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UK retail power faces up to reconsolidation

The market share of challengers hits a landmark figure, but M&A could remake a hegemony, simply with different actors

The UKs retail energy sector achieved an unenviable reputation for being a broken market over the last two decades. This was true for both electricity and gas, which were dominated by a so-called ‘Big Six’. At the start of the 2010s, these companies had a 100pc share of the residential power market, according to figures from regulator Ofgem.

The Big Six was made up of UK utilities Centrica, born out of the old British Gas monopoly, and SSE, in addition to units of France’s EdF, Germany’s RWE and Eon and Spain’s Iberdrola. They were vertically integrated businesses and owned the vast majority of conventional UK generation assets, which was a significant barrier to entry.

Their dominance became a domestic political issue, with every retail price increase met with newspaper fury about industry fat cats ripping off the public. Whether the price rises were a response to rising wholesale costs or whether retail margins remained low were not topics up for reasoned debate.

‘Getting the market working’ became a quest for political parties of all hues, with Ofgem tasked with various initiatives to alter the landscape. Most striking was a domestic price cap policy first proposed by the leader of the left-leaning Labour opposition party ahead of the UK’s 2015 general election. Decried by the rightist Conservatives as socialist interventionism on the campaign trail, the party U-turned by including the policy in its manifesto for another national poll it won in 2017. A cap on default tariffs for gas and power came into force at the start of 2019.

Incumbents squeezed

Have government intervention and the entry into the market of a significant number of challengers worked in eroding the Big Six’s oligopoly? To some extent, yes. According to Ofgem’s latest figures, up to the end of September 2019, the traditional Big Six’s share of the retail electricity market was at its lowest since the start of Ofgem’s dataset in 2004 at 70pc (see Figure 1.). It was still above 90pc only four years previously.

“New entrants erode market share while the government's tariff cap limits profit margins” – Kenefick, BNEF

But the term Big Six is already outdated. In late 2017, SSE announced plans to merge RWE’s Npower business with its own retail arm, in a move that would have reduced six companies to five. That deal was never consummated; just four months later, RWE agreed to fold Npower into the domestic supply business of fellow German Eon. And while SSE was initially keen to continue a transaction that would have cut six to four, it ultimately abandoned the deal in late 2018.

But SSE did not abandon its efforts to find a solution for its retail arm. In September last year, the same month the Eon-RWE deal completed, it announced that it would sell the business to new market entrant Ovo Energy. The transaction received regulatory approval in December and completed in January. 

Two trends are at play. The old Big Six are losing market share to nimbler competitors. But, in response, they are fighting back or getting out. 

Insurgency

“Incumbent retailers continue to struggle; new entrants erode market share while the government's tariff cap limits profit margins,” says Michael Kenefick, an associate at consultancy Bloomberg New Energy Finance (BNEF).

“New entrants, such as Bulb and Octopus Energy, benefit from newer customer management systems and target more digital-savvy consumers who are more comfortable with automated processes such as direct debit,” he continues. For example, Eon recently agreed to use Octopus' platform technology to manage its customer accounts.

70pc – big Six share of retail power market

“Successful sustained customer growth [for new entrants] has ranged from targeting niche markets—like smart prepayment—to having a simple offering such as one single variable tariff with transparent and well communicated price changes,” says Anna Moss, retail manager at consultancy Cornwall Insight.

“Good systems and customer service are needed to retain customers. Many new entrants have embraced telesales and face to face sales to a much greater extent.”

But, while the new entrants continue to win market share, most have yet to turn a profit, warn both Kenefick and Moss. The latter also notes that the challengers typically see a higher level of customer churn—unsurprisingly, given their customers are by nature more engaged with the energy market, having switched at least once before.

Cap impact

The price cap also had a heavier impact on the retail businesses of the Big Six as they have more consumers on standard variable tariffs, says Moss. “Many large suppliers have recorded significant negative impact in their financial results,” she says.

There was some speculation that the lower brought about by the price cap would slow switching rates by removing the incentive to move supplier. “But this is not the case as there are savings of £300+ still available,” notes Moss.

The incumbents are, though, mounting a fightback. “The large suppliers have responded to the challenge brought by new entrants,” she says. “Some of the methods used include bringing in more efficient systems, innovative propositions and changing sales channels. The Big Six have also picked up some of the exiting suppliers, especially through the supplier of last-resort process.”

While the new entrants continue to win market share, most have yet to turn a profit

This is what happens when Ofgem moves the customers of a firm that has had to exit the market to an alternative provider. Unfortunately, there have been a slew of such cases—the regulator recorded 16 supplier exits over the last five quarters for which it has data.

“Company attrition is a function of a competitive market,” says Kenefick. “But when an energy supplier folds and fails to pay government levies such as the Renewable Obligation, other retailers and consumers must pay those costs.” 

“One of the negative impacts of failed new entrants is that it effectively creates another cost that is being passed back to consumers,” agrees Moss. “But Ofgem has introduced more stringent licensing for entry.”

And there is no evidence that the collapses are deterring switching. “There is still a fairly high proportion of switchers choosing to move to a small supplier each month,” Moss notes.

A new dominance

Prior to sealing its SSE purchase, Ovo had long been the most successful new entrant in terms of taking market share until overtaken by Bulb in Ofgem’s Q2 2019 figures. But it reached a peak of only 5pc market share, which is also as far as Bulb has got (see Figure 2.).

The SSE deal catapults it to 16pc, or third place behind Centrica and the enlarged Eon (Eon and RWE are still separate in Ofgem’s data), both on 19pc. The gap between these firms and EdF in fourth is thus five percentage points, much larger than in the past (see Figure 3.). “The Big Six has now become the Big Three,” says Kenefick, as these three clear leaders now have a combined 55pc market share.

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