HyperNormalTimes

Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

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November 28, 2021

Energy Supply Failure Echoes Banking Failure

A New Paradigm Emerges for Utility Warehouse / Telecom Plus

Two of the most systematically important and politically sensitive sectors of a modern economy are money and credit and energy supply. So critical indeed are these sectors that we accept that providers of these services should be at least regulated, or even wholly-owned, by our governments.

Historical causation is always unclear and often impossible to untangle. However, what is clear about the banking crisis is that it was not the fault of the banking industry alone. The path to recklessness pursued by the rapacious bankers was not an act of unaided self-harm. The regulatory and supervisory climate of the preceding period was culpable, with significant parts in this joint enterprise played by government treasuries, central banks and industry regulators. Indeed, the blatant nature of the joint enterprise involved in this generational catastrophe is probably the main reason no banking leaders were ever prosecuted.

Northern Rock was one of the first dominos to fall in the crisis because of the way it was allowed to operate. Like all banks, Northern Rock was allowed to assume risk in the way it funded itself. A key measure of balance sheet risk is the degree to which the duration assets (loans) and liabilities (deposits) match or mismatched in the case of Northern Rock.

Historically as family dynasties, the long-established banks, typically grew over several generations by building retail deposit bases matched with long-term assets, like high-quality mortgages. However, if you want to challenge the incumbent players in a market, you need to grow more quickly. Opening branch networks and developing long term trust and support from retail customers is slow and expensive. Northern Rock was among several challengers who were in a hurry. Encouraged by the political will for more people (voters) to have the opportunity to own their own homes was nurtured by a banking industry able to convince its political masters that the slicing and dicing of the risk they undertook made it disappear. This dangerous myth created a regime that allowed ambitious players like Northern Rock to build a business based on the shaky premise of borrowing short and lending long. When the ability to borrow short dried up, they were exposed as the regulated fraud they had been allowed to become.

Today, in plain sight, the energy supply industry is being crushed by a crisis with a similar back story to that of the banking crisis thirteen years ago. Just as Northern Rock was allowed to fund its balance sheet recklessly, so have the challenger retail energy suppliers been allowed to borrow short and lend long in their market. In this instance, the trick has been to commit to supplying electricity at or below the regulated price cap without securing long term supply agreements to back up their contractual obligations to their customers.

As with the banking crisis, the people whom this joint enterprise of regulatory capture supposedly protects will be the same people who will now bear the costs of the incompetence and fraud involved. Just as Northern Rock was regulated by the Bank of England and the FCA, the retail energy suppliers are under the regulatory umbrella of Ofgem. In both cases, under the cloak of protecting retail customers from undue risk, the government watchmen have been captured by the industry they are mandated to regulate. A shared delusion has been allowed to take hold that the customer can be protected from the reality of risk inherent in the business whose output they need. However, the lesson from both episodes is that danger might be delayed, but it cannot be avoided.

In what Ofgem describes as an unprecedented rise in wholesale energy prices this year, the business models of the vast majority of retail energy suppliers have become uneconomic. In the last ten weeks alone, half of the UK’s energy suppliers have failed. Ofgem is operating as a clearinghouse for the customers of the failed suppliers, bundling them up and handing them over to other suppliers.

The fallout from this industry failure has yet to unfold fully. The significant impact will land in March next year when the Ofgem price cap (SVT or Standard Variable Tariff) is updated. This contrived number is the maximum price an energy supplier can charge a retail customer for electricity in the UK, and it seems likely that this number will have to go up by at least 50%.

However, what is increasingly clear is that there is one particular and differentiated energy supplier is set to rise from this economic and political firestorm with a much-improved business prospect. This business is Utility Warehouse, which is the operating name of Telecom Plus PLC. The UW operating model is highly differentiated from other energy suppliers. I mentioned this business and why I thought it was interesting in a blog post from September about ways of playing the energy transition. click here .

Uniquely among the energy suppliers in the UK, UW operates a multiservice proposition for its customers. Energy supply is typically the lead generation product, but they also have been very successful at cross-selling other services such as fixed and mobile telephone, broadband and insurance. Crucially as its lead marketing tool, UW has a long-term electricity supply agreement with nPower, now part of Eon, to supply electricity to UW customers until 2033 at a price that enables Telecom Plus to make a profit at the SVT. This attractive proposition can be enhanced by the opportunity for UW customers to enjoy single billing across its range of services and benefit from an award-winning customer service team.

As a result of the turmoil year to date, about 4.2m customers (representing 15% of the entire UK market) have been allocated to an energy supplier they did not choose. These customers will be moved to higher price tariffs in the next few months as their new supplier looks to recoup the costs they have taken on with this new relationship. This hurried reallocation of customers represents a highly fertile ground for UW agents to sign up new customers. Indeed in October, as this crisis was developing, UW agents signed up a net new 15 000 customers, which is more than the entirety for 2020. The management describes this as an inflection point for their prospects.

The Telecom Plus strategy has endured the dormant level of new customer flow into the business over the past seven years. In this period, the UW team focused on retaining their customers by cross-selling new services and investing in customer care, while the new entrant suppliers were offering their switching bonuses to new customers at ludicrously unprofitable rates. This was a painful but correct strategy to adopt. However, it was costly in terms of the valuation of the business resulting in Telecom Plus gaining the reputation for being a faded former growth company.

This period of excessive competitive supply into the retail electricity market is now over and UW / Telecom Plus has been patiently waiting for this time to come. The new opportunity for Telecom Plus to convert these new customers into long-term high-value customers in a business that has some attractive cash flow and return on capital metrics is exciting. It can now recruit more agents who can now grow the customer base at a meaningful rate. Not surprisingly, the stock market has already noticed this improved potential, and the shares have performed well in recent weeks. However, this is a market dynamic that could persist for several years to come*.

Jeremy

Ealing

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