IRM Insights: Energy - UK's Fuel Crisis
By: Mike Stark, Secretary with contributions from Alexander Larsen, CFIRM, Group Chair, Grant Griffiths, Deputy Chair, and the IRM SIG Committe
Since the energy market opened up to new suppliers, many SME’s (small-medium enterprises) have flooded the market trying to gain market share. However, in recent weeks, 17 of these energy suppliers have gone bankrupt, leaving approximately 17 million consumers without a supplier.
This has happened as UK gas prices exceed the UK energy price cap, where UK gas prices almost reached 300p/therm during September before falling to 240p/therm in the last week. Any cost exceeding the UK energy price cap cannot be passed on to the consumer and is therefore absorbed by the energy suppliers – meaning they are selling gas at a loss.
Whilst the UK energy price cap is reviewed bi-annually (October and April) this may not be frequent enough in more volatile markets. In the latest review of the UK energy price cap on 1st October, the price cap increased 12%, passing significant increases onto consumers and businesses – some of these also going out of business.
What fuelled the crisis?
Root causes are in abundance, with a squeeze on gas supplies, increased demand for gas globally, higher volatility in the market, reduced UK gas storage, and a UK energy price cap which is only reviewed bi-annually. The number of UK energy suppliers has also increased rapidly. Where these new energy suppliers are trying to grow their market share, but at what cost?
Trading in commodity markets is a very sophisticated area, which requires a very robust governance structure and risk and controls framework, clearly defining risk appetite and aligning this to the strength of the balance sheet and cashflows. Companies have either not fully considered their risk appetites and capacity, or they have deliberately gone beyond their capacity with the result being bankruptcy.
Gas markets are margined daily where energy suppliers post cash daily (margin calls) to clearing brokers whilst revenues from consumers are generally only received monthly and/or quarterly in arrears, creating a strain on cashflows in rising markets. More sophisticated energy suppliers can stress test and hedge against price increases by buying financial (call) options (which requires payment upfront of an option premium), buying gas futures and buying gas on a longer-dated basis.
Whilst hedges lock in prices, there are nearly always costs associated with doing this that requires a healthy balance sheet and cash flow. When new energy suppliers grow too quickly, taking on too many new customers they become much more sensitive to price rises. The impact of which we are now, unfortunately, witnessing as these SME energy suppliers start to collapse.
What could have been done?
Could more have been done to prevent these failures? The UK government has said it would consider quarterly reviews of the UK energy price cap but was adamant they would not use UK taxpayers’ money to bail out energy suppliers but would provide government loans to energy suppliers taking on new customers from failed energy suppliers. However, these failed energy suppliers could have done more to align Risk Management and Governance with their strategy. This was a common failing amongst many companies, with some falling off the regulators' radar, like Ofgem due to their size.
In 2010, Carol Beumier, speaking about the 2008 Banking crisis stated: “Several organisations went well beyond their “Risk appetite” – sometimes without even realizing it”. This is a quote that is equally relevant today. In fact, there is a lot in common with the banking crisis where risk management was lacking. More needs to be done to ensure past mistakes are not repeated and instead are turned into lessons learned (and actions taken). New market entrants need to have the expertise, risk management, financial strength, and regulations in place to reduce such an event from happening again.
The wider impacts
Gas prices also affect the wider supply chain, and price changes will be reflected in many other sectors. As we approach winter in the northern hemisphere, the demand for gas seems unlikely to recede any time soon. Increases in gas prices have a wider economic impact beyond just the price of the gas commodity itself. It will drive higher prices for many other products, and manufacturers, transportation, and other sectors will experience higher costs which will be passed on to the consumer as household bills for non-energy related goods and services increase.
Having just gone through the shock of Covid-19, with lockdowns and social distancing and the necessity to embrace digital transformation and home working, it is important, now more than ever, for organisations to look at their risk management approaches and ensure that they consider all critical dependencies and supply chains in order to build resilience against any further shocks they may face, such as these recent energy price spikes.
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