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What are the reasons behind the energy price cap?

Posted by Caitlin Latimer on 3 May 2019 at 9:57 am

The recent price cap came into effect on 1 January 2019 to protect customers on a variable tariff and was supposed to be saving around 11 million people on average of £76 per year on their energy bills. However the cap has since been reviewed by Ofgem and from April onward the cap will be increasing due to a rise in wholesale costs. As a result of this big energy suppliers are expected to raise prices by £117, eliminating the savings that were originally predicted when the cap first came into effect.

If a rise in the wholesale energy prices is the cause of the price cap, what exactly is causing the rise in energy rates?

Let’s begin with where our energy actually comes from, approximately 80% of the country’s heating and 35% of electricity are generated from natural gas. According to Ofgem (2018), wholesale costs make up 36% of the average household's dual fuel energy bill – which is the largest proportion. The next largest contributors include network costs (25%), operating costs (18%) and then environmental and social obligations (10%). Consequently, the wholesale cost of gas alone could have a significant impact on our energy bills.

Despite our great reliance on gas to heat and fuel our county, the UK only produces 45% of its own wholesale gas from the North Sea. However the decline in North Sea Oil and Gas production has meant the UK is becoming increasingly more dependent on imports from European sources - primarily Norway (21%) & Russia (35%).

As well as a growing reliance on foreign gas supplies, there are other variables that can cause the wholesale rate of gas to increase. These can include (but are not limited to). . .

Oil Costs

Gas and oil contracts are often combined and the prices affect each other, so if the cost of oil goes up it can increase the cost of wholesale gas as well. Oil prices have been fluctuating very regularly over the past few months and were at their highest in early April 2019.

Recent Weather

Due to recent extreme weather, notably the ‘Beast from the East’, it has caused gas shortages and then price spikes as a result for the high demand for heating. During the summer periods the gas storage stock would normally start to replenish, however the following summer Europe was then hit by a heatwave which resulted in low wind power output and hydropower levels also resulting in a higher demand for gas.

Infrastructure

The low supply of gas has also been accompanied by the UK’s biggest gas storage facility, the Rough site, recently closing down due to safety concerns and being uneconomic.

Brexit

Two weeks before the Brexit announcement resulted in the wholesale electricity price rise by 20%, since then prices have fluctuated but have risen back at those levels again. Brexit will create further uncertainty as it is unclear how gas will be moved through interconnectors (pipes that carry natural gas between the UK and Europe) if the UK leaves the EU Internal Energy Market.

However despite the price cap being raised recently as a result of wholesale rates, energy experts and Ofgem are expecting rates to start falling which could result in a lower cap near the end of the year.

My advice is to stick to fixed rate tariffs unless you feel that you have a good enough understanding of the energy market, or only go on a variable tariff with an energy supplier that has no exit fees so you can switch to a new tariff or supplier when necessary.


References

https://www.theguardian.com/business/2019/feb/07/energy-bills-to-rise-by-more-than-100-pounds-for-15m-households-as-price-cap-lifted

https://uk.reuters.com/article/uk-britain-gas-analysis/soaring-british-winter-gas-prices-point-to-energy-price-cap-increase-idUKKCN1M11YW

https://www.uswitch.com/gas-electricity/guides/wholesale-gas/

https://oilprice.com/Energy/Energy-General/World-Bank-Warns-Of-Extreme-Volatility-In-Oil-Markets.html

https://www.bbc.co.uk/news/topics/cmjpj223708t/oil

https://www.businesselectricityprices.org.uk/retail-versus-wholesale-prices/

http://www.ukerc.ac.uk/news/uk-government-must-provide-road-map-for-gas-after-brexit.html

https://www.ofgem.gov.uk/data-portal/breakdown-dual-fuel-bill

https://www.bbc.co.uk/news/business-46720908

 

Related blogs

Advice on switching energy suppliers: an insider's scoop (part 1)

Advice on switching energy suppliers (part 2)

Smart switching: will it transform the ways we hunt for cheaper energy bills?

If you have a question about anything in the above blog, please ask it in the comments section below.

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