Energy crisis: what is the ceiling price and why will bills rise so sharply? | Economic news

Energy regulator Ofgem will today unveil the new price cap level that applies to average dual fuel bills.

The cap, which will apply from April 1 to September 31, is set to rise by around 50% to £2,000 a year, a record increase largely driven by wholesale gas prices.

With the cost of living rising on many fronts, energy prices have become a key political and practical issue for millions of households.

What is the ceiling price?

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The energy price cap sets the maximum amount that can be charged to customers on a variable dual-fuel tariff for typical gas and electricity usage during a six-month period.

Introduced in 2019, it is based on a number of factors including the wholesale cost of electricity over the previous six months.

Ofgem estimates that 22 million households currently benefit from variable rates, the inflated number of around 2 million customers whose providers went bankrupt last year.

Last October, the price cap rose by 12% to £1,277, but analysts predict it will rise by around 50% this time, adding up to £700 to bills due to a sustained rise wholesale gas prices.

The price cap is not the maximum anyone can be charged – customers with high energy consumption will have higher bills – but rather reflects typical usage levels.

What makes up energy bills?

The cap is calculated on the basis of wholesale fuel prices plus a range of taxes and operating costs.

In the last price cap announcement, the bills were split as follows: 36% wholesale costs; 25.35% network fee; 18.62% operating costs; 15.33% environmental and social costs; VAT 4.76%; 2.24% other costs; 0.93% supplier pre-tax profit margin.

A sustained increase in wholesale gas prices is the primary driver of rising bills.

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“Extracting more gas is not a realistic strategy”

Why has the price of gas increased so much?

The price of natural gas is about four times higher than a year ago thanks to a combination of last year’s cold European winter which drained supplies; increased demand from Asia and China; and for gas-fired power generation that bridged the energy gap when renewable sources were unavailable during a relatively quiet summer.

What about other elements of a bill?

Environmental and social costs include projects to help decarbonize the energy supply, such as improving the insulation of customer homes.

There has been pressure from Tory backbenchers to reduce these so-called “green taxes” which are technically levied on electricity generation.

Social costs include schemes to help the most vulnerable customers, including the Warm Homes Discount (WHD) which offers a discount of around £140 to more than 1.5million people on particular benefits.

What is the impact of the price increase?

More than 20 suppliers went bankrupt last year because they could not meet the prices offered to customers while paying high wholesale prices.

Around two million customers have been transferred to other suppliers who have effectively taken them over with a combined loss of around £2bn, as the wholesale price of energy is above the current price cap.

These so-called Supplier of Last Resort (SOLR) costs are usually shared by all bill payers in the year they are incurred, but would add around £100 the following year.

What is the government doing to help?

Energy suppliers have been lobbying the government to provide support to customers and tackle what they say is a dysfunctional market since it became clear that the pass-through of higher prices was inevitable.

Talks have been going on for months but intensified last month with the takeover of the Treasury after initial negotiations with the Department for Business and Industrial Strategy.

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Energy boss calls for help on bills for poorest households

The Treasury is said to have drawn up a £6billion loan scheme which would see around £200 passed on as a rebate to all energy customers.

This would still leave an average raise of around £500 to all customers for the foreseeable future.

It is believed that the money would be loaned to suppliers to pass on to customers. Suppliers would then refund money from customer bills when gas prices drop by keeping the bills higher to cover the cost.

As of Wednesday evening, energy suppliers still did not know the details of the project.

The government says it wants to target aid to the most vulnerable and the WHD is expected to rise at least in line with existing plans to increase its value to £150 and reach three million people.

As the WHD is paid from customer bills, it is estimated that these changes will add £24 to the average bill unless the Treasury intervenes.

Reducing the 5% VAT rate has been all but ruled out by ministers and it remains unclear whether green levies will be resolved, perhaps by shifting their funding to general taxation.

An alternative commercial loan scheme, negotiated by suppliers with Barclays, to allow the costs of SOLR to be spread over several years, was reportedly approved by Ofgem last Wednesday to be vetoed the following day.

When will the prices go down?

Not anytime soon. Gas markets suggest prices will remain high for several years to come, not least because gas is the main transition fuel for economies around the world trying to transition from carbon-based power generation to renewables.

Based on current prices, analysts predict the next price cap review in October will see a further £400 increase, meaning government intervention may need to continue.

Richard L. Militello