23 September 2021

The real reason energy companies are going bust? Not enough gambling in The City

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Forget low winds, lack of fracking and a cable destroyed in a fire, the real reason energy supply companies are going bust left, right and centre is that there’s not enough risk taking in The City.

Price volatility is inevitable in global markets, since we don’t have the ability to fix wholesale prices in other countries. However in Britain, retail prices are fixed for a large percentage of the market. This poses dangers for those who buy wholesale and sell retail – prices can move against their position. But financial speculation can help insulate suppliers from that risk.

Futures and options markets exist to enable people to gamble. That’s their purpose, however much traders prefer to talk about investment strategies and so on. In a wheat futures market, the farmer can sell her wheat before the crop is even planted and the baker, or flour miller, can fix the price of supplies many months in advance. The people taking the risks of price movements through crop failure, glut, shipping problems, fungal attacks and all the rest, are the speculators. The effect of this is to move risk from those who don’t want it to those who do, and the result is greater security of price for the producers of the underlying physical goods.

What’s causing those price changes in the energy markets is interesting. But what’s causing those retail energy companies to go bust is that they didn’t offload the risk onto the gas and energy futures markets. Energy suppliers have a fixed price for output and a variable price for their main input. They therefore have a choice – bet that wholesale prices won’t change very much, or pass the risk to one of the thousands of people gasping to spend billions to take that gamble off their hands, for a fee of course. Rather too many took that first option and are now falling into bankruptcy, which makes the speculator’s fee seem modest by comparison.

The larger lesson here is that we do have a market solution to the price variability inherent to the system. Those who claim that financial markets are nothing but hotbeds of speculation are right – that’s the point of them. Futures and options markets enable retailers to toss risk over to people who want it so they can keep supplies of important commodities flowing.

Those who would introduce a crippling a financial transactions tax (aka Robin Hood Tax) should be regarded with the deepest suspicion. Kill the futures markets and all of the energy companies would be going bankrupt right around now. And that would be a dark day for all of us.

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Tim Worstall is Senior Fellow at the Adam Smith Institute

Columns are the author's own opinion and do not necessarily reflect the views of CapX.