The next price cap coming into effect in October will include an additional £41 uplift to reflect wholesale costs incurred by suppliers as a result of customers shifting onto standard variable tariffs, Ofgem has announced.
The regulator said the adjustment is necessary to prevent further supplier failures, the costs of which would be borne by consumers.
The combination of soaring energy prices and the price cap on default tariffs has meant suppliers are typically no longer offering cheaper fixed price tariffs. Customers have therefore shifted to standard variable tariffs (SVTs) en masse as fixed price contracts come to an end.
Ofgem said there are now 24 million customers on SVTs – an increase of 13 million since the price cap was introduced in 2019. Suppliers have had to purchase energy to cover this unexpected SVT demand at prices above the wholesale cost allowance in the cap.
Back in February, Ofgem revealed that the current price cap of £1,971 that came into effect in April would include a £61 uplift to reflect additional wholesale costs incurred by suppliers during period seven (October 2021 to March 2022).
The regulator said this would include £41 for unexpected SVT demand – £18 for electricity and £23 for gas – as well as £12 for additional shaping and imbalance costs and £8 for exceptional backwardation costs. It said this uplift would apply to both period eight (April to September 2022) and period nine (October 2022 to March 2023).
At the same time, Ofgem proposed to start updating the price cap on a quarterly basis to reduce the time lag between market prices and their reflection in the cap.
Following an initial consultation, the regulator stated this as its minded-to position in May. It also revealed it was considering a further adjustment to the price cap to cover additional wholesale costs incurred by suppliers during periods eight and nine.
Ofgem has now confirmed its intention to move ahead with the shift to a quarterly price cap and apply a £41 uplift to reflect unexpected SVT demand during period eight. It said the upwards adjustment will apply for 12 months, starting in October.
However, the regulator has decided against raising the cap to cover the costs of unexpected SVT demand during period nine after concluding they are not likely to be sufficient to justify an adjustment. Despite the decision to update the price cap on a quarterly basis, Ofgem still defines the price cap periods as covering the six months of each season – summer and winter. It said the £41 uplift will not apply to the price cap for prepayment meter customers.
Ofgem has also decided against applying an adjustment to cover additional shaping and imbalance costs for periods eight or nine. The regulator said it has not seen convincing evidence that shaping and imbalance costs – the former incurred when suppliers refine their trading positions to meet demand – have materially differed from the existing allowance during period eight, or will do during period nine.
It has, however, decided to make an additional upward adjustment of £6 to cover exceptional backwardation costs incurred during period seven after reviewing further evidence submitted by suppliers. This adjustment will also apply for 12 months, starting in October.
Furthermore, Ofgem has also confirmed its decision to update the price cap methodology to include a specific allowance for backwardation costs.
To smooth out seasonal fluctuations in energy prices, allowances for wholesale costs are set based on forward prices over a 12-month reference period starting at the beginning of the relevant price cap. This results in the under-recovery of costs during the winter – referred to as backwardation costs – and the over-recovery of costs during the summer – referred to as contango benefits.
The price cap methodology assumes that these backwardation costs and contango benefits roughly offset each other over prolonged periods. However, Ofgem said this assumption does not necessarily hold during period of high price volatility.
It is therefore introducing an ex-ante allowance for exceptional backwardation costs that would not be recovered through contango benefits. Starting in October, backwardation costs above a £9 deadband – £4 for electricity and £5 for gas – will recovered over six months following the start of the relevant price cap.
This is a change from the regulator’s minded-to position in May of a 12-month recovery period.