Ofgem published a working paper on its benchmarking approach for the operating cost review

Ofgem published a working paper in October 2023 on its benchmarking approach for the operating cost review, part of its wider review of the operating cost allowances in the energy price cap¹. The paper set out the choice between maintaining a cap with a high efficiency expectation, which maximises customer price protection, and seeking alternative primary outcomes¹.

The operating cost allowance covers a supplier's own costs of retailing energy, such as call centres and IT systems, and excludes the cost of buying energy, meeting environmental and social obligations, and network charges¹. Operating costs account for up to 21% of the overall bill in a given cap period and are spread across three components: the operating cost allowance itself, the payment method uplift for Standard Credit and prepayment customers, and the Smart Meter Net Cost Change¹. The review covers four areas: core operating costs, debt-related costs, smart metering costs and pass-through industry charges¹.

Ofgem set a stringent operating cost benchmark in 2018 at lower quartile minus £5, to focus on customer protection and incentivise suppliers to make efficiency improvements¹. The consultation document records that Ofgem received feedback from suppliers in response to the October 2023 benchmarking working paper¹. It also states that Ofgem has followed a hybrid approach in the request for information issued in July 2023, and in a second draft request for information issued on 18 April 2024¹.

The consultation document, published on 14 May 2024, sets out the review and its options. It says:

"We are consulting on our review of the operating cost allowances in the cap, which includes core operating costs, debt-related costs, smart metering costs and pass-through industry charges."

The document also records changes to how often the cap is updated. From October 2022, Ofgem changed from six-monthly cap updates to quarterly cap updates, and in August 2022 it updated Standard Licence Condition 28AD and Annex 2 of the licence conditions to reflect that change¹. A temporary debt-related cost adjustment known as "Float" was implemented in April 2024¹. Ofgem introduced a temporary adjustment of £31 to the cap from cap period 12a (April 2024 to June 2024) for 12 months, with the intention of delivering a true-up process in April 2025 alongside this review¹. The document also proposes to use the current model to set the allowance between October 2024 and March 2025 without carrying out an update¹.

Why it matters for households

The operating cost allowance is one of the components that makes up the price cap, which Ofgem says currently protects 29 million customers on standard variable and default tariffs¹. Because operating costs are the costs suppliers have most control over, the benchmark Ofgem sets affects how much of a household's bill reflects efficient retailing rather than inefficiency¹. Operating costs are also the second largest single contributor to the standing charge, after network costs, and Ofgem is examining whether these costs should continue to be allocated to the standing charge or whether a unit-rate approach could be more appropriate¹. That allocation choice matters for a home's energy independence because it changes how much of a bill is fixed regardless of how much energy is used, and how much varies with consumption. The review also covers debt-related costs, which affect the costs suppliers recover through bills, and smart metering costs, which relate to the rollout of meters in homes¹.

What happens next

The consultation closed at 11:59 pm on 14 June 2024¹. Ofgem said it intends to issue a decision in February 2025, which should allow it to implement any updates to the operating cost allowance in April 2025¹. It expects to implement any decisions from the review for the April 2025 cap period¹. Ofgem said it would publish non-confidential responses alongside a decision on next steps on its website¹.

Sources1 cited

1. Energy Price Cap: Operating cost allowances review, consult.ofgem.gov.uk