What is energy price cap? Ofgem limit on UK bills explained, current level, how much will it rise in October
The Ofgem price cap is expected to deepen the cost of living crisis from October 2022 by pushing up inflation rates
Energy regulator Ofgem - which has the job of protecting consumers from excessive heating and power charges - increased its energy price cap by 54% to £1,971 in April 2022, with even bigger rises predicted to come in the next few months.
The situation has become a key battle in the Conservative Party leadership race, while Labour leader Sir Keir Starmer has suggested freezing the price cap.
So how does the Ofgem price cap work - and how has it changed?
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.
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 - until 2022 at least.
You are likely to be put 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 nine 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.
So, what you’re billed will almost certainly 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.
It does this by analysing several factors that impact our energy bills, as well as usage and market data over a review period.
- 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.
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 is the energy price cap changing?
Ofgem has confirmed that the energy price cap will be updated quarterly, rather than every six months, as it warned that customers face a “very challenging winter ahead”.
The regulator said the change would go “some way to provide the stability needed in the energy market”, adding: “It is not in anyone’s interests for more suppliers to fail and exit the market.”
It said Russia’s actions in Ukraine had led to volatility in the global energy market experienced last winter lasting “much longer, with much higher prices for both gas and electricity than ever before”.
As expected, Ofgem warned that as a result of the market conditions, the price cap would have to increase later this month to reflect increased costs.
However it said that the changes would mean that any fall in wholesale prices would be passed on in full to customers and more quickly with the quarterly price cap.
Ofgem chief executive Jonathan Brearley said: “I know this situation is deeply worrying for many people. As a result of Russia’s actions, the volatility in the energy markets we experienced last winter has lasted much longer, with much higher prices than ever before. And that means the cost of supplying electricity and gas to homes has increased considerably.
“The trade-offs we need to make on behalf of consumers are extremely difficult and there are simply no easy answers right now. Today’s changes ensure the price cap does its job, making sure customers are only paying the real cost of their energy, but also, that it can adapt to the current volatile market.
“We will keep working closely with the Government, consumer groups and with energy companies on what further support can be provided to help with these higher prices.”
However, Martin Lewis accused Ofgem of “kowtowing to the lobbying of the industry” as he said the move to quaterly changes would suit energy firms more than consumers.
The price cap’s existence is legislated to run until 2023, but the government has indicated it could be extended.
Ofgem is also 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?
The Ofgem price cap is currently set at £1,971 for people on variable tariffs who pay via monthly direct debit.
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.
The next price cap announcement is scheduled to be announced in August and will come into effect in October for three months.
Another cap will then be introduced from January 2023 and will run for another three months.
Given the Russia-Ukraine war and the subsequent sanctions against Vladimir Putin’s regime, as well as Moscow’s own threats to cut the West off from its energy, the next cap is set to soar.
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.
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.
In May, Ofgem boss Jonathan Brearley said the cap could jump to “in the region of £2,800” in October - a rise of more than 42%.
However, this figure now appears to be well short of the mark.
A new forecast from Cornwall Insight - an energy consultancy that has so far correctly predicted how the cap will rise - predicts it will reach £3,582 in October and £4,266 in January.
These figures equate to respective rises of 82% and 116% compared to the current limit.
“While our price cap forecasts have been steadily rising since the summer 2022 cap was set in April, an increase of over £650 in the January predictions comes as a fresh shock,” said Craig Lowrey, principal consultant at Cornwall Insight.
“The cost-of-living crisis was already top of the news agenda as more and more people face fuel poverty – this will only compound the concerns.
“Many may consider the changes made by Ofgem to the hedging formula, which have contributed to the predicted increase in bills, to be unwise at a time when so many people are already struggling.”
Another energy consultancy, Auxilone, has predicted an even steeper rise in the price cap.
It says energy bills could hit £3,628 (84% higher) in October, £4,538 (130% higher) in January and then £5,277 (168% higher) in April.
However, it appears likely further intervention is likely from the government.
The frontrunner to be the next Tory Prime Minister - Liz Truss - has said she will introduce more targeted support for vulnerable households, with her allies suggesting she will scrap the £400 universal energy bills discount.
Meanwhile, Sir Keir Starmer has said a Labour government would freeze the energy price cap.
What have MPs said about Ofgem price cap?
A report published in July by MPs who sit on the Business, Energy and Industrial Strategy committee has described the price cap as out-of-date.
It urged the government to consider abandoning the limit, and to replace it with a discounted social tariff for the most vulnerable households.
“We were told by a number of witnesses, ‘if you think things are bad now, you’ve not seen anything yet’,” committee chair Darren Jones said.
“This winter is going to be extremely difficult for family finances and it’s therefore critical that public funds are better targeted to those who need it the most.”
It has since been backed by Craig Lowrey from Cornwall Insight, who said the cap “is not working for consumers, suppliers or the economy”.
The BEIS committee report also criticised Ofgem and the government for their response to the energy bills crisis.
It accused the energy regulator of “incompetence over many years”, which allowed poorly run and backed companies to start energy companies.
This “negligent” behaviour led to the failure of 30 suppliers when energy prices began to soar from late 2021 onwards, the MPs said.
Ofgem said the massive gas price spike “would have resulted in market exits under almost any regulatory system”, but admitted its previous regime was “not robust enough” and this contributed to some suppliers failing.
Meanwhile, the government was criticised for allowing the energy bills crisis to ‘race ahead’ of it.
It pointed out problems with Rishi Sunak’s support packages - including the fact that some payments would go to people with second homes.
“To prevent millions from dropping into unmanageable debt it’s imperative that the support package is updated and implemented before October, when the squeeze will become a full-on throttling of household finances and further tip the economy towards recession,” the report said.
The government said: “No national government can control global inflationary pressures; however, we have introduced an extraordinary package of support to help households.”