Spotlight on the retail energy market

Posted by Liz Rees in Latest insights category on 16 Aug 18

I guess the energy sector is of interest to most of us, whether as price-conscious consumers or as investors, so I thought I’d take a look at the companies that deliver gas and electricity to our homes. This market has under-gone radical change in recent years, opening up to new entrants and providing consumers with greater choice.

Following a spate of privatisations, starting in the 1980s, utilities were stock market darlings for a number of years. They produced healthy returns for investors, with reliable and inflation-linked dividends, from servicing loyal customers and enjoying predictable demand. This all changed in the late 1990s when full competition was allowed, enabling the public to choose between suppliers.

Corporate activity ensued, with many UK companies gobbled up by overseas predators. For example, EDF (Electricity de France) now owns the former London Electric, Seeboard and SWEB, while RWE of Germany owns npower which incorporated Midlands Electricity. Even Scottish Power, which bought Manweb, is a subsidiary of the Spanish firm Iberdrola, the global leader in wind energy.

The remaining UK listed companies have had a tough few years and SSE is currently spinning off its household supply arm to npower. Centrica, parent of British Gas, has seen institutional investors bail out following dividend cuts while customers also voted with their feet; 340,000 left in the first half of this year. The company has sold its loss-making gas production capacity and a new Chief Executive is trying to re-invent it as a services business.

Providing energy to our homes involves: power generation, transportation, and supply to end users. Energy companies can operate in any or all areas. Suppliers buy energy from the wholesale market or directly from generators and arrange for it to be delivered to consumers. Smaller suppliers have been given slight advantages over the Big Six which also have to contend with government-imposed price-caps, carbon taxes and the advent of alternative technologies.

Consequently, the market share of the Big Six fell to a record low of 78% in December 2017, compared with 98% a decade ago, according to energy regulator Ofgem. Last year, around 5m electricity consumers and 4m gas consumers switched supplier and more than a third of these switched away from the Big Six to a challenger firm.

At a personal level, prompted by stories in the press that the big players are uncompetitive, and my fixed term with EDF having ended, I finally got round to reviewing my own supply. I visited a few comparison websites and they threw up similar proposals, with a few ‘exclusive deals’. Sure enough, both the standard rate and fix options from EDF looked expensive. Among the larger suppliers only Scottish Power ranked highly on price, while many of those that stood out I had never heard of. So would I be taking a big risk by signing up to the enticing offers from Zebra, Igloo, Rhubarb, or any other exotically named but unfamiliar company, touting for my business?

I believe the main reason people are reluctant to switch to a small supplier, is fear they may go out of business and supply would be disrupted. However, if the worst happens, the regulator (Ofgem) will appoint a supplier of last resort and compulsorily transfer you to them, with no disruption, though probably on different terms. You are then free to move to another supplier without exit penalties.

I took the plunge and opted for a small supplier with a reasonable 18 month fix, renewable energy and a high service rating. Failure is often a function of poor service, so it’s worth checking the reviews. Future Energy and Iresa ceased trading this year, with some others struggling to survive. Ofgem is currently looking to tighten the regulations on granting a licence to operate.

Whilst the rise in the oil price may be pushing up our bills, we still have the lowest unit prices in Western Europe. So it seems to me that proactive consumers are set to be the winners for the time being with the utility business model under pressure. From an investment point of view, there seem to be further challenges ahead and I would be wary of funds with high direct exposure to utilities.

Better opportunities may be found in companies capitalising on new technologies such as renewable power where costs are declining rapidly. Over a third of global electricity is set to come from wind and solar by 2040 (according to Bloomberg New Energy Finance) and demand will be augmented by the need to meet carbon emissions targets. A good place to start could be a Sustainable or Smaller Companies Fund. Holdings may include Drax (renewable electricity from wood pellets) or Smart Metering Systems (energy management solutions).

The industry is evolving rapidly and I wouldn’t be surprised to see the tentacles of Amazon or Google and the like reaching the utilities arena, either by acquiring an incumbent, or starting afresh. The oil majors are also diversifying and Shell bought supplier First Utility last year. Maybe the buzz of corporate activity will transform the supply side but for now I would seek innovators, or simply clean up your household finances with a switch to a better deal. It’s a little bit of effort for, in some cases, a substantial saving.

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