Radical reform could be a stabilising force for energy retail

This article was first published in Utility Week.

The need to do something different in the retail energy sector to enable the energy transition has long been accepted, with multiple voices and opinions contributing to the debate on the “what” and the “how”.

Over the last 12 months the sense of urgency about the necessity of reform has ramped up significantly, exacerbated by the energy crisis, and wider political and economic developments. The strategic review announced by Shell of its position in the domestic retail market including in the UK has now provided a new shockwave for the already shaken sector. But what does it tell us about the state of the market, and what are the implications for participants and the reform agenda?

Importantly, and unlike much of the domestic retail consolidation seen over the past two years, Shell’s review is a measured response and is taking a long-range perspective on the sector. The fact that they have taken this step indicates they are unsure if the rationale still holds that a downstream presence is necessary and value adding to the new generation of post-oil and gas integrated energy companies in the way it did when it acquired First Utility in 2018.

Many participants in the market, from large to small, from the newer entrants to the longer term players, have questioned whether the balance of risk and reward in retail is right. The financial upsides are slim at best even for the best performing and the value of vertical integration via a downstream hedge is questionable. The downside risks are painfully obvious, several market participants have endured losses of hundreds of millions of pounds, and suffered the reputational and financial risks associated with navigating the obligations that come with being a licensed retailer.

Over and above the mechanics, suppliers carry a moral obligation to customers, particularly right now with the responsibility of administering support packages and making sure funds get to struggling households. Getting it wrong comes with high profile negative press coverage, regulatory fines, and the overheads involved with rectifying any problems.

With these dynamics, many in the domestic energy retail sector are questioning the long-term viability of their continued participation. Equally, those who contemplated entry and decided against are likely to feel their caution was justified.

If the core function of being a supplier is unattractive, it follows that more than ever there is a strategic imperative for companies to use their critical activity of supplying electricity and gas as a platform to get beyond just being a commodity business.

There are attractive opportunities adjacent to energy supply. The energy transition involves a proliferation of low carbon technologies for businesses and households alike. Despite the complexity and uncertainties of the future landscape they offer good rewards for the investment risk. Energy suppliers have the customers, the brand and the expertise to make the most of these opportunities.

Moving beyond energy supply is a good idea for most if not all suppliers but the question is, will it compensate for the challenges involved in the core business of reselling electrons and gas? The scale of financial risk in the commodity reseller role, based on financial performance across the sector over the last two years, would suggest not.

We now face a situation where suppliers’ core functions are not attractive enough to secure new investment or for new entrants to thrive. Equally, existing established players are questioning their position and there are structural impediments to innovation. Doing nothing to address these risks exacerbating the already difficult circumstances for customers, suppliers and government alike. It is now clear that incremental change won’t be sufficient to address the fundamental problems and a more radical approach will be needed.

A specific consultation on reforms to enable the future of retail energy has been long promised. It was referred to as imminent in the original REMA consultation in July 2022 and hinted at recently including by Jonathan Brearley in his recent speech at the Institute for Government. Yet it’s not yet clear when the much-needed clarity of direction will emerge. A strategic vision and clear plan for the future of retail would undoubtedly help Shell’s considerations as well as support other suppliers trying to see beyond the immediate crisis and plan for their own futures.

We are in strange times when the spectre of radical reform has the potential be a stabilising rather than destabilising force. Yet the challenges faced across the sector means there is now a real appetite for the hard work of reform.