there is demand all around the world, often at similar times, means that it is likely that fossil fuel prices will remain volatile.

However, digging into why global wholesale prices have risen by 250% during 2021 reveals a much more complicated landscape.

The UK imports most of the fossil fuels used in the country from abroad - 28% of all our energy has been imported in 2021 so far. Although we were a net exporter of energy at the start of the 1980s, due to exploitation of North Sea fossil fuels, domestic production of coal, oil and gas has decreased substantially since 1990 – by around 98%, 47% and 7% respectively.

This means of all the gas imported to the UK, most comes from Norway (55%) via a pipeline, but the rest of the natural gas is transported to the UK as Liquified Natural Gas (LNG) on ships, which we mostly get from Qatar (20%) the USA (11%) and Russia (5%). All these imports mean that the UK is reliant on the global fossil fuel market, which has been very volatile recently.

One reason for this volatility is simply increased demand (not matched by increased supply) for gas following the coronavirus lockdowns and economic bounce back once they ended. This is especially true in Asia, where demand has been very strong for LNG, fuelling competition between the UK and others for shipments. As the weather turns colder across the entire Northern hemisphere in the coming winter months, demand for gas for heating will increase even more. This is likely to further push up the prices of the fuel.

Another reason is that last winter (2019/20) was very cold so lots of gas held in storage across Europe was used up. However, the fuel in storage has not been replaced to the same level meaning there is a lack of gas stored for back up across the continent. In the UK this is particularly relevant as the Rough storage facility, owned by Centrica (parent company to British Gas), was shut in 2017 and not replaced, leaving us with less storage than many other nations.

Aside from decisions about replacing storage facilities, gas held in storage has not been replenished as large oil and gas producers like Russia have withheld gas flows into Europe despite it normally providing more of the fuel.

The reasons for this are strategic and political; withholding gas into Europe gives Russia greater leverage over the EU for important decisions, like approval of the controversial Nord Stream 2 pipeline that it wishes to build to connect to Germany. It also has economic benefits for Russia; the oil and gas giant Gazprom (38% owned by the Russian state) has a monopoly on supply from the country and reported record profits of $20bn in the nine months to September 2021. Annual dividends for investors will also be doubled this year compared to 2020.

Increases in wholesale prices have also been linked to rising carbon prices – essentially taxes on polluting fossil fuels to discourage their use – as climate change has risen increasingly up the political and public agenda. In the EU, carbon prices reached an all time high of €68 / tonne following COP26, with those in the UK expected to follow the same highs in coming auctions.

Over the last decade, the UK Government and the energy regulator Ofgem have aimed to keep energy bills low by encouraging competition between different suppliers. This meant that the traditional “Big 6” suppliers (EON, EDF, SSE, Scottish Power, British Gas, npower) and a few smaller companies were joined by many, smaller new entrants to the market, such as Good Energy.

In June 2021, there were 49 domestic suppliers in the UK market. Some of these smaller players had rapidly grown in size, for example Bulb was the fastest growing energy supplier between 2017 and 2019. However, it has now ceased trading – alongside 22 other companies that have now exited the market, covering 4.26m customers.

Often, smaller suppliers in the UK exist on very thin profit margins where their profits are very close to the line that marks breaking even and making a loss to remain competitive and secure consumers looking for the lowest possible price. This means that when wholesale prices are high, like they are at the moment, the margins become even thinner, and some companies can cross over the line into making a loss. If loss-making persists for long enough, the company may burn through all its capital (or savings) and cannot continue to operate.

In addition, it’s common for suppliers to offer fixed term tariffs, where customers that choose these tariffs lock in a certain price for each unit of energy used for a set time, usually 1-2 years. Because the prices of fuels are always changing depending on the global market, when gas prices are high these tariffs can result in the customer paying less for the energy that they use than the supplier pays for it – so again the supplier makes a loss, an unsustainable situation for their business.

Similarly, the energy price cap that was brought in by Ofgem to protect people that aren’t on a fixed tariff sets a limit on the amount that a supplier can charge for energy per year. In winter 2021/22, that price is £1,277. Some suppliers have said that the current price cap is set too low, because they can’t pass all the high prices that they are paying for gas prices onto their consumers – so again they are operating a loss.

