Powering the switch to green energy
02 Feb 2022
It’s been hard to escape media coverage of the seismic shocks hitting the energy industry at the moment, but what does it all mean for energy users, and what should you do about it? In this energy prices update, we recap on what’s causing the current situation, and offer some tips on the implications for households and businesses.
• What’s going on with energy prices?
• What have high energy prices meant for households?
• What have high energy prices meant for energy suppliers?
• What have high energy prices meant for businesses?
• Energy prices update – the advice for households
• Energy prices update – the advice for businesses
• What help is available for households?
• What help is available for businesses?
The price that suppliers pay for the energy they sell to homes and businesses has skyrocketed over the last 12 months. The increases have been caused by a number of factors, including:
So far, the impact on households has been softened by a piece of regulation known as the ‘price cap’. This limits how much energy suppliers can charge customers on ‘variable’ tariffs. Variable tariffs are the deals your supplier will put you on if you fail to actively choose an alternative tariff (you can read more about the difference between different tariff types here).
Since 1 October 2021, the price cap has been set at £1,277 a year for a typical dual fuel home (but a massive increase will kick in from 1 April 2022). It’s important to remember that the cap restricts the price you can be charged per unit of energy, not the total amount you can be charged, so homes that use more energy than average will pay considerably more than £1,277 (and those that use less will pay less).
Variable tariffs are typically more expensive than alternative deals, known as ‘fixed rate tariffs’, where the supplier commits to fix the price you pay per unit of energy for a set period, usually 12 months. But, the price cap has turned this on its head. As wholesale prices have risen, suppliers have been unable to offer deals at levels below the price cap, and variable tariffs have become the cheapest deals available to households.
As a result, the advice for homeowners has been to sit tight and do nothing. This has included customers whose fixed rate deals have come to an end – by simply allowing themselves to drop onto the supplier’s variable rate, protected by the price cap, households have guaranteed they’re on the cheapest rate available (despite this generally being higher than their old tariff).
To understand the impact energy prices have had on suppliers, you need to understand the concept of ‘hedging’. Hedging simply means securing a price now for something that you will use later. In markets for commodities like energy, where prices can be volatile, buying in advance can allow a business to capitalise on periods of low prices by locking them in, while reducing exposure to potential higher prices in future. If you’ve ever signed up your home or business to a fixed tariff, these work in exactly the same way.
In order to offer fixed price deals, energy suppliers also have to hedge the energy they’ll sell to you over the length of the contract. You, the customer, promise to stay with the supplier for a set period (normally 12 months), and so the supplier has the confidence to buy 12 months’ worth of energy for you in advance. Because the supplier can lock in the price they will pay over the course of the contract, they can commit to charging you a fixed price. That’s why many suppliers charge penalties to households who leave fixed deals early – because they’re left with energy they’ve paid for that they may not be able to sell profitably.
For an energy supplier to buy energy in advance, they need to know with some certainty that they’ll be able to sell that energy when the time comes. So a supplier buying energy in spring that will be used the following winter – or even the following spring – needs to know they’ll have enough customers to use that amount of energy when the time comes.
In general, the more energy that suppliers bought in advance before the current price rises hit, the better off they’ve been. Energy used by customers that hasn’t been covered by hedges has to purchased at current market rates, and because the household price cap restricts suppliers’ ability to pass on all of those high costs to households, that can mean huge losses.
This situation has tended to favour the larger, older energy suppliers, who have lots of customers who never switch. Because they don’t switch, those suppliers can have confidence in buying energy for them in advance. In contrast, newer suppliers who have had to attract customers by offering fixed rate deals know that those customers are more than likely to switch away at the end of their deal. That makes it much riskier for them to buy energy in advance on behalf of those customers.
Larger suppliers also tend to be better capitalised (in lay terms, they find it easier to lay their hands on large amounts of cash), and so can afford to hedge over longer periods.
As a result (and with a few notable exceptions), it’s tended to be the smaller, newer suppliers that have struggled the most, and more than 25 have now gone into administration.
This is bad news for everyone. In the short term, the customers of failed suppliers have been “protected” by a process called the ‘Supplier of Last Resort‘ (SoLR). Under SoLR, those customers are transferred to a new supplier, appointed by Ofgem, the energy regulator.
“Protected” is the term Ofgem uses, but in many ways it’s a bit misleading. SoLR does mean homes can’t be cut off and any surplus in your account with a failed supplier will be transferred over to the new supplier. But, affected households will lose the benefit of any fixed rate deals they may have had with the old supplier, in almost all cases ending up on the new supplier’s price-cap-protected variable tariff, which can mean paying considerably more.
Worse for all consumers is the fact that the costs incurred by the new supplier in taking on extra customers in unfavourable market conditions are added to levies on remaining suppliers that cover the maintenance of the energy grid, known as ‘network costs’. These in turn are passed on to end users, which means households face big increases in bills to cover around £2bn of SoLR costs (and counting), even before the continued impact of high wholesale prices is factored in.
Businesses are not protected by the price cap. As a result, businesses on ‘deemed’ rates (the equivalent of a ‘variable’ contract for households) have felt the immediate impact of rising wholesale prices as suppliers passed these on to end users.
Unfortunately, there have also been some cases where multi-year ‘fixed rate’ deals entered into before the current price rises have not been honoured by suppliers (often because the suppliers they themselves rely on have gone bust, forcing them to secure new supplies for energy they thought they’d hedged (and sold to customers) at much lower rates than are now available.
Businesses whose previous contracts with suppliers have come to an end during the last six months or so have also faced big jumps in pricing, and have had to decide on whether to fix again, or ride out high prices on their supplier’s deemed rates in the hope lower prices will follow soon. More on that below.
