How can UK energy suppliers ride out crisis in 2021?

In recent years the UK energy market has been made all the more competitive, thanks to multiple small suppliers entering a space that was once the domain of only large suppliers. These smaller suppliers have relied on exploiting a maturity mismatch—that is, finding profit between buying in the spot energy market (a day-ahead market where prices are based on supply and demand) and setting long-term prices at which to lock in customers. However, as these suppliers have recently seen, when spot prices spike it is all too possible to go from profitability once day to racking up millions of pounds in losses the next.

In 2021, we have seen UK energy supplier businesses collapsing an alarming rate. So far this year seven suppliers have gone bust, affecting more than a million households. There will surely be more; at the time of writing, UK energy companies large and small are begging the government for a bailout. Bulb, the UK’s sixth largest energy company, is currently one of those. To put the severity of the crisis in context, back in January 2021, there were 70 energy suppliers in the UK; industry sources predict there could be as few as 10 by December 2021.

To establish how energy suppliers might navigate these times of acute crisis, it is helpful to understand why the sector is struggling in the first place. Geopolitical issues, a global surge in gas demand, extreme winters and rebounds in consumption are all factors. Here we will explore some of the most pertinent issues facing the UK energy market right now— namely, the shortage of supplies, pricing regulations and the effects of the UK’s recent exit from the EU.

Low supplies, high demand

The UK is heavily reliant on wind and natural gas for energy generation. In 2020 wind provided 25% of the UK’s total energy mix while natural gas accounted for about 32% of all energy produced, well above the European average of 30%. Unfortunately, climatic conditions in 2021 have resulted in wind producing just 7% of UK’s total energy. This has been compounded by a global shortage of natural gas—in part due to cold winters—which has meant increased consumption.

The UK is not alone in terms of supply issues. Europe relies heavily on two countries for gas: Russia (which, on average provides about 33% of Europe’s gas) and Norway (which provides around 20%). Both Russia and Norway have suffered production problems of late. Between the end of July and the middle of August 2021, gas flow from Russia to Europe through the Yamal-Europe pipeline more than halved, falling to just 20 million m3 per day (from 49 million m3 per day). Before that, its usual rate was 81 million m3 per day. Gazprom, Russia’s state owned gas utility, has blamed a cold European winter, but there have been suggestions that by restricting its supply of gas to Europe deliberately, Russia can place pressure on Europe to approve the Nord Stream 2 pipeline.

Norway has also suffered production problems, with June’s natural gas output totalling 7.9 billion m3 —well below the forecast 8.55 billion m3. These factors combined are forcing Europe to look towards the international light natural gas (LGN) markets. However, high demand in countries like China, Japan and South Korea have already pushed international LGN prices to new highs. All of this translates to a 200% increase in UK natural gas prices over the last six months.

The net result is rapidly increasing UK wholesale electricity prices. In mid-September 2021, prices peaked at £424 per megawatt-hour, an 842% increase on the five-year average of around £45 per megawatt-hour. Prices have stabilised somewhat since then; the latest data from the European Power Exchange (EPEX) puts wholesale prices at about £155 per megawatt-hour. However, UK wholesale prices are still considerably higher than those for the rest of the EU.

Price cap problems

To prevent energy companies from overcharging customers and to guarantee price stability, UK energy prices are capped by the Office of Gas and Electricity Markets (Ofgem). In October 2021, this increased by 12% to £1,277 per year. Despite hitting an all-time high, the cap is still too low for some energy companies to turn a profit while wholesale energy prices are so high.

The next official review of the price cap is in April 2022, signalling a tough six months ahead for energy suppliers—some of which will inevitably fail to survive. So, what happens now? Ofgem mandates that when energy suppliers go bust, their customers are automatically transferred another (usually bigger) supplier. These bigger suppliers, already squeezed by high wholesale electricity prices, are insisting that they will need financial help from the government if they are to take on new customers.

Now the government has two options: remove the energy price cap and expose customers to higher prices reflective of the global market or bail out the energy suppliers with taxpayer money. The UK’s Business and Energy Secretary has ruled out scrapping the price cap and has said that the government is considering statebacked loans to support struggling energy companies. With nothing finalised just yet and analysts predicting that gas prices will stay high over the winter, the crisis isn’t going away anytime soon.

The impact of Brexit

Back in 2016, Prime Minister Boris Johnson promised lower fuel bills after Brexit. But that’s not exactly how things have panned out. Despite the already considerable impacts of supply issues, the UK’s high electricity prices have certainly been exacerbated by Brexit. This is because the UK is connected to the EU via interconnectors that enable electricity to flow between mainland Europe and Great Britain. Before Brexit, the UK was part of the EU’s internal electricity market and more specifically, the EU’s single day-ahead coupling mechanism (SDAC). The SDAC is complicated, but the basic premise is that electricity auctions throughout the EU are done by an allocation algorithm called Euphemia, which essentially meant that everyone shared electricity. If, for example, the UK had more electricity than it needed, it would be reallocated to wherever it was needed in the EU. But now, with Brexit, the UK is no longer part of the SDAC and instead benefiting from Euphemia’s automatically generated allocations of electricity supplies, it x

How have the big 6 coped?

