Ofgem has begun a review of suppliers' wholesale costs for default tariff customers, covering the period October 2022 to September 2023, which the regulator describes as cap periods 9a to 10b1. In July 2023 the regulator set out the case for and scope of the workstream in an open letter, and in August 2023 it sent a final Request for Information (RFI) to all suppliers in scope, asking those with at least 100,000 default tariff customer accounts to provide data and evidence on the wholesale costs they incurred1.
The review will consider whether an adjustment to the cap is appropriate, in either direction, and whether the wholesale allowances continue to reflect the efficient costs a notional supplier may incur1. Ofgem said its initial analysis suggested that, on average, realised costs may potentially have been lower than the provided allowance over the period1. The data, collected from 11 suppliers representing 96% of the retail market, showed a wide variety of wholesale costs relative to allowances, with some suppliers appearing to have experienced costs below the level assumed in the cap and others higher3.
Ofgem set out three principles to guide its decision making: protection of customers; that any adjustment should be appropriate across suppliers; and that it would be more likely to adjust where costs or benefits resulted from external factors rather than suppliers' commercial choices1. For an adjustment to be made in either direction, the difference between costs and allowances must be material and systematic, assessed by benchmarking1.
"Wholesale costs account for the largest portion of a customer's bill."
The cap's wholesale assessment includes a core direct fuel allowance, estimated from forward contracts for electricity and gas measured over an observation window, and additional direct fuel allowances covering shaping and imbalance costs, transaction costs, additional risk and uncertainty set at 1% of direct fuel costs, and unidentified gas and electricity transmission losses1. The additional direct fuel allowances are indexed as a fixed percentage of direct fuel costs rather than recalculated1. The review will also consider the recovery period for backwardation costs, introduced in Ofgem's August 2022 decision on changes to the wholesale methodology with a six-month recovery period1.
Why it matters for households
Wholesale costs are the largest single contributor to customers' bills, so whether the energy price cap allowance for them matches what suppliers actually paid feeds directly into the default tariff rate that households on standard variable and default tariffs pay1. The cap is set under the Domestic Gas and Electricity (Tariff Cap) Act 2018 and applies to a notional efficient supplier, not to each company's own circumstances, so an adjustment would move the cap level for all default tariff customers rather than for individual households1. Ofgem has said it does not need to set the cap at a level that would ensure all suppliers recover their costs1. For a household's energy independence, the practical effect is on the standing default rate available if they do not switch, and on the financial resilience of the suppliers serving them.
What happens next
Ofgem rescheduled its intended follow-up consultation from late September to late November or early December 2023, which also moves the implementation date of any adjustment, should one be decided, from January 2024 to April 2024 at the earliest1. The regulator said the change in timescales would allow it to consult directly with suppliers on the information they provided in the RFI1. It also carried out a putback process, giving individual suppliers its analysis of their data before setting out minded-to positions, and said it did not see it necessary to implement a confidentiality ring in addition1. Ofgem invited views on its framework by close of business on Monday 23 October 20231.
Sources3 cited
- Review of additional wholesale costs in the default tariff cap - update, ofgem.gov.uk
- Energy price cap wholesale adjustment decision, ofgem.gov.uk
- Energy price cap wholesale costs review, ofgem.gov.uk