In some cases this has resulted in eye-watering increases in energy bills at a time when many businesses are already reeling from the impacts of Covid-19.
Possibly the the only thing we know with absolute certainty is that, if you take your power and gas from the national grid, you will be paying much more in 2022 than you have at any time over the past decade. Budget for that now, and if you’re concerned about your ability to pay, we’ve provided links to additional support and resources below.
Tip #1: Prepare for higher prices
As things stand, the price cap is adjusted once every six months. The adjustments follow a prescribed formula based on wholesale prices over the preceding 6-9 months, the logic being that most suppliers should be buying most of the energy they sell in advance. That’s why the current price cap – effective from 1 October 2021 and based on energy prices over the preceding period – is so out of whack with current wholesale prices.
While this has been good news for households in the short term, those current prices will be factored into the next price cap, which will take effect from 1 April 2022. The new cap has been set at £1,971 for a typical home – a 55% increase.
So, while the price cap over this winter has reflected lower prices from previous periods, the next price cap will offer no such protection.
Tip #2: Don’t rely on the price cap
The next few months should see wholesale energy prices starting to fall. Prices are traditionally lower over the summer, and reduced demand for energy in warmer months should allow for stocks to be replenished ahead of next winter. Here are a few key factors to keep an eye on:
Energy prices typically follow a seasonal trend. Power consumed in winter tends to be more expensive, because colder weather means greater demand relative to supply. As demand slackens over summer months, prices fall. If you’re a household looking for a 12 month fixed rate deal, this seasonal fluctuation gets factored in. Suppliers have to hedge (buy the energy they’ll sell to you in advance), so that means any 12 month deal will incorporate both low summer prices and high winter prices
With energy supplies so under pressure (particularly when it comes to gas), one of the key determinants of future energy prices is the degree to which depleted reserves can be replenished over the months ahead. Both in winter and summer, prolonged periods of mild weather are likely to mean lower prices in future.
There is broad consensus that global politics is playing a big role in the current crisis. Russia, which supplies much of Europe’s gas, has been keeping supply at well below normal levels despite a surge in demand. Most immediately, this appears to have been an effort to pressurise the German government into approving use of a new undersea gas pipeline from Russia, known as Nord Stream 2. Completed in September 2021, Nord Stream 2 will allow Russia to bypass its current overland gas shipment route via the Ukraine.
Russia’s current menacing behaviour towards Ukraine may be about much more than gas shipments, but the threat of invasion is playing its part in driving future prices up. How that – and the Nord Stream 2 situation – are resolved will be big factors in energy prices over the next 12 months.
The price rises of the last 12 months have in part been driven by the resurgence of economic activity following the Covid-19 shutdowns on 2020. Demand in Asia has been particularly significant – demand for natural gas in China was 21% higher in 2021 than in 2020. Whether this trend continues will be an important factor in determining prices over the next year or so. With cost of living increases hitting consumers across much of Europe, it is possible an economic slow-down may result.
With this level of uncertainty, the level and speed of any falls in longer-term wholesale prices is similarly unclear. As prices fall, suppliers should be able to offer fixed price deals again at levels below the new price cap, making it important that households monitor options carefully to take advantage of these deals when they happen. Because switches take around three weeks to go live after you submit a switch application, you should start to look around for alternative offers in mid March, to ensure that, if they’re available, you’re on supply with your new provider before the change to the price cap on 1 April.
Tip #3: Start shopping around from mid-March
Over the last few months the guidance for businesses falling onto – or already on – out of contract rates has been pretty straightforward. Facing a winter of peak pricing, it’s often made sense to settle on a 3+ year fixed rate contract that softened current highs with anticipated returns to more normal market conditions later in the term.
As we emerge from the winter peaks, this situation is changing. Subject to the many unknowns above, it remains likely that wholesale prices will ease over the coming 3-4 months, and that with the worst peaks out of the way, better deals may be available. Riding out the remaining winter months may therefore pay off.
The challenge, of course, is knowing just how much prices are likely to drop away, and just how much of those falls suppliers will be willing to pass on to customers. Whatever happens, prices for energy bought now for use in future won’t get anywhere close to prices pre-2021 for a couple of years at least, so businesses need to budget for higher energy costs whatever happens.
Whether to plump for a fixed rate straight away or wait it out in the hope of more competitive tariffs depends both on your appetite for risk, and your energy use profile. If you’re likely to using a lot of energy over the next few months, controlling the cost of that will be more of a priority. If your energy use is flatter over the year, then waiting it out may make more sense. Either way, talk to us, and we can walk you through your options and help you understand what’s best for your individual business.
If you are struggling with the cost of energy, there may be some support available to you. We have compiled a list of useful resources, to help:
The Warm Homes Discount Scheme is a one off payment of £140 for households who are:
The payment is made directly by the supplier once a year, and is available irrespective of whether you pay for your energy by direct debit or pay as you go.
You can find out more on the gov.uk website:
This is a new £500 million support package – the Household Support Fund has been created to help vulnerable households this winter. For help and advice on accessing this fund, contact your local council. For more info on the Fund, see:
Citizen’s Advice offer links to various grants available from specific energy suppliers – take a look to see if yours is listed.
If the weather is recorded as or forecast to be zero degrees or lower over seven consecutive days, a Cold Weather Payment of £25 may be available. The Cold Weather Payment is available November 2021 to 31 March 2022.
For advice on managing debt, the following organisations may be able to provide support and assistance:
If your business is facing rising energy costs, first talk to us to make sure you’re not paying more than you need to be.
The energy regulator, Ofgem, also has a comprehensive list of support available to businesses struggling with energy bills.