Published in La Tribune, on January 6, 2025
Requiring electricity suppliers to exercise prudent management is a good thing. But how far can we go without stifling entrepreneurship and distorting competition?
Inexperienced consumers
During the energy crisis of 2021-2023, the wholesale electricity market was the scapegoat for many European politicians, who accused it of unfairly transferring income to producers. In reality, the wholesale market did exactly what it was designed to do: balance supply and demand in real time and send signals of scarcity in the form of time-varying prices. What is not working as intended in the liberalized electricity sector is final demand. Apart from large consumers, demand in the wholesale market does not come from the end customer, as most buyers are unable to adjust their electricity consumption to spot prices that vary from hour to hour. It is retailers who are exposed to the variability of wholesale market prices where they source their supply. They resell electricity to the end consumer at a fixed, or at least slightly variable, price. In doing so, they absorb wholesale price variations. Many companies, regulators, policymakers, and economists have considered electricity retailing to be primarily a marketing activity where, as in most other sectors, large volumes are purchased upstream to be resold to consumers in a more or less competitive environment. The financial component of this activity has been underestimated, particularly risk management, even though it is essential in a sector where the product cannot be stored.
A risky business
The lack of preparation on the part of retailers to adapt to unforeseen events has already had catastrophic consequences during the energy crises in California (Borenstein 2002) and Texas (Cramton 2021), where suppliers had to purchase electricity at high market prices and resell it at a much lower contract price. Between 2021 and 2023, the United Kingdom saw 31 energy suppliers run out of business due to soaring wholesale gas prices and their impact on electricity prices, leaving more than two million customers under the protection of the market regulator (Ofgem) to maintain their supply.
During the same period, retailers in the European Union who had not taken precautions to hedge their financial positions also went bankrupt. National regulators were forced to reassign their customers to surviving competitors. Amending Directive 2024/1711 (June 13, 2024), which aims to improve the functioning of the EU electricity market, requires Member States to ensure that "suppliers have in place and implement appropriate hedging strategies to limit the risk generated by changes in wholesale electricity supply to the economic viability of their contracts with customers" (Article 18a). Member States had until January 17, 2025, to adopt the legislative, regulatory, and administrative provisions necessary to comply with the directive. To date, France is at the bill stage (DDADUE, submitted to the Senate on November 10), which provides on page 80 for the insertion of Article L. 332-9 into the Energy Code. It will create prudential obligations for suppliers to guarantee the provision of services over the duration of the contracts they offer, and entrust the Energy Regulatory Commission (CRE) with the task of defining and monitoring the procedures followed by energy suppliers to demonstrate compliance with their technical and financial obligations, as well as the power to sanction them in the event of non-compliance. It should be noted, however, that customers whose supplier is in default are not abandoned, as a "backup supplier" is already responsible for providing them with the expected electricity (Energy Code Article L333-3).
How much pressure is there?
The Directive leaves open the choice of measures that could secure the retail electricity market. Retailers may be subject to stress tests, for example measuring their ability to respond to shocks in wholesale prices and/or a cold spell affecting consumption levels. They may be required to set up a risk management department within their organization. More restrictively, they may be required to comply with specific financial ratios, more or less inspired by the regulation of banking and financial institutions. The most prescriptive approach is to set physical hedging requirements, i.e., a balance between contractual obligations to end consumers and sources of supply, whether internal, contractual, or on wholesale markets.
Pending the adaptation of the legislative framework and in anticipation of increased risks linked to the end of the ARENH (replaced by the Universal Nuclear Payment, VNU), the CRE took the lead with a public consultation launched on July 3, 2024, on a proposal for prudential rules that could apply to electricity and natural gas suppliers, and the publication of its conclusions in the deliberation of November 13, 2025. The deliberation states that the CRE gives priority to compliance with volume commitments. Companies that do not meet this "hedging criterion" will be subject to a financial solvency or liquidity test, and those that fail the test will be required to enter into a compliance plan. In addition, the CRE encourages suppliers to adopt a hedging and risk management policy, in particular by restructuring their internal organization.
Competitive bias
In the markets, as in everyday life, one must be wary of excessive caution. The height of caution is walking on your hands for fear of getting hit on the head by a tile, wrote Alphonse Allais. Imposing financial and technical constraints on suppliers increases their fixed costs (in terms of skilled personnel and control hardware and software), which gives large companies an advantage through economies of scale. The coverage obligation creates a link between customer portfolios and secure sources, thereby introducing rigidity between the downstream (retail market) and upstream (wholesale market) sectors. It is a soft form of vertical integration in an industry where "de-integration" was one of the pillars of liberalization. The fact that a retailer owns production assets and/or a portfolio of long-term contracts is no longer considered a breach of the sacrosanct market principles long promoted by the European Commission. With this new regulatory framework, European and national regulators recognize that the electricity industry is not like other industries. It is the security of supply to residential and professional customers, in parallel and sometimes in conflict with environmental regulations, that will set the course for all future reforms. A preview of this can be found in the guidelines published by the CRE in July 2024, which aim to improve the transparency and clarity of offers to consumers, thereby guaranteeing them better protection.
