Scottish & Southern Energy in strong position:
E.ON UK is raising its residential gas and electricity prices by 18.4% and 9.7% respectively from August 21, 2006. Ahead of another winter of supply insecurity, retailers are bracing themselves for further wholesale price spikes. SSE remains steadfast, however, proving that suppliers can still successfully hedge against a high commodity price. The UK's second largest residential energy supplier, E.ON UK, has joined rivals Centrica, RWE npower, EDF Energy and ScottishPower in announcing its second domestic gas and power tariff rise in 2006. In contrast, Scottish and Southern Energy (SSE), the final member of the so-called 'big six', is adamant that it will not be immediately involved in the latest round of price hikes. Traditionally one of the lowest-cost providers in UK energy retailing, SSE has consistently built market share in recent years, and following the spring round of tariff increases it announced it had breached the 7 million customer mark. Having relegated RWE npower to fourth place, SSE now appears well placed to challenge market leaders Centrica and E.ON UK. While the UK's leading energy retailers have varying structural hedges, all are short of equity gas supplies at a time of record high prices at the NBP. E.ON UK appears set to benefit from the participation of sister company, E.ON-Ruhrgas, in the Balgzand-Bacton Line (BBL), which is scheduled to come onstream in December 2006. Direct access to the Dutch TTF wholesale market will negate, to some extent, the need to purchase at a volatile NBP. This may, however, serve to open the Powergen brand to the wider structural exposure of the E.ON group. Ruhrgas's long-term import contracts with Russia are coming under increasing scrutiny from regulators in Germany and Brussels. E.ON's drive to swap downstream assets with Russian state monopolist Gazprom in return for upstream access is a sensible response. Across the entire E.ON group, Europe's largest utility, only 2% of gas sales are offset by equity gas assets. It is also not unimaginable that the reticence among continental shippers to release stored gas into the Interconnector in winter 2005 will re-emerge this winter and may also affect available volumes to the new UK-Netherlands link. Centrica is taking a different approach to its German rival, investing heavily in UK upstream assets. Although its British Gas brand remains the most exposed to rises in both the gas and power markets in absolute terms, significant production interests - in the current high price climate - provide some protection to overall profitability. As the former UK gas incumbent, Centrica continues to push British Gas as a premium brand. Although not unconcerned by recent customer losses, it will continue to accept the loss of relatively unprofitable gas customers in the short-term. Centrica's 'Fix and Fall' price protection scheme, under which a tariff reduction is guaranteed in 2007, may come back to bite should wholesale gas prices remain high. Any delay to Norway's vast Ormen Lange project - which is projected to supply up to 20% of UK demand upon completion - will be a cause for consternation at its Windsor HQ. Although further price rises are inevitable in the next 12 months, SSE has re-iterated it will not be raising tariffs again in 2006. While understandably declining to comment on its specific commercial positions, SSE believes it is "in good shape" to make this commitment. But we must then ask how it has sustained its challenge to Centrica and E.ON UK in the face of soaring wholesale energy prices, despite being the most exposed to the NBP of all the 'big six'. A lucky hedge may or may not explain this. Purchasing wholesale gas to cover a residential base, over which you have little guarantee of ongoing supply, is an onerous task with forward wholesale prices at record highs. At times of high customer switching, a retailer could easily be taking physical delivery of gas which it is does not have a market for. Additional balancing costs aside, this opens the utility to the risk of re-selling gas back into a lower priced market and taking a hit. Subsequently, the majority of residential energy supply is hedged against short-term delivery contracts. Only 3% of gas bought at the NBP in 2006 has been contracted beyond the month-ahead contract. If, however, SSE has been bold, secured cheaper longer-term gas contracts and has backed itself to maintain and/or expand its customer base, it could potentially reduce its exposure to the NBP and remain a low cost provider. SSE also had a motive to this. Faced with the overtures of larger companies, the critical mass at which a UK utility can avoid a takeover bid has been steadily rising. It was the price, as opposed to ScottishPower's 5 million customers, that convinced E.ON to look to Spain for its next major acquisition. Ultimately, SSE will have to raise its tariffs again in the future, but its continued ability to delay tariff hikes and win new business may be more a result of judgment than luck. 29.8.06