The UK has been dominated by the cost of living crisis throughout much of 2022.
Much of the crisis has been driven by rocketing energy bills. Beginning in late 2021 due to a surge in global gas and electricity prices caused by the recovery from the Covid-19 pandemic, costs soared in the wake of Russia’s invasion of Ukraine.
The Kremlin’s war has driven up prices internationally because markets have been concerned - and proven to be correct - about Moscow opting to restrict Europe’s access to energy in a bid to halt the continent’s support for Kyiv. But UK prices in particular have risen as a result of the policies of successive governments which have left the country overly reliant on gas and without adequate storage capabilities.
In more normal times, the Ofgem energy price cap was intended to shield consumers from the worst price rises. But in the wake of the current situation, it has created chaos through major price hikes.
In September, it was superseded by the Liz Trussgovernment’s energy price guarantee - a policy that is in operation this winter but has been modified by the Rishi Sunak government from April 2023 onwards.
So, what is Ofgem - and is it still operating a price cap? Here’s what you need to know.
What is the Ofgem energy price cap?
Ofgem - or the Office of Gas and Electricity Markets - is the UK’s energy regulator. Independent of government, it says it works to keep energy prices as low as possible, protect consumers and drive the UK towards its net-zero target.
Part of its role is to set a cap on what suppliers can charge people who are on default - i.e. standard variable - tariffs for a unit of energy, so as to stop them from being ripped off. This includes consumers who have prepayment meters.
These variable tariffs are usually more expensive than fixed-rate ones and tended to be followed by the UK’s poorest and most vulnerable households - until 2022 at least. You are likely to be put on one if you’ve never switched supplier, your fixed rate term has ended, your supplier has gone bust, or you’ve moved house.
Given consumers have been advised to avoid fixing their energy bills or switching suppliers for the last nine months, millions of UK households are now on variable tariffs. When you look at your energy bill, the price cap governs the maximum standing charge and price per kWh of gas and electricity your supplier can charge you.
So, what you’re billed will almost certainly be above the price cap because it doesn’t determine the maximum you will have to pay for your energy usage. A typical household’s bill will sit around 55% above the price cap. A fact that is also true of Liz Truss’s energy price freeze that is set to come into effect from 1 October and will last two years.
How is the energy price cap calculated?
Ofgem determines its energy price cap by calculating how much it would cost a typical energy supplier to supply an average home. It does this by analysing several factors that impact our energy bills, as well as usage and market data over a review period. These include:
- Wholesale gas and electricity costs (i.e. what it costs suppliers to buy energy)
- Network costs (e.g. what it costs suppliers to maintain energy infrastructure, like pipes and wires)
- Social and environmental obligations (for example, the cost of adhering to government climate policies, including green levies)
- Supplier operating costs and margin (roughly 2% of the average bill under the price cap)
- Headroom allowance (an amount that helps suppliers manage unexpected costs, thus theoretically allowing them to offer competitive deals)
- Taxes, like VAT
The factor that’s driven the major increase to the price cap has been wholesale costs. These have more than doubled, rising 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 Liz Truss government as part of the energy price guarantee.
As well as wholesale costs, the cap has been pushed up because of how much it cost to move millions of consumers to new suppliers when dozens of energy firms collapsed in autumn 2021 - adding roughly £61 to the cap. Ofgem has also said network maintenance costs have gone up - a likely consequence of the UK’s supply chain woes - while policy costs, like the rise in the warm home discount rebate, have risen.
How is the energy price cap changing?
Ofgem moved from a biannual to a quarterly price cap in August. When it announced the change, Ofgem said it would help “provide the stability needed in the energy market”.
However, this has now been superseded by the energy price guarantee, which will set the maximum suppliers can charge consumers for units of electricity at an average of £2,500 this winter, with the cap set to increase to £3,000 for a year from April. The price cap’s existence is legislated to run until 2023.
The energy price guarantee subsidises energy suppliers so that they can only charge a maximum unit price, with the government shouldering the rest of the bill. At present, the caps are £0.34 per kWh, with a daily standing charge of £0. 46 for electricity, and £0.10 per kWh with a daily standing charge of £0. 28 for gas
What is new energy price cap?
The Ofgem price cap is still being calculated by the regulator as a result of its statutory obligations. It is not only a useful indication of how much help the government’s energy price guarantee has provided, but also tells us how much government borrowing has been required to fund the scheme.
The October price cap saw a rise of 80% to £3,549 from the April rate of £1,971. For 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 is rising another 21% to £4,279 for the average household. According to Cornwall Insight - an energy market analyst group - this hike means the government is estimated to have to shell out £42 billion for the entire 18-month duration of the support package.
It says the final cost of the package could be “potentially higher than currently budgeted for” as the government has “exposed” itself to wholesale market dynamics over which it has no control.
While this cap means your energy bills will not rise by the huge amount that they would have had the Ofgem cap been implemented, your energy bills will still depend on your usage. So, the current £2,500 ‘cap’ is not the maximum amount you will be charged.
Given the Russia-Ukraine war and the subsequent sanctions against Vladimir Putin’s regime, as well as Moscow’s own threats to cut the West off from its energy, the wholesale price for energy is soaring. This is because all of these things throw into question supplies from Russia, which is the world’s second-biggest producer of natural gas.
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 even less gas to go around.
Markets are raising prices because they are factoring in that demand may have to be met by a smaller pool of supply in the coming months. While UK energy bills are now locked in for 18-months, supply might still be an issue for the UK.
Does the energy price cap have a future?
MPs who sit on the Business, Energy and Industrial Strategy committee described the price cap as out-of-date and urged the government to scrap it in a report published in July 2022. They said it should be replaced with a discounted social tariff for the most vulnerable households.
“We were told by a number of witnesses, ‘if you think things are bad now, you’ve not seen anything yet’,” committee chair Darren Jones said. This winter is going to be extremely difficult for family finances and it’s therefore critical that public funds are better targeted to those who need it the most.”
Cornwall Insight has also said the cap “is not working for consumers, suppliers or the economy”. With the energy price guarantee now in place, it now means the price cap may not have an immediate future.