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Energy price cap: what is Ofgem limit, how does it work, review period explained and October 2022 prediction

Rishi Sunak is due to announce more government support after Ofgem’s boss revealed the energy price cap could rise by more than 40% in October

Households up and down the UK are facing a major cost of living crisis due to inflation caused in part by rocketing energy bills.

A global shortage of gas over the past 18 months, high post-Covid demand, and the Russia-Ukraine war have pushed up gas and electricity prices for around 22 million UK households.

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In April, the Ofgem energy price cap rose to £1,971 - almost 58% higher than it was in April 2021.

But this week, the energy regulator’s boss said the price cap is set to go even higher.

Rishi Sunak is now set to make government energy bills support more generous.

Ofgem’s energy price cap has risen markedly over the last 12 months (image: Getty Images)

But what exactly does the Ofgem cap mean - and how could it be set to change?

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 consumers who have prepayment meters.

The war in Ukraine has thrown Russian gas supplies into doubt (image: Getty Images)

These variable tariffs are usually more expensive than fixed-rate ones and, until the last six months at least, tended to cover the UK’s poorest and most vulnerable households.

You are also likely to be on one if you’ve never switched supplier, your fixed rate term has ended, your supplier has gone bust, or you’ve moved house.

Given consumers have been advised to avoid fixing their energy bills or switching suppliers for the last six 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.

The energy price cap has been forecast to hit £2,599 in October (image: Getty Images)

So, what you’re billed will almost certainly be above the price cap because it doesn’t govern 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.

It does this by analysing several factors that impact our energy bills, as well as usage and market data over a review period.

The UK imports around half of its gas requirements (image: Getty Images)

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 factor that’s driven the major increase to the price cap has been wholesale costs.

These have more than doubled from an average of £528 for the winter 2021/22 cap to £1,077 for the summer 2022 cap.

(Graphic: Mark Hall)

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 £68 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 could the energy price cap change?

Since its introduction in 2019, the energy price cap has changed twice a year - once in April to cover the summer months when energy needs tend to be lower, and again in October for the more energy intensive winter months.

However, Ofgem announced on Monday (16 May) that it’s looking into the possibility of changing the cap every three months.

The energy price cap covers what rate a supplier can charge you at, rather than the maximum they can charge you in a bill (image: AFP/Getty Images)

It says this would help both consumers and suppliers.

The change would mean Brits wouldn’t face the same dramatic rise in the price cap that was seen in April, Ofgem argues, and would also see their energy bills drop much quicker when record high prices subside in future.

The public body also argues it would allow energy suppliers to predict how much energy they would need to buy with greater accuracy, thus lowering the chances of a repeat of autumn 2021 when dozens of suppliers went bust.

“Our top priority is to protect consumers by ensuring a fair and resilient energy market that works for everyone,” says Jonathan Brearley, Ofgem’s CEO.

“Our retail reforms will ensure that consumers are paying a fair price for their energy while ensuring resilience across the sector.

High global demand means the world’s gas supplies are in lower supply than usual (image: Getty Images)

“The last year has shown that we need to make changes to the price cap so that suppliers are better able to manage risks in these unprecedented market conditions.”

However, Martin Lewis accused Ofgem of “kowtowing to the lobbying of the industry” in an interview on LBC.

He says the move to quaterly changes would suit energy firms rather than consumers.

The price cap’s existence is currently legislated to run until 2023, but the government as indicated it could run beyond next year if they feel it’s required.

Ofgem is also currently consulting on changes which could add between £40 to £80 to annual bills from October.

Usually, suppliers take on an extra cost burden during the winter months when energy usage is at its highest, before recouping them over the summer.

But given current record high prices, Ofgem could allow firms to recoup these extra costs throughout the year.

What could the Ofgem cap rise to?

Ofgem’s proposed changes come against a backdrop of record high energy prices.

The price cap is currently set at £1,971 for people on variable tariffs who pay via monthly direct debit.

Wholesale gas prices have risen markedly across the globe (image: Getty Images)

For those with prepayment meters it sits at £2,017 because Ofgem says it costs suppliers more to process these payments than monthly direct debits.

At present, the next price cap announcement is scheduled for August and will be in effect between October 2022 and April 2023 (although a January announcement could be brought in if Ofgem’s proposed quarterly announcements come into effect).

This is because all of these things throw into question 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, could mean there is even less gas to go around.

So markets are raising prices because they are factoring in that demand may have to be met by a smaller pool of supply in the coming months.

Russia has threatened to turn the taps off to the west (image: AFP/Getty Images)

On Tuesday (24 May), we received our biggest indication yet of how much the price cap could go up by later this year.

Ofgem boss Jonathan Brearley said it could jump to “in the region of £2,800” in October - a rise of more than 42%.

This figure exceeds previous estimates.

According to predictions published in April by Cornwall Insight, an energy analytics firm, the price cap looked set to rise to £2,599.92 from October - 32% above the April Ofgem cap and more than double the previous October cap.

At the time, it predicted the cap could fall back to £2,040.55 in April 2023.