Ofgem’s price cap was replaced by an energy price guarantee, which limited the price of gas and electricity
The cost of living crisis has gripped the UK for most of 2022.
The biggest driver of the crisis was skyrocketing energy bills. Starting in late 2021 due to higher global gas and electricity prices due to the recovery from the Covid-19 pandemic, costs have soared in the aftermath of the Russian invasion of Ukraine.
The Kremlin war drove up prices internationally because markets were concerned – and proven right – about Moscow’s choice to restrict Europe’s energy access in an effort to stop the continent subsidizing Kiev. But UK prices in particular have risen as a result of policies by successive governments that have made the country overly dependent on gas and without adequate storage capacities.
In normal times, Ofgem’s energy price cap was meant to protect consumers from the worst price hikes. But in the aftermath of the current situation, it has created havoc with massive price increases.
So, what is Ofgem – and does it still operate with a price cap? Here’s what you need to know.
What is Ofgem’s energy price cap?
Ofgem – or the Office for Gas and Electricity Markets – is the UK’s energy regulator. Regardless of the government, it says it is working to keep energy prices as low as possible, protecting consumers and moving the UK towards the net zero target.
Part of its role is to cap what suppliers can charge people in default — the standard variable tariff — for a unit of energy, in order to prevent them from stealing. This includes consumers who have prepaid meters.
These variable tariffs are usually more expensive than fixed-rate tariffs and tend to be followed by the poorest and most vulnerable households in the UK – until at least 2022. You will likely be put into one if you never switch supplier, your fixed rate term expires, your supplier goes bankrupt, or if you move house.
As consumers have been advised to avoid fixing their energy bills or switching suppliers for the past nine months, millions of households in the UK are now subject to variable tariffs. When you look at your energy bill, the rate cap controls the maximum permanent charges and rate per kWh of gas and electricity that your supplier can charge you.
So, what you’ll pay will almost certainly be above the price cap because it doesn’t specify the cap you have to pay for your energy use. Typical family bill will sitting about 55% above the price cap. A fact that also applies to the Liz Truss energy price freeze which is set to take effect from October 1 and will last for two years.
How is the energy price cap calculated?
Ofgem sets its energy price cap by calculating how much a typical energy supplier would cost to power an average home. It does this by analyzing the many factors that affect our energy bills, as well as usage and market data over the review period. These include:
- Wholesale gas and electricity costs (i.e. what it costs suppliers to buy energy)
- Network costs (for example, the cost of maintaining power infrastructure, such as pipes and wires) to suppliers
- Social and environmental obligations (for example, the cost of adhering to government climate policies, including green fees)
- Supplier operating costs and margin (about 2% of average invoice under price cap)
- Headroom allowance (an amount that helps suppliers manage unexpected costs, theoretically allowing them to offer competitive deals)
- Taxes, such as value added tax
The factor that greatly increased the price ceiling was wholesale costs. That increase has more than doubled, rising by 131% from an average of £1,077 for the summer 2022 cap to £2,491 from October. Wholesale costs will now be covered by the Les Truss Government as part of the Energy Price Guarantee.
In addition to wholesale costs, the cap was raised by the cost of moving millions of consumers to new suppliers when dozens of power companies collapsed in the autumn of 2021 – adding nearly £61 to the cap. Ofgem also said that network maintenance costs had risen – a possible result of supply chain problems in the UK – while policy costs had risen, such as a rise in the warm home rebate.
How does the energy price ceiling change?
Ofgem moved from a semi-annual rate cap to a quarterly cap in August. When it announced the change, Ofgem said it would help “provide the required stability in the energy market”.
However, this has now been replaced by the Energy Price Guarantee, which will set a maximum that suppliers can charge consumers for electricity units at an average of £2,500 this winter, with the cap set to increase to £3,000 for a year from April. A price cap has been legislated through 2023.
The Energy Price Guarantee subsidizes energy suppliers so that they can only charge a maximum unit price, with the government footing the rest of the bill. Currently, covers are priced at £0.34 per kWh, with a daily fixed cost of £0. 46 for electricity, £0.10 per kWh at a daily fixed cost of £0. 28 for gas
What is the new energy price ceiling?
Ofgem’s price cap is still calculated by the regulator as a result of its legal obligations. Not only is it a useful indicator of how much government assistance has been provided to underwrite energy prices, but it also tells us how much government borrowing is required to finance the scheme.
The price cap for October saw it rise by 80% to £3,549 from the April rate of £1,971. or those with prepayment meters, it increased from £2,017 to £3,608 because Ofgem says it costs suppliers more to process these payments than monthly direct debits.
But in January the cap had risen another 21% to £4,279 for the average family. According to Cornwall Insight – a group of energy market analysts – this rise means it is estimated that the government will have to shell out £42 billion for the entire 18-month period from the support package.
It says the final cost of the package could be “higher than what is currently budgeted” because the government has “exposed” itself to wholesale market dynamics over which it has no control.
While this cap means that your energy bills will not rise by the huge amount that they would have had the Ofgem cap implemented, your energy bills will still depend on your usage. So the current ‘cap’ of £2,500 is not the maximum amount you will be charged.
Post-Covid demand from major economies like China, which has already been responsible for much of the global wholesale price increase, could mean there is less gas left.
Markets are raising prices because they are mindful of this demand that may have to be met by a smaller pool of supply in the coming months. While UK energy bills are now closed for 18 months, supply may still be an issue for the UK.
Does the energy price ceiling have a future?
MPs participating in the Business, Energy and Industry Strategy Committee called the price cap outdated and urged the government to abolish it in a report published in July 2022. They said it should be replaced by a reduced social tariff for the most vulnerable.
“A number of witnesses told us, ‘If you think things are bad now, you haven’t seen anything yet,'” said Darren Jones, chair of the commission. “This winter is going to be very difficult for the family’s finances, and therefore it is critical that public funds are better channeled. to those who need it most.”
As Cornwall Insight said, the cap “doesn’t work in the interest of consumers, suppliers, or the economy.” With the energy price guarantee now, it now means that the price cap may not have an immediate future.