What is the UK energy price cap and why is it rising?

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The cost of energy is about to rise for UK households as regulator Ofgem prepares to raise the cap on how much it allows providers to charge. That’s when wholesale natural gas prices have surged following the Russian invasion of Ukraine. In early August, Ofgem warned that a challenging winter was ahead. Analyst estimates point to an increase of around 80%, a reflection of record gas and electricity prices. Whoever replaces Boris Johnson as prime minister will face strong calls from lawmakers, activists and industry to overhaul the home charging system.

1. What is the price cap?

The system, unveiled in January 2019 by Ofgem under Theresa May’s government, was designed to save consumers money by setting out how much suppliers could charge households per unit of energy and gas they use. It covers the majority of households, around 24 million in the UK, with a so-called standard variable rate, and caps the level of profit an energy provider can make at 1.9%. It has offered protection to those who have not been able to shop around and switch providers regularly. Savvy consumers have traditionally saved many hundreds of pounds a year by switching providers.

A common misconception is that the measure limits how high a household bill will be. But this is not the case, since the total in most cases will still depend on the amount of energy that household actually consumes. The cap set by Ofgem is expressed in terms of average energy bills, not an absolute cap. That limit is set to rise on Friday to £3,554 ($4,185), effective October 1, according to Cornwall Insight Ltd. That’s more than the £1,971 in place since April.

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The level is nowhere near where it is expected to be next year. With no end in sight to Russia’s war in Ukraine and wholesale gasoline prices rising more than 60% so far in August alone, analyst forecasts for future highs are constantly being revised. Cornwall Insight predicts the price cap will rise further to above £5,300 in the second quarter of 2023 and remain above £4,700 throughout 2023. The government is implementing a blanket rebate of £400 on energy bills for households, payable in monthly installments between October 2022 and March 2023, to ease the cost.

4. How is it calculated?

The turns in the wholesale markets are the most important components of how the level is established. As the price of gas, or that of power generated in nuclear power plants and wind farms or brought by cables from the mainland, soars, the level of the cap is also adjusted upwards. If wholesale rates fall, as they have in the past, the cap will also fall. While renewable sources have accounted for a growing proportion of the UK’s electricity supply, gas remains the main driver of overall price, with the majority of UK homes getting their heat from gas. Due to large market swings, the limit will now be adjusted quarterly instead of every six months, Ofgem said in early August. That translates into an underlying price per unit of energy used and a fixed daily rate for being connected, called a permanent charge. That charge has also been increased to recover the £2.9bn cost of failed supply companies.

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5. Why is it controversial?

It was introduced as a measure that would save consumers money. And while the cap was fairly stable, or even decreased, for some time, the close link to the wholesale market meant that once the energy crisis hit, rates for even the most vulnerable consumers skyrocketed because they weren’t protected. Businesses and activists alike have called for the system to be replaced by a social tariff paid for by taxes on better-off consumers. Still, the government has so far resisted such calls, and earlier this year legislated to keep the cap alive beyond 2023.

6. Do other countries have something similar?

The price ceiling is a British concept, although utility contracts in most other countries are also linked to a greater or lesser extent to the wholesale market price. A series of measures are being introduced to protect consumers in European countries, ranging from the reduction of value added tax to the limitation of price increases and the payment of billions of euros to consumers.

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