The energy price cap examined


The head of one of Britain’s biggest utilities has called for the energy price cap to be abolished to prevent soaring wholesale gas prices from triggering an “absolute massacre” of suppliers.

Scottish Power chief executive Keith Anderson warned of a “significant risk” that the retail gas market could shrink to “just five or six companies” amid the ongoing crisis, which has already resulted in the collapse of more than a dozen UK suppliers since August.

Without intervention, Anderson told the Financial Times (FT), “we are in danger of just sleepwalking into an absolute massacre”.

Ignacio Galan, CEO of Iberdrola, which owns Scottish Power, told the BBC: “The price cap decision was made in a very particular situation, to protect the consumer. But when the situation changes, it doesn’t work.”

Price cap 

Wholesale gas prices have rocketed in recent months amid a surge in global demand as the world emerges from the pandemic.

But the UK’s energy suppliers have been unable to pass on the extra cost to customers as a result of the energy price cap, an instrument put in place by the energy regulator, Ofgem, to protect consumers from excessively expensive bills. 

Introduced in 2019, the cap sets the maximum price that energy companies can charge per kWh of gas and electricity, known as the unit rate, as well as the cost of getting power into your home, known as the standing charge.

It serves as a cap on only the most expensive tariffs, and is designed to protect “those who are unaware of or are unsure of how to switch to a new deal or provider in order to save money”, the i news site said.

Complex calculations

Ofgem sets the price cap based on a “broad estimate” of how much it costs a supplier to provide gas and electricity services to a customer, explained The Telegraph.

The calculation is made up of “wholesale energy costs, network costs such as maintaining pipes and wires, policy costs including government social and environmental schemes”, the paper added. “Operating costs, such as billing and metering services, and VAT”  are also thrown into the mix.

It also applies to customers on a standard variable tariff, meaning that if consumers have never switched energy firms, or switched more than a year ago, they have most likely defaulted to the energy company’s standard tariff. 

The energy price cap is reviewed twice a year, with changes taking effect on 1 October and 1 April. This year, the energy price cap has already risen twice, rising to £1,138 from 1 April, followed by a 12% increase on 1 October to £1,277. The second increase saw it reach its “highest point ever”, i news said.

The increase is mostly due to rising wholesale energy prices, and so Ofgem has allowed energy companies to charge higher prices.

‘Massive burden’

Scottish Power chief Anderson has said the energy crisis has “exposed deep flaws” in the way the energy market is structured and that there had been “serious failures” from Ofgem, the BBC reported.

He told the broadcaster that due to the collapse of dozens of energy companies, “well run” companies were being forced to take on millions of customers at a loss, which could place a “massive burden” on the energy sector for the next 12 to 18 months.

He added that suppliers would make a loss of £1,000 when consumers previously on fixed price deals were brought over to new suppliers.

“Every customer taken on at the price cap means £1,000 of cost,” he told the broadcaster. “We estimate the total cost to the industry of between £4bn and £5bn. The risk is that you will end up going back to the big five or the big six.”

Initially, Anderson told the FT that the energy cap should be adjusted up to four times a year. But he appears to have revised this position, later telling the BBC that the cap should be “abolished”.

Instead, he proposed setting a “special tariff” for those in fuel poverty, which would mean the most affluent customers would pay more, touting it as a more “progressive” way to regulate the industry.

Ofgem has indicated it could review how the energy price cap works in light of the wholesale gas crisis, which could result in reform of “how it is calculated and how frequently it can be adjusted”, according to The Telegraph.

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