Energy bills and the price cap

Energy bills comprise a variety of costs including wholesale, network, social and environmental, and other direct costs, as well as VAT and supplier profits. These costs can all fluctuate, meaning the causes of rises and falls in energy bills are complex.

Introduced to address a lack of competition in the energy market in 2019, the default tariff cap (also known as the energy price cap) sets an absolute, top-level price per unit of electricity and gas for customers on domestic default tariffs in Great Britain. The intention is that the cap should be low enough to protect vulnerable customers, but high enough to encourage suppliers to offer tariffs below the level of the cap, to maintain competition and incentivise switching.

Unprecedented increases in wholesale gas and electricity prices, and associated tariff rises, have meant the price cap has gone from one of the more expensive tariffs in the market, to one of the cheapest available.  Currently, 24 million households are on tariffs protected by the cap.  

August 2022 cap increase

On 26 August 2022, the energy regulator Ofgem announced a further 80% increase in the cap, meaning that a ‘typical’ household (with average consumption, dual fuel and paying by direct debit) would be paying an annual bill of £3,549 from 1 October 2022. The regulator also warned that while it was not giving projections for January due to the volatility in the market, “prices could get significantly worse through 2023.”

Jonathan Brearley, CEO of Ofgem, said the new Prime Minister would need to act to address the price rises facing consumers. He said Ofgem had been working with ministers, consumer groups and industry bodies on a “set of options” for the new Prime Minister, adding: “The response will need to match the scale of the crisis we have before us. With the right support in place and with [the] regulator, government, industry and consumers working together, we can find a way through this.”   

How is the price cap set?

Ofgem sets the price cap using its own estimates of the different costs that suppliers will face in the next price cap period. These mainly consist of the wholesale cost of gas and electricity, network costs, supplier operating costs and the costs of government policy which are passed on to customers. It adds an element for supplier profit of just over 1.9% of revenue. Finally, VAT is added at 5%.

In late 2021, in response to instability in the energy market and rising energy bills, Ofgem launched consultations on measures to reform the price cap methodology and make other changes to the regulation of the market. In August 2022, the regulator announced that, following the consultations, it was making changes to come into force from 1 October 2022, including:

• Moving to a quarterly review of the price cap, from the current six-monthly assessment;
• A shortened notice period between the announcement of the cap level and its implementation;
• The inclusion of backwardation costs in the methodology.

Alternative proposals

There is widespread concern about the impact of increasing energy prices on vulnerable customers in winter 2022-23. There have been several proposals to temporarily freeze the price cap or replace it with a different method of price regulation. 

The Government has provided support to help energy consumers with rising energy bills. It hasn’t proposed any change to the price cap but has said it is considering what reforms are needed to ensure the energy market is resilient and customers are protected. Provisions in the Energy Bill 2022-23, currently being considered in the House of Lords, would enable the existing price cap to be extended beyond 2023.