Domestic Energy Bills – What lies ahead in 2022?
We’re hearing a lot about the energy price cap – so what is it and what could it mean for our household energy bills over the rest of the year? Local energy consultant Dr Mark Earthey explains how the cap works and shares his forecasts for where prices could head next.
With the cost-of-living spiralling higher, driven mainly by energy prices, all eyes will be on energy regulator Ofgem as it prepares to announce the new domestic energy price cap for October 2022. Its official announcement is not due until August, but as the basis of its calculation is in the public domain, it is possible to forecast the level of the October price cap using available data.
How the price cap is calculated
The price cap is the maximum that energy suppliers can charge for their energy and is intended to prevent customers being overcharged. Back in February, energy consumers were rightly shocked when Ofgem announced a steep increase in the cap from £1,277 to £1,971. Up until that point, the Price Cap had been relatively stable, and energy suppliers had managed to keep their tariff prices well below it. The chart below shows the price cap’s history since its inception in 2018:
Ofgem calculates its price cap on the basis of:
- Energy costs, or the price of the energy required to produce the electricity, set by global energy markets;
- Non-energy costs, or the price of delivery through the network, plus operating costs, policy costs, VAT, profit margin, and a host of others.
The relative contributions of these components to the price cap can be seen in the chart. ‘Policy costs’ include the much-maligned ‘green levies’ which, among other things, partially fund the development of renewable energy. There are moves afoot to have these suspended, or even scrapped.
However, the biggest driver of the April 2022 price cap increase is the dramatic rise in wholesale energy costs (blue on the chart). These costs have doubled, from around £500 to over £1,000, far outweighing all the other cost increases combined. Furthermore, wholesale energy prices are set globally, and beyond the control of any single national government.
So, what is happening to wholesale energy prices?
Ofgem’s calculation takes an average of wholesale energy prices over a six-month period ahead of the start of the cap. This approach protects consumers from price spikes, but at the same time fails to pass on the benefits of price collapses. The graphs below for electricity and gas prices illustrate this point:
You can see that over the period 2018 – 2021, average prices used in the cap were fairly stable, but from July 2021, the averages increased, causing the April 2022 price-hike. Rolling these graphs forward into Q1 2022 does not offer many grounds for optimism:
The February/March price-spikes resulting from Russia’s invasion of the Ukraine look set to lift average wholesale energy prices well above those used in calculating the April 2022 price cap. Even taking recent price falls into account, Ofgem’s averaging methodology has locked in an increase.
So, what is the outlook for domestic energy bills from October 2022?
At Maitland Energy Consulting, our latest forecast for the October 2022 Price Cap is £2,600, over 30% higher than in April. This is not as high as some pundits forecast, mainly because we have used prices up to 18 May. Given we are nearly two-thirds of the way through the averaging period, there would have to be a prolonged price move up or down to shift the average much away from this value.
The dire conclusion is that energy poverty is likely to get worse before it gets better. It will be some time before wholesale energy prices return to their long-term averages, if they ever do. The Government’s hands are tied – a windfall tax could offer short-term relief, but doesn’t solve the structural flaw that UK energy prices are set primarily on global markets.
At the same time, it’s clear that suspending the green levies will make little difference to the final price to energy consumers. However, suspension would do lasting damage to the drive to renewable energy. The UK may have a low reliance on Russian gas, but certainly not a low reliance on global gas. A short-term ‘dash-for-gas’ would invite climate disaster, so a rapid switch to renewables has to be the right way forward.
STOP PRESS: On 16th May, Ofgem announced a public consultation into changing the frequency of adjustment to the Price Cap to enable consumers to benefit more quickly from falls in wholesale energy prices. This consultation closes in June, and it will take Ofgem most of the summer to evaluate its options. It is most unlikely that this consultation will impact the October price cap.
We can only hope that common sense prevails, and that Ofgem makes the price cap much more responsive to consumers’ needs. We must also insist that green levies are maintained, even increased, in real terms. The fairest way of doing this may be to fund renewables via general taxation, rather than extracting more money from the energy-poor. We owe this to our children and our planet.
Dr Mark Earthey is a local energy consultant with over 30 years’ experience in the UK and European electricity, gas, carbon, and hydrogen markets. He works closely with local government, and community energy projects such as Ovesco and Community Energy South, focusing on energy forecasting and sustainable generation. He is CEO of Maitland Energy Consulting Ltd.