Price cap is already loss making before it comes into force
Updated: Nov 13, 2021
Gas prices are making the Price Cap a loss making tariff
I just wanted to share an extract of some analysis we've been working on.
Gas prices are making it hugely challenging right now for domestic suppliers to make any money even when pricing at the Price Cap.
If you're having a hedge a customer at the cap right now, then the cap is loss making tariff.
Theoretically, there's currently some positive gross margin from April onwards, apart from the fact that the cap will also change again from April.
Paul Richards articulated the impact of this better than I have, in the comments. Because of the fact that the cap will be updated in April, any macro level changes to wholesale costs (eg Nord stream 2 going live) will change the level of the next cap period, but not allow you to recover your losses.
OFGEM's hedging methodology for the cap is challenging, if not impossible, to achieve - and is reliant on illiquid products which are not easily available to all suppliers.
As well as the losses being incurred by suppliers, customers are facing an increase in bills - driven by gas prices. The part of the solution proposed by OFGEM is they "plan to trial automatic switching for customers on expensive default tariffs to cheaper deals". Given the current state of the wholesale market this would mean moving customers from one currently loss making tariff onto a further loss making tariff.
As I've said before - offering a loss making tariff is fine, as long as you have the pockets to be able to fund the losses - which is effectively a private company subsidising a customers energy costs. We talk to clients about the 'Cost to Discount Budget', as a way to track the costs of offering discounted tariffs - as these costs are real, and should be reviewed in the same way direct/third party acquisition costs are monitored and managed.
Offering loss making tariffs can not continue forever, the accumulated losses will quickly catch up with you. And with OFGEM looking at limiting the amount of customer credits (effectively pre payments for energy) suppliers can hold, then charging a month in advance for a deeply discounted tariff is unlikely to be a suitable strategy for growth.
Under the cap, you're allowed to make ~£23 of margin (Usage of 2.9 and 12) over the course of 12 months. Let's call it £2 a month.
Under this cap, you are at negative ~£30 Gross Margin by the end of November. This is before paying staff, metering costs, and overheads.
If you're offering a deeply discounted tariff today, you're at negative ~£25 Gross Margin by the end of October, and negative ~£75 by the end of November
We're in for a challenging few months.