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Are Energy Companies Too Big to Fail?

Lessons from Royal Bank of Scotland

Business JuiceAre energy suppliers too big to fail?

10 years ago, when asked that question about the UK banking sector pretty much everyone would have said yes.

Now? It’s a very different scenario.

According to new insight into the credit crunch and high profile rescue of the disastrously run Royal Bank of Scotland (RBS) there are fears that the nightmares of the Edinburgh based financial powerhouse are far from over.

Indeed despite the £45bn taxpayer bailout there is concern that RBS is still creaking towards imminent failure with crucial lessons unlearnt. That is the conclusion from new book Shredded: Inside RBS, The Bank That Broke Britain.

As a small business owner, many of whom may have experienced RBS as a lender and witnessed the corporate excess at first hand, there is perhaps a little sang-froid in the news but there is a serious underlying concern that institutions that were previously viewed as impregnable, if not altogether dependable, are in fact potentially built on foundations of sand.

It is armed with this knowledge that we need to potentially temper views of the energy market.

Whilst we are in no way suggesting that the “five broad areas of alleged criminality and wrongdoing” that brought RBS down and continue to dog its recovery have parallels in the energy market, there are significant similarities in the characteristics of the sectors.

Like the banking sector, UK energy supply is dominated by the few, has been accused of profiteering, poor customer focus, unwise strategic investment and being responsible for a general malaise in the market due to a “that’ll do” attitude, with little differentiation and underwhelming products.

It is this backdrop that brings into question the potential for a similar scenario to hit the energy markets in the coming years.

Big energy company failures aren’t new, they do happen, albeit rarely, and whilst some active UK suppliers are posting buoyant results such as SSE, the likes of British Gas Business have delivered two profit warnings in short order and others such as nPower (RWE) are seemingly in a constant state of reorganisational flux readying themselves for a market exit.

Whilst there is no suggestion a failure is imminent it is interesting to reflect on the ‘desire’ for the Big 6 energy suppliers to individually remain in the market. A market where they are constantly under negative scrutiny by the media, under a formal Competition Markets Authority investigation with the threat of costly breakup hanging over them, all at a time of significant infrastructure investment requirements.

Coupled with less than stellar financial results and poor leadership there is a potential recipe for a Big 6 energy business however large to hit trouble and to be a very unattractive proposition for a ‘white knight’, leading to the potential scenario where bailouts are required.

This doomsday scenario is probably overplayed but there must come a tipping point for any business where future investment and even involvement in a market stops being worth it. With only 2 of the Big 6 being British owned and therefore for the majority the UK isn’t their core market the ‘connection’ to remain is equally questionable.

What would happen in the event of a supplier failure?

Happily, the energy industry, unlike the banking sector, has thought about this one and since the opening of competition in the deregulated energy markets has enshrined a concept of ‘Supplier of Last Resort’.

This is whereby when a supplier, big or small, fails, the rest of the industry have an opportunity to ‘bid’ for those customers and the best bid, not just on a financial basis, is awarded to a supplier who then takes ownership of those ‘stranded’ customers and their contracts.

Crucially all contract terms are honoured and the principle is that your energy cost as a business will not alter, only the party that bills you will. This has proven a successful measure in the rare incidences of energy supplier failure.

It’s comforting then that there is a greater level of preparedness in the energy industry for such an event than was the case in the banking industry. However the ‘Supplier of Last Resort’ was designed for small failures or a single larger supplier failure, the problem may arise that a Big 6 under unprecedented pressure could see multiple failures, removing the likely Supplier of Last Resort recipients from the very market they were designed to uphold!

Whilst all this is some distance away, and impending disaster is not around the corner, the phrase “never too big to fail” is as true as it ever was.

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