So far, the UK’s bigger energy suppliers have managed to withstand sharp wholesale price increases and ride out an extremely tough environment for utilities. What sets the ‘Big 6’ apart from the smaller players is their arsenal of superior data ecosystems and analytical functions. These allow for sophisticated data models that enable accurate pricing, improved planning, better hedging and profitability forecasting, allowing them to use their reserves to hedge against changes in prices. At the same time, the bigger suppliers have leveraged their data ecosystem to better retain the customers that were positively contributing to their cash flows. In contrast, smaller suppliers were far more vulnerable to market shifts as they catered to an opportunist, volatile customer base that was quick to change suppliers for a better offer. Incorporating smart solutions like EXL’s Management Information Assistant (MIA), a search based business intelligence tool, and Margin Enhancement through Incorporation of Sigmoid (METIS) has allowed for reduced operations failure in the case of British Gas.

Moving beyond crisis: finding a way forward

For energy suppliers to survive the harsh winter ahead and thrive in the future, it is vital that they find ways to better predict and prepare for level shifts. Now is the time to start investing in the tools and technology needed to create a sophisticated data warehouse—with the necessary data science talent needed to extract value from it. Business continues to be impacted by the COVID-19 pandemic and the ongoing threat of intermittent lockdowns and business disruptions. The market is unlikely to stay static or even resemble the trends of the past. This exacerbates the need to transform key business functions, leading to increased margin, reduced customer churn and lower operational costs.

We see significant opportunities for achieving these drivers through that smart application of data and analytics tools. For example:

1. Improve energy hedging and forecasting

The COVID-19 pandemic and the emerging energy market scenario have changed the baseline for business going forward. Pre-made forecasting packages and algorithms have been found to be inaccurate in forecasting demand, leading to organisations overbuying when COVID implications are ignored or underburying when recent data is force fitted. Now is the time to develop bespoke forecasting algorithms using more recent consumption patterns alongside historical seasonal trends, portfolio gains and losses, and evolving government policies.

2. Embrace pricing optimisation

The sudden spike in wholesale energy prices should be captured in order to determine the optimal price for customers, while keeping it within the price cap. Rather than offering flat prices to every customer belonging to the same cohort, energy suppliers can optimise pricing on the basis of customer traits using AI-led METIS. This would maximise the expected margin (i.e. margin quoted x predicted conversion rate) and ensure that they are maximising their profit basis from customers who are willing to pay while optimising their revenue and portfolio strength basis with customers who would churn if quoted the usual price.

3. Establish algorithm-driven portfolio performance reporting

Robust margin reporting models should be developed for the portfolio, with the capability to refresh them on daily basis to monitor portfolio health, expected revenue and margin for a substantial period. Effective algorithms would incorporate appropriate consumption profile shapes in order to obtain accurate margin per customer while estimating the correct portfolio strength by leveraging machine-learning-derived decay curve and growth curve for the foreseeable future.

4. Rethink the customer retention strategy

Every supplier must now ensure that their high-margin and high-revenue customers are retained with an appropriate fix, to maintain stable cashflow with a strong margin. A series of propensity models should be developed for each cohort of customers to identify the appropriate time to engage them for contract renewal. Since Cost-to-Retain is substantially lower than Cost-to-Acquire, attractive deals should be offered to customers for renewal along with optimal quotes. To make renewal more compelling to customers additional services and energy contracts should be offered, since customers holding multiple contracts with a supplier are less likely to churn, compared to those who have standalone contracts.

5. Transform business operations

In addition to maximising the portfolio’s margins by increasing or stabilising revenue, suppliers should also attempt to lower the cost of business operations for serving customers. We see a pressing need to transform how business operations work for an energy supplier across key journeys like metering, billing, payment collection and customer switch. Solutions like EXL’s Management Information Assistant (MIA) allow suppliers to monitor journey performance in real-time along with key fallouts and their root causes. MIA also proactively suggests optimal fixes while also creating workflows for the backend team to work on. This transformation eventually leads to lower Cost-to-Serve and a dramatically improved customer experience.

A combination of these key initiatives can help suppliers to avert risk and increase their chances of business survival—or at the very least, plan better in order to ride out market turmoil and maintain a healthy portfolio which will flourish over time, once the UK’s energy market stabilises.

To discuss how EXL can help your business harness powerful data and analytics tools to better protect against the effects of a tumultuous market, contact Prem Prabhanshu.