Energy market proposals could hurt UK suppliers' margins
Measures proposed by the Competition & Markets Authority (CMA) to increase competition in the UK energy market may reinforce pressure on supply margins in the medium-term, according to Fitch Ratings.
The CMA's proposals include possible price caps on the highest tariffs, with Centrica, the owner of British gas, and SSE being the most exposed of the so-called ‘Big Six’ energy companies to any regulatory changes as market leaders, Fitch noted.
Since both companies are predominantly UK-focused, the ratings agency said they would face challenges in meeting their projected EBIT supply margins of 6.4% (5% after tax). Average EBIT margins on sales to residential customers for the Big Six were 3.3% between 2009 and 2013, ranging from 2.1% in electricity to 4.4% in gas.
However, there are a range of other factors driving supply margins, such as volumes for gas and the growth of independents, which had 12.6% market share in April 2015, Fitch said.
On the plus side, the ratings agency said CMA’s conclusion that vertical integration does not adversely affect competition significantly reduces the chances of suppliers being forced to break up.
Chris Moore, director of corporates at Fitch Ratings, said, “Nevertheless, the potential price-cap remedy follows the CMA's calculation that industry profits in excess of the cost of capital amounted to about £900m a year.
“This calculation is based on the difference between return on capital and cost of capital. It might be a standard approach for capital-intensive businesses, but its value in assessing a customer service business is questionable, given that supply is not capital-intensive. Energy companies may therefore challenge this finding, particularly if it signals a broader change in approach to assessing their profitability.”
Moore also said CMA's proposal of greater tariff choice seems to contradict the simplification of tariffs from the Retail Market Review in 2014.
Additionally, proposals for a further assessment of the contract for difference (CfD) auction mechanism and of the eligible technologies suggest the CMA wants to achieve even better value for money for customers from renewable energy built under the CfD remuneration mechanism.
“Given that SSE did not participate in the first CfD auction, this may make future participation less likely, which could lead to further capital expenditure cuts,” Moore concluded.