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Energy's next big challenge

Energy service providers look like a smarter play than the 'big six' providers as the sector continues to debate potential price caps
June 14, 2017

Energy companies became unwitting punching bags in the recent run-up to the general election, as both the major parties saw an opportunity to win favour with the public by promising energy price cuts, hitting back against the 'big six' groups that control 85 per cent of the UK retail electricity market and 83 per cent of the gas market. However, in recent years the UK energy markets have seen an increasing number of companies looking to provide both energy supply and wider energy services. And while our view on the London-listed members of the big six has cooled in recent months, there are still pockets of value among the smaller players.

The market can be split into those that buy energy at wholesale prices and sell it on at a mark-up - the suppliers - and those that provide services to either the purchasers of energy or the providers of energy. One example of these would be Smart Metering Systems (SMS), which installs smart meters on behalf of energy suppliers, helping them fulfil the government policy of offering every home and small business a meter by 2020.

The number of energy suppliers has risen sharply in the past decade, from 11 in 2007 to 52 at the end of 2016. Last year, an investigation by the Competition and Markets Authority (CMA) into the energy market claimed suppliers outside the 'big six' now held 13 per cent of the market in both gas and electricity, higher than at any point since the market was liberalised.

 

 

 

 

However, the prospect of an energy price cap still looms. The industry avoided a wide-ranging cap when the CMA ultimately recommended a secure database of customers' tariff details that could be accessed by other energy suppliers, allowing them to contact those customers to offer them cheaper deals. Price caps were, however, introduced for pre-payment meters in April 2017, and before the release of the Conservative manifesto in the recent election, many analysts were braced for a price cap of sorts in a forthcoming report from the Department of Business, Energy and Industrial Strategy.

Michael Donnelly, analyst at Panmure Gordon, said a cap would be ill advised, as the biggest proportion of household energy bills are made up of government tariffs. Corporate profits only account for a small part of the overall sum: "The cap is attacking the smallest and most irrelevant part of the [bill]," he said.

Mr Donnelly also said that if a potential cap goes ahead, it would be likely to take the form of either a targeted cap, aimed at reducing costs for the fuel poor; a relative cap, which could reduce the number of lower-priced tariffs as it limits the most expensive; or a blanket cap, whereby no bill would be allowed above a certain number. The latter, Mr Donnelly said, is the least likely.

It's difficult to judge how such a cap would affect the smaller end of the market. On the one hand, less well financed companies may struggle to get credit the way the 'big six' can, putting them at a severe disadvantage. On the other hand, small companies may inspire greater loyalty, for example Good Energy (GOOD), which sells electricity entirely from renewable sources, may find environmentally conscious customers choose them for reasons beyond price.

 

 

 

 

Another factor affecting energy prices is the wholesale price of both electricity and gas. Prices can vary widely and are influenced by the use of commodities such as gas and coal in generators. Coal use has been dropping, but a report from Ofgem showed it was still used to generate 21 per cent of UK electricity in 2015, down from 31 per cent in 2008. Volatility in energy prices creates opportunities for companies such as Inspired Energy (INSE) and Utilitywise (UTW), which advise on and procure energy on behalf of businesses, as they can help clients find value as prices fluctuate.

 

IC VIEW:

With the installation of a Conservative coalition in Downing Street, the prospect of a publicly owned energy system has moved out of view. However, there is little indication that energy prices won't continue to make up a significant part of the political discussion in the short term. While the 'big six' seem most likely to bear the brunt of any changes, it's difficult to know how any political change will affect the smaller energy suppliers. Those that provide energy services are less vulnerable to energy prices and, for that reason, are probably the smartest play in the current environment - at least until more detail emerges. However, these companies vary widely, so it pays to be wary of other structural challenges.

 

Favourites

While the full details of what will happen with energy prices remains unclear, we think the best place to find value is the energy services providers. Earlier this year we tipped Inspired Energy, which provides energy procurement, analysis and management for companies. It has a small stable of SME clients, accounting for around a quarter of revenues, while the rest comes from large corporates such as Travis Perkins (TK) and Victrex (TK). The group's forward order book has in recent years been a reliable indicator of future growth. At its most recent results, the book was up 14 per cent to £28m.

Outsiders

A previous tip, Flowgroup (FLOW), ran into trouble when the government capped the number of energy-efficient micro-CHP boilers that could receive feed-in tariff payments, endangering the group's proposition for a boiler that "pays for itself". The group set up an energy supply business called Flow Energy, which has been growing rapidly, but managers recently announced they were looking to sell this and raise further money in order to roll out its boilers in Europe. There's just too much uncertainty to justify buying in now.