What is the UK energy price cap and why is it rising?
1. What is the ceiling price?
The system, introduced in January 2019 by Ofgem under Theresa May’s administration, was designed to save consumers money as it sets out how much suppliers could charge homes per unit for electricity and gas that they use. It covers most households, around 24 million in the UK, on a so-called standard variable tariff, and caps the level of profit an energy supplier can make at 1.9%. It offered protection for those who were unable to shop around and switch providers regularly. More sophisticated consumers have traditionally saved several hundred pounds a year by switching suppliers.
A common misconception is that the measure limits the amount of a household’s bill. But this is not the case, since the total will in most cases depend on the amount of energy actually consumed by the household. The cap set by Ofgem is expressed in terms of average energy bills, not an absolute cap. This cap was raised on August 26 to a record £3,549 ($4,188), effective October 1. This was up from the £1,971 in effect since April.
The level is far from where it should reach next year. With Russia’s war in Ukraine looming and wholesale gas prices jumping more than 60% so far in August alone, analysts’ forecasts of future cap levels are constantly revised. Cornwall Insight has predicted that the price cap will climb further above £5,300 in the second quarter of 2023 and will remain above £4,700 throughout 2023. The government is implementing a block discount of £400 on household energy bills, payable in monthly installments between October 2022 and March 2023, to alleviate the cost.
4. How is it calculated?
Fluctuations in the wholesale markets are the most important elements in determining the level. When the price of gas soars, or that of electricity produced in nuclear power plants and wind farms or transported by cable from the continent, the level of the ceiling is also adjusted upwards. If wholesale rates drop, as they have done in the past, the cap will also drop. While renewable sources account for a growing proportion of the UK’s electricity supply, gas is still the main driver of the overall price, and most UK homes get their heat from gas. Due to strong market fluctuations, the cap will now be adjusted quarterly instead of every six months, Ofgem said earlier in August. This translates into an underlying price per unit of energy used and a fixed daily connection charge, called ongoing charge. This charge has also increased to recover the £2.9bn cost of bankrupt supply companies.
5. Why is it controversial?
It was touted as a measure that would save consumers money. And although the limit was quite stable, if not falling, for a time, the close link with the wholesale market meant that once the energy crisis set in, tariffs, even for the most vulnerable, soared because they were unprotected. Businesses and activists have called for the system to be replaced with a social tariff paid by levies on the wealthiest consumers. Even so, 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?
Price caps are a British concept, although utility contracts in most other countries are also more or less tied to the wholesale market price. A number of measures are in place to protect consumers in European countries, ranging from reducing value added tax to limiting price increases and paying out billions of euros to consumers.
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