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Retailers are facing a nightmare of a situation… Changes in the profile of demand across their customer segments and portfolio increased risk associated with customer defaults, price regulation and a regulator that appears unsympathetic to their plight. It is expected, but not inevitable, that all might not make it through to the other side.
This brief explores the pressures currently being faced by retailers and the associated implications.
The demand profile across the portfolio has changed, for how long?
COVID-19 has changed both the volume and nature of electricity demand. While this information might be interesting for some – it has real implications for the financial viability of retailers.
Retailers buy and sell electricity based on their expectations of demand. The electricity they buy (up to three years in advance) is based on their expectations of demand across each customer segment, and products are priced on costs, in line with customers’ demand profile.
Short term and sudden changes in electricity consumption across different customer segments (i.e. reductions in C&I demand and increases in residential demand) and in the profile of consumption (i.e. shifting peaks) are important to retailers and can have a significant impact on their cash flows. Depending on how retailers have hedged their customers’ demand in the contracts market (over the counter or ASX Energy Futures), some retailers may be over hedged for customer segments that they didn’t expect to reduce and those serving C&I customers have possibly bought too much volume in advance of COVID.
Looking at the ASX base swaps from Q2 2020 provides some indication that smaller retailers may be over hedged. Typically, small retailers would be buying a similar volume of these swaps to their expected average load in advance. Because the overall load has decreased, the value of these swaps has declined potentially leaving retailers who rely on these ASX products more heavily over hedged.
More customers are defaulting, and payment plans are on the rise
The role of a retailer in the electricity market is to bundle the costs of electricity supply into a single price for end-use consumers. These bundled costs include wholesale electricity, use of networks and contribution to green programs. If a customer doesn’t pay a retailer – the retailer must draw on their cash reserves to make these upstream payments.
This typically isn’t an issue as retailers generally charge all customers a little extra as compensation of this risk that they carry. But with close to a million Australians now out of work and the hardship that this brings to their lives, the rates of default and the numbers on payment plans are on the rise. When customers can’t pay their bills on time – as in any business – managing cash flow is challenging.
Price regulation removes one of the legitimate strategies that retailers have to deal with increased risk
One of the efficient responses to an increased risk of default would typically be to increase the risk premium attached to retail products. While these increases offer prices to consumers, it gives retailers a slight buffer to protect against the risk of insolvency as a result of mass default.
But we now live in a world of retail price regulation and the regulated standing offer prices set across the NEM (and particularly in Victoria) do not provide much if any, risk premium. With Governments and regulators focused on easing the financial pressures facing consumers – it is unlikely that they will revisit their regulation stance anytime soon. What this means is that most retailers would be unlikely to have much cash in reserve to cover costs in the short term, and they are unlikely to be able to recover any losses over the longer term.
Kumar is a Partner in the Financial Advisory practice and is responsible for the Energy and Resources Sector. He specialises in portfolio management, policy advice, commercial and financial analysis, market modelling (electricity, gas and renewable energy), strategic positioning and assisting clients with growth strategies. Kumar helps his clients make future decisions with confidence.
Emma is a Director in Deloitte’s Energy Transition team. She focuses on how Australia’s energy markets are changing in response to climate change and emission reduction objectives. Emma has extensive experience working with energy clients to understand the energy market transition, identify opportunities and risks within the transition and develop strategies to capture growth opportunities.