How utilities are just like banks | FT Alphaville

How utilities are just like banks

As we’ve reported before, UK natural gas prices are destined to stay low for the foreseeable future as a slew of  liquefied natural gas cargoes, unwanted elsewhere, is redirected to British shores.

Most cargoes will have originally been intended for the US market, but a boom in alternative natural gas production in the country has now muted demand for imports — releasing a record number of cargoes  into the spot market.

Here, for example, is a table from Reuters indicating just some of the LNG tankers known to be making their way to the UK and Europe in the next month:

LNG Tanker arrival - Reuters

UK natural gas prices have already been feeling the effect, with day-ahead prices in December averaging about 25p per therm this week, despite it being a time of year when the market would traditionally expect natural gas to trade much higher.

Of course, you would think low natural gas prices would be a relief to a struggling UK economy, especially since the UK is among the most natural-gas focused economies in Europe.

The thing is, there is a problem.

Just like many UK consumers were offered products to fix tariffs back in 2008 when natural gas prices were much higher — up until 2012 in some cases — so were industrial and commercial players.

Now, according to Nick Campbell, an analyst at energy consultancy Inenco — a firm that advises companies on how to manage their energy exposure — many companies have found themselves stuck with uncompetitive three-year deals fixed back in 2008 when prices were sometimes twice as high.

An indication of the popularity of such deals for retail customers, for example, came in Centrica’s full-year 2008 year results:

The rapid rise in wholesale energy prices during the first half of the year required price rises to customers in January and July in order to maintain reasonable profitability. Although there was a short term increase in customer churn, sales of energy accounts remained high, with our Fixed Price 2011 proposition proving particularly popular in the third quarter of the year. At the end of 2008 we were serving 15.6 million accounts, of which 3.6 million had the reassurance of a fixed price product. In January 2009, as a result of a recent fall in wholesale energy prices and with energy bought at high prices in 2008 being partially used up, we announced a reduction of 10% in our standard gas tariffs and the introduction of a prompt payment discount for our credit customers.

(The 10 per cent discount, by the way, did not apply to customers who had locked- in on prices.)

You might think companies and customers shrewd enough to avoid fixed deals back in 2008 would at least now have the opportunity to fix at low prices.

But, it turns out, not so much.

First, most commercial fixed-rate deals have been taken off the market. Meanwhile, those companies able to participate in the wholesale market have encountered credit-related issues preventing them from doing so.

As the FT reported on Thursday, the number of European companies defaulting on their debts is expected to run at more than twice the historic average until 2011, according to Standard & Poor’s.

Utility companies, of course, do not want that sort of exposure, especially since many of their long-term contracts are already underwater.

As Inenco’s Campbell explains:

Businesses’ hopes of riding out the recession are being hampered because, despite the falling gas price, they still can’t get the credit needed to secure long-term energy contracts. At a time when struggling industry is trying to control costs and get back on its feet, and despite falling demand and increased LNG supplies causing the natural gas price to tumble, the large energy suppliers are increasingly nervous about providing credit because they don’t want to risk exposure to the market if customers go bankrupt.

In other words, utilities are behaving like banks — who, as we know, are equally reluctant to pass on wholesale savings to customers on credit-related fears.

What’s more, as Campbell goes on (our emphasis):

Hundreds of thousands of UK companies are being asked to pay up to six months in advance for their energy. Suppliers appear to be targeting businesses by sector, and industries heavily exposed to the downturn — such as manufacturing, carmaking, construction and retail — are particularly hard hit.  There is less risk appetite where these businesses are concerned and the vast majority of businesses in these sectors can expect to be hit by these restrictions. The tighter restrictions have been implemented because energy suppliers are worried that, if customers become insolvent, they will be left to pick up the costs.

Not only that, Campbell informs companies that fail to use up energy volumes agreed in long-term contracts can expect to be liable for surcharges — a fact which clearly adds pressure to an already fragile UK business sector. As he explains:

In the current economic climate, this obviously places extra pressure on businesses.  Companies also face a variety of obstacles before even entering a supplier agreement. These can include a six month deposit and use of margin accounts.  The credit constraint is a problem for the whole economy including the energy markets. Just as the banks may restrict lending even though interest rates are at all-time lows, suppliers and credit insurers are keen to limit exposure to risky sectors.

And while utilities are behaving like banks, it seems much of their behaviour  actually stems from how they themselves are being treated by both the financial sector and wholesale suppliers. Campbell concludes:

The situation is also causing concern for energy producers, like the big generating companies, which need to know they have long-term contracts in place in order to secure the finance to build new plants as well as invest in renewable energy and carbon capture technology.  As the recession ends, and demand for energy grows, the delayed investment in capacity could push prices up significantly just when businesses would be going all out to get back on their feet. We’ve seen loan guarantees in the finance sector, what we need is something similar to boost confidence so that the credit teams in the energy sector can get the market moving again.

But it is not only the end user that is current suffering from contract restrictions.  Suppliers of gas such as E.ON, who source gas from producers such as Gazprom are also struggling under take or pay contracts. A proportion of gas has to be bought on oil index linked contracts due to the terms of the contracts. This has therefore made it a painful period for them as they have seen the spot gas price crumble under pressure of falling demand, increased LNG production and unconventional gas finds. E.ON yesterday (Wednesday) announced it would be attempting to move away from the long term supply contract environment, which reinforces the damage the gap between the spot and oil indexed contracts is causing suppliers. This would suggest that the suppliers appear to see this large discrepancy between the spot and oil indexed contracts remaining, due to the expected glut of gas from LNG, continued lower demand and unconventional gas being brought to market.

The oil-index natgas price issue though is probably best left for another post.

Related links:
LNG transatlantic arbitrage in action
– FT Alphaville
Doth a global natgas glut come (already)?
  – FT Alphaville