However, there are many more things that affect whether or not a supplier goes bust. For example, some suggest that Bulb Energy did not buy energy as far in advance as Ofgem assumes when setting the price cap, a process known as hedging. Hedging is buying energy at set prices in advance, rather than at the prices at the time. Essentially, avoiding hedging leaves companies vulnerable to spikes in prices as they are forced to pay whatever the market rate is rather than buying cheaper energy in advance.

It’s thought that Bulb did not hedge their prices and instead “bought energy closer to prevailing wholesale prices. With prices soaring in recent months it has been unable to pass on these higher costs to consumers because of the energy price cap” set by Ofgem - who has admitted “that the cap no longer reflected the true costs suppliers were facing”.

Ofgem has confirmed that it is looking into imposing stricter regulations on hedging, as most of the suppliers that have gone bust partially or wholly unhedged. The regulator may decide to set a minimum capital requirement for these companies to ensure they have a means of underpinning their strategy, should prices spike again.

In the winter of 2021/22, it’s likely that wholesale prices will continue to rise as demand increases due to colder weather and a lack of forthcoming gas supplies from countries like Russia. This may mean that more energy suppliers go into administration, however there are a number of scenarios that might occur if this happens.

Firstly, for smaller energy suppliers the Supplier of Last Resort (SoLR) procedure kicks in – where customers are moved to another supplier without disruption to their power. Any existing money in a customer’s account should be credited to their account with the new supplier in time, but the new supplier does not have to honour the deal that customers had with their old supplier – meaning some can end up paying substantially more than they budgeted.

The new SoLR is chosen by Ofgem during a competitive process. Ofgem then directs a new company to take over once they are confident that they can supply additional customers in addition to their own existing one.

However, when Bulb Energy went bust they had 1.7m customers, which Ofgem deemed was too many to undertake the SoLR process. Instead, Bulb went into a Special Administration Regime (SAR) where it will be run by an administrator and funded by the UK Government until a buyer can be found for the company, or if it is rescued e.g. through a restructure such that it can operate again, or all its customers have switched to another supplier.

So far, the number of suppliers that have ceased trading this winter has resulted in an estimated cost of £120 per household this year. However, this could increase if more go bust or if there is another SAR required for a larger supplier.

There are schemes in place to support households that might struggle to keep warm or pay bills this winter. The Winter Fuel Allowance, Warm Homes Discount, Cold Weather Payment and Energy Company Obligation all aim to protect households from impractical energy costs that could jeopardise health and wellbeing.

The energy price cap is expected to go up significantly in the new year to reflect the rapidly rising wholesale gas costs. Some estimates show the price cap rising by £400, but others think it may be higher. This may help energy suppliers to cover costs and reduce the risk of them going bust, but will mean that consumers protected by the price cap will pay substantially more on energy bills. Available fixed term tariffs will likely go up too.

In the longer term, costs associated with suppliers going bust (such as the SAR process which will mean that government incurs cost) will be passed onto consumers. Currently, cost estimates are £3.2bn or around £120 per household, on top of the increasing costs of gas and electricity for household bills.

It is well known that having good energy efficiency (such as insulation and efficient doors and windows) can reduce energy bills substantially year after year. This can help to minimise energy use in the home, protecting consumers from higher costs. The Government’s Heat and Buildings Strategy does discuss energy efficiency in some detail however it is focussed mainly on the private rented and social rented sectors and there is no incentives or plan in place for owner occupied homes.

In addition, the rising costs of fossil fuels is likely to be a global trend that continues over the years. Volatility in this market can be avoided by the switch away from fossil fuels in the economy, from transport to heating and cooking within the home. Moreover, continuing the transition from electricity generation from gas to homegrown renewables will also help to insulate the UK from price shocks such as this one as we are less reliant on global markets influenced by large oil and gas players like Russia.

The Government has already set an aim to decarbonise the power system completely by 2035, however the current energy crisis may accelerate this as renewables increasingly look to make the most economical sense as well as environmental.