Lessons from Britain's stricken energy sector: be Octopus not Avro

We should have seen it coming. Seemingly from nowhere, tens of small energy companies set up in the UK. All the talk is of racing to the bottom, of consumers switching between them, just like that, to secure the cheapest deal.

Firms are even launched that specialise in enabling users to move across. They will find the best price, leave them to get on with it, easy. Those companies that do nothing but switch also prosper.

The buzz and the numbers are strong, everyone needs gas and electricity. The City can’t get enough of this new bonanza. Words like “renewable”, “efficient”, “sustainable” are chucked around.

Investment committees that must check whether tests for ESG, the initials that have become a mantra, are complied with, and pronounce themselves satisfied. The energy fledglings are as eco-friendly as they can be, so that’s the E for environment; they do all the right things by their workers where diversity and inclusion and looking out for their poorer customers are concerned, so that’s the S for social; and they’re properly managed, so that’s the G for governance sorted.

The City piles in, there are shares to be had, profits to be made. If you fit the right criteria, who knows, there might even be a job in it for you. It was telling how many non-executive directorships at start-up UK energy firms were going begging in the Opportunities sections of head-hunter websites.

They did well, wooing hundreds of thousands of consumers from the established players. Suddenly, the rug has been pulled from under. They’ve come crashing down. They built their business on what was known in the trade as the “maturity mismatch”, the difference between the spot price for energy in the market and the long-term prices agreed by their customers.

Things were fine while the spot price was below the end user price. But when the former rose, the gap or mismatch between the two narrowed and the likelihood of profitability vanished.

Firms have gone under, leaving investors out of pocket and consumers without an energy supplier (not without energy, the regulator Ofgem is guaranteeing they will be able to transfer to an alternative home).

It’s a mess, one with an eerily familiar feel. Not for the first time, City caution was thrown to the wind. These were companies without reserves of cash. If the going got tough they had nothing to fall back upon. They tended not to do, either, what any careful person might do and insure themselves against the market turning – they didn’t hedge against the spot price climbing.

Yet, the City rushed in. As it has done on every single occasion a bubble has been created – never mind that bubbles have an unfortunate habit of bursting. In recent times, they did it with the banks in 2007 and before them, dotcom stocks. History is littered with further examples.

The pattern is the same: there’s the promise of spectacular gains; it’s all built on the back of a feelgood factor, in this case greater consumer choice (as it was in the run-up to the banking crisis with the rise of ready mortgage lenders), there is minimum regulation and supervision (again, the official watchdog has been found wanting, as it was in 2007). Crucially, no one is pressing the pause button and asking what if? Everything is based on this model but what if it changes, what then?

In 2007, the banks – notably in the UK, Northern Rock but there were others – could lend crazy on crazy multiples, often without proof of earnings because they were able to borrow. They were tapping the wholesale credit market. When that tightened, as Americans started defaulting on their sub-prime loans and rates went up, as illiquidity took hold, the banks had nowhere to turn.

Then, once the banks were rescued, or allowed to fail as in the case of Lehman in the US, and minds turned to not creating the circumstances in which there could be a recurrence, the solution was to require the survivors to maintain higher reserves. For banks, read energy. It’s a rerun of 2007 and the result will be the same: a smaller number of operators obliged to show they’re in strong financial fettle.

The paradox to this is the intervention of Al Gore. The former US vice president, so-nearly president and environmentalist has jumped in, via his Generation Investment Management (or GIM) fund to pump up to $600 million into the UK’s Octopus Energy. The green start-up, founded only in 2016, receives $300m now and another $300m next June if certain, undisclosed conditions are met.

At first sight, the move looks contrarian. But Octopus is the one from the pack to have made the leap. It serves more than 3.1 million households, is ranked among the biggest five energy suppliers and a valuation of $4.6 billion makes it worth more than Centrica, owner of British Gas.

Octopus was created, not to do quite nicely thank you, but to determinedly break the stranglehold of the Big Six group of British energy providers. Formed out of a fund management business, as opposed to pure energy, Octopus is heavily technologically driven. It had high ambition and smart kit to match.

Success is down to a software platform that it’s already licensing to admiring large beasts, including Origin, E.ON, npower and Hanwa. In all, 17 million accounts are managed globally, using Octopus’s Kraken technology that claims to manage power usage more efficiently. It’s this that Gore is buying into.

His swoop was in the planning for months, long before some of Octopus’s fellow youngsters found themselves being squeezed. Evidence that Octopus is different came with its agreement to take 580,000 customers of Avro Energy that has gone bust.

In case, too, anyone should suppose it’s a mad environment play by Gore, they ought to realise that GIM is run by David Blood, who use to head Goldman Sachs Asset Management. I know David and he is clever, no slouch, nor is he a gambler with other people’s money. GIM will have done its homework, he will have been sure of that.

Far from appearing perverse, the timing could be neat. Gore is climbing aboard just as Octopus can benefit from the downfalls of others. Not bizarre at all then, but a smart, thought-through strategy. If only the same could be said for fellow energy sector members and their gung-ho backers.