How the U.K. Energy Crisis Is Hitting Household Suppliers

(Bloomberg) -- The U.K. has one of the most deregulated energy markets, designed to keep prices low and competitive. Customers can buy natural gas and electricity for homes directly from large suppliers or smaller ones who purchase from the wholesale market and sell it on. The system works fine in normal conditions but has been breaking down under pressure from sky-high prices caused by supply disruptions in Europe. Domestic fuel bills look set for large increases in 2022, even with price caps to protect households.

1. How are things breaking down?

As of mid-January, 25 U.K. domestic energy suppliers had gone out of business since August, forcing about 4 million homes to switch providers. The most significant failure so far was Bulb Energy Ltd. with 1.7 million customers, the country's seventh-largest supplier. A special administrator was appointed by a judge -- the first of its kind in the energy sector. In this process, the costs of running Bulb will be supported by the Treasury, the first forced nationalization of a British company since the 2008 banking crisis.

2. Why can't suppliers just raise prices?

The U.K. regulator, Ofgem, sets a cap for energy prices for consumers and reviews it twice a year. Bills already climbed 12% for about 15 million households starting in October 2021 after an Ofgem increase, and they could surge another 50% in April, according to Investec Bank Plc. Rising bills were pushing up inflation, which hit 5.4% in December, the highest since 1992. Smaller suppliers can undercut rivals when wholesale prices drop below the levels paid in advance by larger companies. When those prices soar, smaller companies are squeezed.

3. What could the authorities do?

The government of Prime Minister Boris Johnson, whose Conservative party faces local elections in May, is considering a fund to help energy firms spread out price increases for customers over a longer period of time. It could use private or state-backed loans, or a mechanism in which the government makes payments to energy suppliers when wholesale gas prices rise sharply, and companies reimburse the state when prices fall below an agreed level, the Financial Times reported in January.

4. What happens when a gas supplier goes bust?

Usually, Ofgem simply assigns customers of a failing supplier to another company. The solution works when those customers are profitable for a rival to take on but is tougher to impose when they bring losses. The cost to a new supplier has been estimated at 1,000 pounds ($1,364) per customer. There are parallels to the global financial crisis a decade ago, when healthy banks were asked to help rescue failing rivals, and separate institutions were set up to handle bad loans.

5. Why does the U.K. market work this way?

Deregulation of the market dates back to the Conservative government of Prime Minister Margaret Thatcher in the 1980s, part of a drive to reduce the state's role in the economy. The aim was to cut costs for consumers and give them more choices. During the past decade, the government encouraged a large number of suppliers to enter the market, contributing to the current high level of competition.

6. Which suppliers are affected?

The list of collapsing companies expands almost weekly. There are now 24 suppliers left in the market, down from 55 at the end of 2020, according to Ofgem. The government insists that the tools in place to manage the disruption are working. But some industry bosses expect just a handful of suppliers to be left by April. Questions also are being raised about whether companies should be left so unprotected against surprise price spikes.

7. What about households?

Consumers wind up paying for companies to absorb the new accounts. The costs of the failed suppliers come to about 72 pounds for each household, and that doesn't include all failures yet. Households face an 18 billion-pound jump in energy bills in April, according to an analysis by Investec. The Resolution Foundation estimates that 6.3 million households in the U.K. will slide into fuel poverty, where more than 10% of net income is spent on energy bills. That's triple the number now.

8. Is this just a U.K. issue?

No. Natural gas prices surged across Europe, due in part to key supplier Russia capping flows to the continent to replenish its own stocks amid freezing weather in October. Gas inventories in Europe in January were the lowest on record for the time of year. China, the world's biggest consumer of energy and commodities, ordered state-owned companies to secure supplies at all costs. European countries have helped consumers, with Spain easing energy bills and Greece announcing a subsidy for all households. Suppliers also have gone bust in the Netherlands, Finland, the Czech Republic and Singapore.

9. What are the possible solutions?

Under existing rules, when a provider fails, the regulator appoints a new one in a process known as Supplier of Last Resort, or SoLR. If a larger firm folds, the government can step in as a special administrator. Bulb likely will remain under control until at least April.

The Reference Shelf

A Financial Times report on possible U.K. state payments to energy companies.
A Bloomberg story on when costs start to hit households, and an article on how top energy firms are split on how the U.K. should tackle higher wholesale costs.
A QuickTake on Europe's power prices.
An Ofgem guide to what happens if a gas supplier goes bust.