Since August 2021 the global gas price has been very volatile, and led to record increases in the price of wholesale gas. It’s now May 2022 and there has been a fall in the wholesale price of gas over recent days on what is called the ‘day ahead’ market, which – as its name suggests – is where you buy gas for immediate use. However as suppliers predominantly buy energy months, and years, in advance on the forward market, what happens on the ‘day-ahead’ market has limited effect. It’s only when there’s a consistent fall in the cost of gas on the forward market, that this will feed through to a reduction in bills.
Dhara Vyas, Director of Advocacy at Energy UK, explains why:
Energy companies buy most of their energy in advance, by a season or a year. This is called ‘hedging’, and it helps protect suppliers from being exposed to sudden price spikes.
Some of the 29 energy suppliers which have gone out of business since last August failed because they didn’t hedge as much in advance, so were soon exposed when prices suddenly spiked to record levels. This forced them to buy energy at unprecedented prices – and at a huge loss – because (as a result of the price cap, which is a maximum amount they can charge consumers), they couldn’t come close to recouping the costs.
It’s also important to note that sometimes energy companies have to supply energy to more customers than they had planned for.
So far around 2.3 million customers have been transferred to another energy supplier, because their previous company failed. Energy is an essential service and it’s important in these circumstances that there is no interruption to their supply, so customer accounts are transferred to other energy supplier. Companies that take on these customers have not been able to hedge and buy energy for them in advance – and have therefore been exposed to buying energy at record prices. This additional cost could reach £2.4bn according to Ofgem and is recouped via bills – underlining why it’s critical that we avoid another wave of supplier failures.
The recent high prices have also meant that more customers have remained on the price-capped (Standard Variable) tariff than suppliers had been expecting. Until the crisis kicked in last autumn, fixed term deals had long been the cheapest option on the market, and many customers would have been expected to switch to those in normal circumstances. In this situation, because companies have not anticipated supplying these customers, many companies might not have purchased energy in advance for them, and have had to pay record prices on the wholesale market. Some companies were subsiding some of their customers by up to £700 per account until the recent price cap rise.
Before the current gas price crisis, most energy suppliers had not made a profit from their domestic retail customers, and the market is in a fairly fragile state, which makes it even harder to withstand price shocks of this scale. Once through the immediate crisis, a new approach to regulating the sector will be essential. Energy UK welcomes the Government’s Review of Electricity Markets Arrangements (REMA) and retail market review which should help address this.
Ultimately, energy price increases in Britain have been driven by international gas prices reaching levels never seen before – and persisting for several months. While Ofgem has announced plans to move to a quarterly price cap review, which would aim to ensure changes in wholesale costs (including falls) are reflected in customer bills much sooner, the immediate outlook is for further bill rises later this year.
This is why we continue to call on the Government to provide more support for consumers ahead of next winter. Another increase in energy bills could place millions more into fuel poverty, on top of those who are already struggling. This is an economy wide cost of living crisis, and urgent action is vital to protect consumers in the short term. In the long term, it will be essential to ensure we have a more sustainable retail sector, that can continue to deliver this essential service to every home and business in the country. The retail market has a key role to play in facilitating the low carbon transition and helping the country achieve its Net Zero targets: but to do so it has to be able to attract investment and innovate for the future.