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Commercial Question

The 2021 energy crisis: what happened and what next?

updated on 05 April 2022

Question

Why are energy companies going bust and what are the wider implications?

Answer

Background

At the start of 2021, there were approximately 70 domestic energy supply companies in the UK. At the time of writing, a total of 28 energy supplier companies have ceased trading, affecting more than 3.7 million customers.

Those that have even vaguely followed the so-called ‘2021 energy crisis’ will know that the primary factor in the downfall of these mostly smaller energy companies was the unprecedented increase in wholesale natural gas prices.

Energy suppliers that do not have the capabilities of producing their own energy must purchase gas and electricity from an energy wholesaler (ie, the companies that actually produce the electricity or extract the gas out of the ground). These energy companies then sell on the wholesale energy to their customers for a profit (hopefully).  

The energy price cap

Energy companies are restricted in what they can charge their domestic customers by something called the energy price cap (EPC). The EPC was introduced under the auspices of Theresa May's conservative government via The Domestic Gas and Electricity (Tariff Cap) Act 2018, and set a maximum amount that energy companies could charge per kilowatt-hour (kWh) of gas and electricity (known as the 'unit rate') per year.

In practice, the EPC acts to protect customers on poorer value default or prepayment tariffs from being overcharged by suppliers. If the wholesale cost of energy falls, then the price cap will also fall and energy bills will come down. If the wholesale cost of energy rises however, the cap ensures consumers will not be hit with an extortionate price hike.

So why are so many energy companies going bust?

In the most simple terms, the combination of unprecedented wholesale gas prices together with an EPC, which sets a limit on how much can be charged, means energy companies are supplying energy for significantly less than what it is costing them to buy.

To insure against unexpected increases in wholesale prices, many of the larger energy companies operate a hedging strategy – whereby wholesale energy is purchased at a fixed price many months in advanced, thereby mitigating against the risk of unexpected increases. However, hedging is very expensive and smaller energy suppliers simply cannot afford to pay for such a luxury, leaving them susceptible to the skyrocketing gas prices – and consequently, the unavoidable haemorrhaging of cash and impending doom.

Possible solutions

With energy bills due to soar in 2022, some of the proposed solutions to the energy crisis are as follows:

  • Abolish VAT of 5% on energy bills – this would be relatively easy, although 5% off a possible £700 increase is clearly not enough.  
  • Extend and expand the Warm Home Discount Scheme. Customers currently in receipt of certain benefits can apply for a one-off payment of £140.
  • Subsidise the energy companies themselves. This would work by establishing a fund that would allow energy companies to draw down government cash when wholesale prices were very high and then pay it back when prices dip.
  • Become less reliant on gas and further explore the age-old problem of how we can better store power – those recommended include gravity storage, concentrated solar power storage, green hydrogen and cryogenic batteries.

Wider implications

The collapse of energy companies in recent months has been well reported on the news. However, arguably the most urgent problem is the needs of small businesses – the majority of which are not protected by the EPC. According to a recent survey conducted by the Federation of Small Businesses, energy costs were the biggest concern facing its members and warned that it could pose an "existential threat" to firms that have already been dealt a blow by covid-19 restrictions.

With no obvious quick fix to the current energy crisis, law firms should be alert to the impact of OFGEM's increase to the EPC increase in April 2022, and will undoubtedly be required to advise the various stakeholders impacted by it. In the long term, it would appear the UK needs to re-evaluate the regulation of the domestic energy market, while exploring alternative methods for storing energy and investing in new technologies. 

Josh Coleman is a first-seat trainee at Womble Bond Dickinson.