Explained: What is the new energy price cap and why are costs rising?

Chancellor Rishi Sunak responding to Ofgem price cap rise on Thursday. (Photo: PA)
Chancellor Rishi Sunak responding to Ofgem price cap rise on Thursday. (Photo: PA)

The price of the gas and electricity that millions of households across Britain buy is going to spike by £693 after Ofgem reviewed its cap on energy bills.

It is likely to put pressure on households, especially those that are less well off who spend a higher proportion of their income on simply keeping their homes warm and lights on.

But why are energy prices rising, and what will the impact be?

Why has there been a surge in energy prices?

The main reason is the price of gas on global markets. Gas prices are around four times higher than they were a year ago, and they have been high for months.

Until now Ofgem's price cap has protected customers, but it is reviewed every six months, and will be changed in April to take into account the price surge.

There is not one single cause for the gas price rise, but people, companies and countries generally are having to compete with each other to buy up gas.

A year ago countries in Europe and Asia burned through a lot of their gas reserves to heat homes during the long winter.

They have therefore had to go back and buy gas to fill up again, which increases demand and pushes up prices.

READ MORE: Confirmed: 1.5m Scots households hit with record £693 a year energy bills rise

Demand is also high as the world comes out of successive lockdowns and businesses try to make up for lost time - many will need lots of gas for this.

Meanwhile, gas production is also lower, and the weather was less windy over the summer - causing more gas to be burned for electricity.

Between them, many of these factors have increased demand and reduced supply, a situation which will almost always lead to higher prices.

Are things going to get better?

That could depend on many issues.

Fortunately this winter has proved milder than it could have been, so less gas has been needed to heat homes.

But many experts still think it could be years before gas prices drop below their high levels.

Goldman Sachs thinks gas prices will remain at twice their usual level until 2025.

Meanwhile, on Wednesday the US announced it was sending 3,000 troops to eastern Europe, where Russia and Ukraine are gearing up for a potential war.

If there is a war, and the west places sanctions on Russia, this could push up gas prices further.

The UK only gets 3% of its gas from Russia - most of our gas is produced at home or pumped from Norway - but many European countries rely on Russia for their gas.

If supplies to Europe are disrupted in any way, this will push up prices in the UK too.

READ MORE: Scots braced for 50% rise in energy bills

What impact will this have on households?

Energy bills will go up, even if you are in the minority of people in the UK who lives in a home without gas heating or cooking facilities, as around 40% of the UK's electricity needs are still met by burning gas at power stations.

So both gas and electricity bills are likely to rise, although of course more so for gas bills.

Bills will be capped at the new rate between April and October.

It will mean another £58 on bills every month for the typical household.

Experts predict that bills could rise further, to more than £2,300 per year for the typical household in October.

What impact will this have on businesses?

Businesses are less heterogeneous than households, so different companies will be affected in different ways.

Most immediately, companies that supply energy to households have been squeezed for months.

More than two dozen of them have already gone out of business since September.

They have often promised to sell gas and electricity to customers at a fixed price for a year or sometimes longer.

READ MORE: Warning: 'Scots will die due to energy price rise'

When customers signed those contracts, the gas price was lower than it is today. Now the gas price has overtaken the contracts, leaving suppliers possibly having to buy gas for more than they can charge for selling it.

Some have taken out insurance by buying this gas a year ahead of time - these companies are generally fine at the moment. But others have not and are struggling to stay afloat.

For these suppliers, the new energy price cap will address this imbalance.

However, other businesses are also being hit, with many manufacturers relying on gas to run heavy machinery.

Ultimately many of the rises in gas prices for businesses are being passed on to customers, with inflation hitting 5.4% in the year to December.