Ofgem published a statutory consultation on 16 May 2022 setting out proposals to change the wholesale methodology used to set the default tariff cap, moving from six-monthly to quarterly cap updates1. The consultation followed an earlier consultation on 4 February 2022 and a call for input on adapting the price cap methodology for resilience in volatile markets, published on 15 December 20211.
The regulator confirmed its decision on 4 August 2022, stating it would proceed with quarterly updates, a reduced notice period and inclusion of backwardation costs in the wholesale methodology, to be recovered over six months1. Ofgem said the changes would take effect from 1 October 2022, with quarterly updates implemented from October 20221. The reduced notice period gives Ofgem five working days to calculate and publish the new cap level, followed by 25 working days for suppliers to notify customers and implement the new price level, a total lag of 30 working days between the observation period closing and the start of the cap1.
"We have decided to proceed with implementing quarterly updates, a reduced notice period and updating the wholesale methodology to include backwardation costs, to be recovered over six months."
Ofgem estimated that moving to quarterly updates would reduce volume risk by 74% compared with a six-monthly index1. On backwardation, costs above a deadband of £9 would be recovered over six months from the start of the corresponding cap period, a shortening from the 12-month recovery period in its minded-to consultation position1. The regulator said the Market Stabilisation Charge came into effect from 14 April 2022, and that it had set out its decision on the Contracts for Difference allowance methodology in the default tariff cap on 23 June 2022, transitioning to the 3-1-12 approach from 6 June 20221.
Ofgem said it had consented to suppliers of last resort making initial levy claims totalling £1.83 billion by December 2021, and that its assessment of the financial risk of supplier failure suggested costs could be significantly higher than the previous winter without measures to stabilise the market1. It also noted government support measures announced at the time, including a £400 grant towards energy for all households, a £650 one-off cost of living payment for around 8 million households on means tested benefits, and a £500 million increase and extension of the household support fund1.
Why it matters for households
The energy price cap sets the maximum a supplier can charge per unit of energy on a default tariff, so the frequency and method of its updates determine how quickly wholesale price movements reach household bills. Moving to quarterly updates means the cap level is recalculated every three months rather than every six, so changes in wholesale prices feed through to default tariff customers sooner, in both directions. The reduced notice period shortens the window between the observation period closing and the new cap taking effect, which Ofgem said allows more current wholesale price data to be incorporated into the wholesale cost allowance1.
The inclusion of backwardation costs addresses the gap between the index used to set the cap level and the way suppliers buy energy for their cap customers1. Ofgem framed the changes as reducing the risk of supplier failure and the mutualised costs that follow, which are ultimately borne by customers. For a household, the practical effect is that the cap level is set more often and on a methodology that reflects a different set of supplier costs, which changes how closely the cap tracks the wholesale market. The Ofgem decisions were made under the consultation process that governs how such rules are proposed and changed.
What happens next
Ofgem said it would announce the cap level for period 9a on 26 August 20221. The decisions take effect from 1 October 20221. Ofgem said it intended to keep the backwardation recovery period under review and to review its decisions once it had fully transitioned to quarterly updates and enough time had passed to evaluate the impact1.