What is the Energy Price Cap and How Does it Work in the UK?

The energy price cap is a key policy in the UK aimed at protecting households from excessively high energy prices. It limits the amount energy suppliers can charge for each unit of energy (measured in kilowatt-hours, kWh) to ensure that prices remain fair, especially in times of market volatility. Introduced by Ofgem, the UK’s energy regulator, the cap is designed to prevent energy suppliers from setting unfair prices, ensuring millions of homes pay a reasonable amount for gas and electricity.

However, it’s important to note that the energy price cap doesn’t cap your total bill—it caps the price per unit of energy. This means your total bill will still vary based on your energy usage.

Why Was the Energy Price Cap Introduced?

The energy price cap was introduced in January 2019 in response to concerns that many households were overpaying for energy, particularly those who hadn’t switched from default tariffs (standard variable tariffs). These default tariffs were often much more expensive than fixed-price deals, but many people stayed on them due to inertia, lack of awareness, or confusion over switching providers.

The cap aims to:

1. Protect vulnerable consumers who may not switch tariffs regularly.
2. Encourage competition in the energy market by preventing suppliers from taking advantage of inactive customers.
3. Provide price stability in times of extreme energy price fluctuations.

The cap ensures that households on default or standard variable tariffs are charged a fair price that reflects wholesale energy prices, operational costs, and a reasonable profit margin for suppliers.

How Does the Energy Price Cap Work?

1. Capping the Price per Unit of Energy

The energy price cap limits the amount suppliers can charge per unit of electricity (kWh) and gas (kWh), as well as standing charges (a fixed daily fee you pay for maintaining your energy connection). However, the cap doesn’t restrict how much you pay overall. Your energy bill will still depend on how much energy you use. If you use more energy, your bill will increase, even though the price per unit is capped.

2. Review and Adjustment

Ofgem reviews the energy price cap every three months (from October 2022), adjusting it to reflect changes in wholesale energy prices, the costs of supplying energy, and any government policies that may impact the market. For example, during periods of rising wholesale energy prices, the cap is likely to increase, reflecting the higher costs energy companies face. Conversely, if wholesale prices fall, the cap is reduced.

3. Different Price Caps for Different Regions and Tariffs

The energy price cap is not uniform across the UK. It varies by region and payment method:

• Regions: There are variations in the cap across the UK based on local distribution costs and other factors.
• Payment Methods: Customers paying by direct debit typically benefit from a lower cap, while those on prepayment meters or paying via standard credit (paying on receipt of bills) usually face a slightly higher cap.

4. Standard Variable Tariffs vs Fixed-Rate Tariffs

The cap applies to households on standard variable tariffs (SVTs) and default tariffs. These are the rates customers are moved to when their fixed-rate deal ends or if they haven’t actively switched to a competitive tariff. Fixed-rate tariffs, where the price per unit is locked in for a set period, are not subject to the price cap. Click here to learn more about different tariffs with Octopus Energy.

5. The Cap for Prepayment Meters

A separate price cap also applies to prepayment meter customers, who often have less flexibility when choosing tariffs and are typically considered more vulnerable. Prepayment meter users must top up their energy in advance, and historically, they have faced higher costs, but the cap limits how much suppliers can charge for energy via prepayment.

What Does the Energy Price Cap Cover?

The energy price cap covers several factors related to the costs suppliers face, including:

• Wholesale energy costs: The largest component, reflecting how much suppliers pay for gas and electricity on the wholesale market.
• Network costs: Costs for maintaining and operating the national gas and electricity distribution systems.
• Operating costs: Costs that suppliers incur to run their business, such as billing and customer service.
• Policy costs: Contributions to government schemes promoting renewable energy and reducing carbon emissions.
• Profit margin: A controlled margin for energy suppliers, set at a reasonable level to ensure stability in the market.

How Is the Energy Price Cap Calculated?

Ofgem uses a formula that incorporates the above factors to calculate the energy price cap. The calculation ensures that suppliers can cover their costs while making a fair profit, but without overcharging consumers. The cap takes into account:

1. Wholesale energy prices: The cost of buying gas and electricity on the open market.
2. Network costs: The price for delivering energy through gas pipes and electricity cables.
3. Environmental and social obligations: Costs related to government schemes like the Warm Home Discount or energy-efficiency programs.
4. Supplier operating costs: The cost of running a supply business, including customer service and infrastructure.
5. VAT: A 5% VAT rate applied to energy bills.

How Often Is the Cap Updated?

Initially, the energy price cap was reviewed twice a year, with adjustments made in April and October. However, in 2022, due to unprecedented volatility in wholesale energy prices, Ofgem decided to review the cap every three months. This quarterly review allows the cap to respond more quickly to changing market conditions and ensures that the cap reflects the real costs of energy supply more accurately.

The next scheduled review adjusts prices for the following three months. For example, the October adjustment would set prices for October to December.

What’s the Current Energy Price Cap?

As of October 2023, the energy price cap for a typical household paying by direct debit is around £1,923 per year. However, this figure can vary based on usage, tariff type, and region. The cap is typically expressed in terms of what an average household using a certain amount of gas and electricity would pay annually.

It’s important to understand that the price cap figure often quoted in the media (like £1,923) is not an absolute cap on your bill. If you use more energy than the typical household, you will pay more. Conversely, if you use less energy, your bill will be lower than the cap figure.

This cap is likely to change every three months, please click here for the most up to date information directly from Ofgem [External Link].

The Energy Price Cap and Market Volatility

In 2022 and 2023, the energy price cap saw significant increases due to spikes in wholesale gas prices, driven by global events like the war in Ukraine and supply chain disruptions. This led to sharp rises in energy bills for UK households. In response, the UK government introduced support measures such as the Energy Price Guarantee (EPG) [External Link] to temporarily subsidize energy costs for consumers.

The energy price cap continues to be an important safeguard, ensuring that suppliers cannot raise prices arbitrarily even during volatile market periods.

How Can Consumers Benefit from the Energy Price Cap?

1. Stay on Default Tariffs: If you don’t want to switch to a fixed-rate deal, being on a default or standard variable tariff means you are protected by the cap.
2. Monitor Changes: Keep an eye on quarterly updates from Ofgem to understand how your energy costs might change.
3. Consider Fixed Deals: Depending on the market, fixed-rate tariffs can sometimes offer a better deal than the capped price, so it’s worth comparing.
4. Energy Efficiency: Regardless of the cap, reducing your energy consumption through energy efficiency measures (like upgrading insulation or using efficient appliances) can lower your bill.

Final Thoughts

The energy price cap plays a crucial role in protecting UK households from soaring energy prices, particularly during periods of market volatility. While it doesn’t limit the total amount you pay, it ensures that energy prices remain fair and reasonable, particularly for those on default tariffs. By understanding how the cap works and keeping track of quarterly updates, consumers can make informed decisions about their energy use and tariff options.