Households across the UK are still being hit by the cost of living crisis - something that looks set to remain with us for much of the rest of 2023.
For much of the last year, we have seen everything from food prices to the cost of a tank of fuel rocket. While the inflation rate is now heading downwards, the high interest rates introduced by the Bank of England to counteract price rises across the economy have added hundreds of pounds to mortgages.
Another spike in the cost of living is anticipated in April, when council tax, water bills and other utilities including mobile and broadband costs are all set to soar. But arguably the biggest bills hike expected to happen in spring will come as a result of the government watering down its energy price guarantee.
Experts, including MoneySavingExpert Martin Lewis, have warned this cliff edge scenario will cause unnecessary pain for struggling households. They argue the government should postpone the decrease in support until the summer when cheaper wholesale prices will start to be factored into domestic energy bills. According to analysis from Cornwall Insight, the difference in cutting back the support and maintaining it equates to £2.6 billion (£26.8bn versus £29.4bn).
If they are proven right, the Ofgem energy price cap will once again become the upper limit for our energy costs. But what is the price cap - and what is the rate that will come in from April 2023?
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 the consumers who have recently fallen victim to have prepayment meters force-fitted.
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 - although most people are now likely to be on one. In normal times, you would only go onto a variable tariff if you’d never switched supplier, your fixed rate term had ended, your supplier had gone bust, or you’d moved house.
Given consumers have been advised to avoid fixing their energy bills or switching suppliers for the last 12 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 (although it is currently being superseded by the energy price guarantee).
So, what you’re billed is likely to 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.
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 for a year. 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 figure Ofgem generates is what it would cost the average home for the energy they use over a 12-month period. The factor that’s driven the major increases to the price cap over the past 12 months has been wholesale costs. These more than doubled between April and October, rising 131% from an average of £1,077 to £2,491 in October.
But now, wholesale prices are 80% below their peak in August and 65% lower than they were in December. Household bills are likely to reflect this change in the second half of the year, according to analysts.
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 (i.e. twice yearly) to a quarterly (i.e. four times a year) price cap announcement in August 2022. 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 has set the maximum suppliers can charge consumers for units of gas and electricity at roughly 34p per kilowatt hour (kWh) for electricity and 10.3p per kWh for gas. The government has done this by subsidising energy suppliers so that they can only charge a maximum unit price - i.e. it has shouldered the extra costs. But this move has been risky given the government has been exposed to the whims of the wholesale energy markets.
It means the average bill has been £2,500 a year this winter. But this de facto energy price cap is set to increase to £3,000 for a year from April - a 20% rise. It is then set to remain at this rate until April 2024.
Longer-term, the future of the Ofgem cap has been called into question. 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.
What level is the 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 2022 price cap saw a rise of 80% to £3,549 per year from the April 2022 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.
In January, the cap rose another 21% to £4,279 for the average household. But the latest announcement has seen it come down by nearly £1,000 to £3,280 for the three months from 1 April 2023 - a move that was almost exactly in line with forecasts by financial services firm Investec and energy consultancy Cornwall Insight. Both predict the cap will fall under £2,200 from July.
When the latest price cap was announced on Monday (27 February), Ofgem chief executive Jonathan Brearley said: “Although wholesale prices have fallen, the price cap has not yet fallen below the planned level of the Energy Price Guarantee. This means that on current policy bills will rise again in April. I know that for many households this news will be deeply concerning.
“However, today’s announcement reflects the fundamental shift in the cost of wholesale energy for the first time since the gas crisis began. And while it won’t make an immediate difference to consumers, it’s a sign that some of the immense pressure we’ve seen in the energy markets over the last 18 months may be starting to ease.”
Despite sounding an optimistic note, Mr Brearley added that he believed it is “unlikely” prices will fall back to where they were before the energy crisis started in late 2021. He urged those who are struggling to pay their bills to get in touch with their supplier.
If the price cap hits the lower rate currently forecast for July, the government will not need to supply any funds for the energy price guarantee and bills will be lower than they currently are. But if the energy price guarantee becomes less generous in April, as scheduled, energy bills will be much higher for around three months.
Why have energy bills been so high?
Given the Russia-Ukraine war and the subsequent sanctions against Vladimir Putin’s regime, as well as Moscow’s decision to cut the West off from its energy, the wholesale price for energy is soaring. This is because all of these things have limited access to 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, has also meant there is even less gas to go around.
Markets have been 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 set to be locked down for another year, supply might still be an issue for the UK next winter.