Ofgem published its decision on 23 June 2022 to change how the Contract for Difference (CfD) allowance is calculated in the default tariff cap. The regulator will remove the £0/MWh floor from the CfD allowance by replacing the Low Carbon Contracts Company's (LCCC) published Interim Levy Rate (ILR) with an expected levy payment, calculated using LCCC CfD payments forecasts and energy demand1.
The decision follows an April 2022 consultation on amending the CfD allowance from cap period nine onwards, to which five suppliers responded1. Ofgem also decided not to introduce a reconciliation of the CfD allowance against outturn costs1.
"We have decided to remove the £0/MWh floor from the CfD price cap allowance by replacing the LCCC's published ILR in our methodology with an expected levy payment, calculated using LCCC CfD payments forecasts and energy demand."
The cap, introduced on 1 January 2019, currently protects 23 million households on standard variable and default tariffs1. Since its introduction, CfD costs have represented £25 per customer at typical consumption, around 2% of the total cap value1. The ILR has typically been positive, reflecting higher prices paid to CfD generators than wholesale prices, but for cap period nine the LCCC forecast negative payments from suppliers as wholesale prices rose, implying a negative ILR. The ILR floor of £0/MWh meant the methodology would not reflect those negative CfD costs1.
In the consultation, Ofgem forecast that the amendment would make the cap £12.51 per customer lower for cap period nine. After the LCCC updated its forecast for Q2 2022 on 12 May, Ofgem recalculated the benefit as £11.44 per customer1. Ofgem also confirmed that generator delays would result in a £2.5 to £4 per customer additional cost impact in cap period eight1. Benchmark consumption values of 3.1MWh per customer per year are applied1.
| Item | Figure |
|---|---|
| CfD costs per customer since cap introduction | £25 (around 2% of total cap value) |
| Forecast cap reduction, cap period nine (consultation) | £12.51 per customer |
| Recalculated benefit after 12 May LCCC forecast | £11.44 per customer |
| Generator delay cost impact, cap period eight | £2.5 to £4 per customer |
Why it matters for households
The CfD allowance is one component of the price cap that Ofgem sets for default tariffs. Under the CfD scheme, renewable generators receive a fixed price for their energy, and suppliers incur costs or benefits depending on whether wholesale prices are above or below that fixed price1. Payments to generators are funded by a statutory levy on licensed electricity suppliers, the Supplier Obligation Levy, invoiced daily on a supplier's gross eligible demand1.
When wholesale prices are high, suppliers can receive payments rather than make them. The old methodology, with its £0/MWh floor, could not pass that benefit through to the cap, so the allowance did not reflect the lower cost. Removing the floor means the allowance can be negative where the LCCC forecasts negative payments, so the cap can better reflect the costs and benefits suppliers face1. Ofgem said not removing the floor could lead to material and systematic impacts1. The decision concerns the method for setting the allowance, not the allowance value itself1.
What happens next
The new CfD allowance methodology will apply from 1 October 2022 onwards1. Ofgem said a decision on how frequently the allowance will be updated will be taken following feedback on its statutory consultation on changes to the wholesale methodology1.