How does the energy price cap work? Ofgem limit explained, how it’s calculated, what October 2022 cap will be

The biggest UK cost of living crisis for decades is set to get worse this winter, as energy regulator Ofgem has revealed its energy price cap will rise 80%.

Kicking in from 1 October 2022, the huge increase is likely to lead to even higher inflation.

Households are already battling a record decrease in real-terms wage packets as well as interest rate hikes, while a recession is also expected to hit later this year.

Given it has such a major bearing over the cost of living, understanding how the Ofgem energy price cap works is crucial.

So how is it calculated?

Here’s everything you need to know.

What is the Ofgem energy price cap October 2022?

The Ofgem energy price cap governs the maximum electricity and gas unit pricing and standing charges for the estimated 24 million UK households who have either a default variable tariff or a prepayment meter.

The existing cap, which was introduced on 1 April 2022, pushed the average household’s annual energy bill up 54% to £1,971.

But, from 1 October, this figure is going to rise another 80% to £3,549.

Prepay consumers will experience a similarly large increase from £2,017 to £3,608.

This latter figure is bigger because Ofgem says it costs providers more to process prepayments than monthly direct debits.

While these caps reflect the maximum amount you can be charged by your energy supplier, your actual annual bill is likely to be more than 50% higher as the caps do not take your usage into account.

Ofgem said the main reasons for the rise were wholesale gas prices, which initially surged as the world’s economies have opened up from Covid lockdowns and have remained high as a result of Russia beginning to switch off Europe’s gas supplies.

“The price of energy has reached record levels driven by an aggressive economic act by the Russian state,” said Ofgem CEO Jonathan Brearley.

“They have slowly and deliberately turned off the gas supplies to Europe causing harm to our households, businesses and wider economy.

“Ofgem has no choice but to reflect these cost increases in the price cap.”

Brearley called on the government to provide extra support to consumers, something which Chancellor Nadhim Zahawi insisted it has been doing.

Why is there an Ofgem energy price cap?

The Ofgem energy price cap was brought in by Theresa May’s government and officially introduced in January 2019.

It was put in place to stop energy suppliers from ripping off their customers - particularly less financially savvy households who don’t know how to access the best deals.

Responsibility for setting it was given the Ofgem - the Office of Gas and Electricity Markets - which regulates the UK gas and electricity market.

How is the Ofgem energy price cap calculated?

Put simply, the Ofgem energy price cap is calculated by working out the cost of buying and supplying energy to UK homes.

Also factored in is a 1.9% profit margin for energy suppliers and VAT.

To get to a figure, Ofgem has to analyse the factors that impact our energy bills, as well as usage and market data over a particular period on a region-by-region basis.

It means the cap can be different depending on where you live (Money Saving Expert has a calculator tool that you can use to see how the price cap will impact your bills).

At present, the biggest factors are sanctions placed on Russia as a result of its invasion of Ukraine and Russia’s own blocks on European access to its gas supplies.

A developing electricity crisis in France, which is having issues with several of its nuclear power plants, is likely to have an impact going forwards.

This review period for the latest price cap took place between February and August 2022, but is set to happen more frequently over the coming year as Ofgem is moving to quarterly, rather than half-yearly, price caps.

Here is a breakdown of all of the factors that are used to calculate the price cap:

• Wholesale gas and electricity costs (i.e. what it costs suppliers to buy energy based on forward-looking energy contracts)
• 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

Wholesale costs are the biggest contributor to the level of the price cap, currently accounting for 70% (£2,491) of the new figure for October.