How does the energy price cap work? Everything you need to know as price cap due to update every three months

Ofgem, the UK’s energy regulator, will make its latest announcement about the energy price cap on Friday, August 26, as experts expect another hike in the maximum amount households can be charged for their energy usage.

Earlier in August, Ofgem announced that the energy price cap will update every three months as household bills are expected to hit £4,200 in January.

The regulator confirmed the maximum unit rate companies can charge for gas and electric will be updated quarterly, rather than every six months.

The firm confirmed that “market conditions” have forced it to change the cap, which determines how much energy firms can charge their customers.

It warned that customers will face a “very challenging winter ahead” as new analysis from Cornwall Insight predicts that the price cap will rise to £3,582 per year in October and £4,266 a year from January.

The regulator said the change would go “some way to provide the stability needed in the energy market”, adding: “It is not in anyone’s interests for more suppliers to fail and exit the market.”

But, what is the energy price cap, what are the changes, and what does it mean for household bills?

Here’s everything you need to know.

What is the energy price cap?

Ofgem, which originally stood for the Office of Gas and Electricity Markets, is the independent regulator of the British energy market and is designed to ensure customers are protected as much as possible.

Therefore, a key part of its role is to set a limit – the price cap – on what energy firms charge customers on default, or standard variable, tariffs.

Variable tariffs have previously been more expensive than fixed-rate deals and people are often on these tariffs if they have never switched suppliers, a fixed term has ended or their supplier has gone bust.

Some 23 million households have their domestic energy bill governed by the price cap.

There is also a separate price cap for customers on prepayment meters.

On a standard energy bill, the price cap will govern the maximum standing charge and price per kWh of gas and electricity that your supplier can charge you.

What does Ofgem’s announcement mean?

The energy price cap was previously updated twice a year, meaning every six months the cap would rise or fall. Now, the cap will be updated every three months, or four times a year.

The cap was originally updated in April 2022, and the next update is expected in October 2022. After that, the next review was expected in April 2023, but it will instead take place in January 2023 and another in April 2023.

Ofgem chief executive Jonathan Brearley said: “I know this situation is deeply worrying for many people. As a result of Russia’s actions, the volatility in the energy markets we experienced last winter has lasted much longer, with much higher prices than ever before. And that means the cost of supplying electricity and gas to homes has increased considerably.

“The trade-offs we need to make on behalf of consumers are extremely difficult and there are simply no easy answers right now. Today’s changes ensure the price cap does its job, making sure customers are only paying the real cost of their energy, but also, that it can adapt to the current volatile market.

“We will keep working closely with the Government, consumer groups and with energy companies on what further support can be provided to help with these higher prices.”

How does the energy price cap work?

The energy price cap was first introduced in 2019, and it acts as a limit on what providers can charge for electricity usage, placing caps on how much the customer pays for electricity and gas (in pence per kilowatt hours) and the customer’s daily standing charge (the fixed amount you pay for energy, even if you don’t use any).

The cap is only applied to standard and default tariffs, however, meaning that customers on fixed-term energy deals can’t rely on Ofgem’s modification.

How is it calculated?

Ofgem bases the price cap on how much it would cost a typical energy supplier to provide energy for an average home.

It uses a raft of factors which impact upon energy bills in its calculations, as well as considering usage levels and market data across a given period.

Wholesale gas and electricity costs for suppliers and the network costs they have to pay, such as infrastructure, are key factors.

Ofgem also considers the operating costs and profit margin of suppliers.

Environmental obligations and taxes can also be considered as part of the price cap figures.

Why are energy prices increasing?

The recent surge in energy prices has been driven by wholesale prices, specifically the soaring cost of gas.

Gas prices on global markets have surged by as much as six-fold having leapt higher before the invasion of Ukraine.

Last year, countries in Asia and Europe used significant amounts of gas stocks during a long winter which helped to drive up prices while the reopening of economies also sparked higher energy usage.

More recently, the invasion of Ukraine by Russia has led to a restriction of Russian gas which has in turn pushed prices higher.

In the UK, very little gas is sourced from Russia but this has not shielded suppliers from the pricing impact across the rest of Europe, which typically sourced around 40% of natural gas from Russia.

What can customers do if they are worried about their rising energy bills?

Ofgem suggests contacting your supplier as soon as you can if you are worried about paying your energy bills or are in debt to your supplier.

Suppliers must work with you to agree on a payment plan customers can afford under Ofgem rules.

People can ask for more time to pay, access to hardship funds and payment breaks or reductions, under the potential options.

Some energy companies offer certain schemes, for example, if someone is making their home more energy-efficient or offering free boiler checks and upgrades.

Some people may also qualify for particular forms of help such as Winter Fuel Payments or the Warm Home Discount Scheme. Some charities may be able to offer grants.