November 10, 2008

Electricity4Business Falters As Soaring Costs Take Their Toll on UK Energy Competition

Eletricity4Business has gone into administration, leaving small and medium sized businesses facing uncertainty and higher bills. The power provider is the latest in a steady stream of small suppliers to exit the retail market amid serious concerns about competition and the intended benefits of deregulating the UK energy markets. The key question now is how these market conditions can be remedied.

Electricity4Business (E4B) is the latest casualty in the UK electricity supply market, and its demise has left Ofgem struggling to target its remit of ensuring competition and maintaining a level playing field, particularly for small suppliers in the UK's gas and electricity markets. E4B's collapse is of particular concern given that it is the second small supplier to exit the market in as many weeks - with Midlands-based Bizz Energy having already gone into administration.

Although Ofgem has appointed a 'Suppler of Last Resort 'to bridge the uninterrupted delivery of energy for E4B's existing customers, many will be adversely affected by this development. Indeed, in the absence of a buyer, customers will be placed on emergency tariffs that are significantly higher than they would have been had E4B remained afloat. As a result, customers have been advised to switch away and save on costs.

The underlying driver that has dogged the fortunes of small UK energy suppliers is said to be the unusually high wholesale energy prices and their inability to cope with market volatility. Crucially, it is the size and (upstream) muscle of the 'big six' energy suppliers that enables their risk management teams to manage their portfolios effectively.

Meanwhile, independent suppliers without any generation capacity have been left to the vagaries of volatile and bullish commodity markets, with little or no influence in hedging rising prices. In the Darwinian sense, it is adaptation, adoption and survival of the fittest that should drive the market. However, those who disagree will cite the fact that this approach will only work as long as firms do not hold a structural advantage to begin with.

A particularly sticky point for Ofgem in light of the recent domestic supply probe is the "lack of a competitive fringe" in the domestic market, which is also very visible in the non-domestic sector. However, the task of establishing accountability, efficiency and equity in today's energy market is an unenviable task, particularly as vertical integration and asset consolidation makes it a messy equation to balance.

On one hand, the challenges that liberalization and free-market reform have brought to the UK's gas and electricity sector can be summarized as greater levels of uncertainty, underinvestment in network infrastructure and, ultimately, higher prices for consumers (particularly in comparison with the rest of Europe). More significant, however, is the fact that liberalization has undermined the UK's national security of supply status.

On the other hand, economists will argue that the nature of competition is not just dependent on market structure, i.e it is not about measuring the number of participants active in a market but also the pressures of potential competition (least of all the innovation, choice, efficiency and opportunity that liberalization has brought). Markets are contestable given that barriers to entry and exit are set to be low. Contestable markets evolve from the theory of perfect competition determining industry structure on the basis of barriers and not necessarily a large number of participants.

The key assumption, therefore, is that low barriers to entry and exit drive competition. However, Ofgem is unable to deliver (and has not delivered to date) an accurate assessment of barriers across the value-chain, particularly generation/production, asset ownership, transfer pricing and trading activity. It is now time to take a more pro-active and holistic approach to regulation before time is called on the invisible hand.

Administrator PricewaterhouseCoopers has been unable to find a prospective buyer for E4B, underlining the current economic climate and market sentiment. Investors with the available capital will be presenting their bids to Ofgem in the hope of securing a cheap deal.

The 'winner' of this latest bout of market consolidation is British Gas Business, which acquired Bizz Energy's customers for the bargain price of GBP87.50 per customer. The primary losers, meanwhile, are small business owners and domestic customers. The deeper issue of how to 'fix' the market is one for the regulator to ponder: the free-market paradigm has taken a battering and its supporters are down, but not quite out, in the fight for natural selection in the UK's energy landscape.