Ofgem published a consultation on 14 May 2024 reviewing the operating cost allowances within the default tariff cap, the mechanism that currently protects 29 million customers on standard variable and default tariffs1. The consultation covers four areas: core operating costs, debt-related costs, smart metering costs and pass-through industry charges1. Responses are due by 11:59 pm on 14 June 20241.
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, which reflects the cost of serving a Direct Debit customer including metering, billing and payments, central overheads and amortised costs; the payment method uplift, covering the additional cost of serving Standard Credit and prepayment meter customers; and the Smart Meter Net Cost Change, which provides an allowance for the smart meter rollout1. Ofgem says operating costs are a key area of the cap because they are the costs suppliers have most control over, and because they can vary by customer type, so can influence variation in bills between customers1.
The review sits alongside other Ofgem workstreams on standing charges, debt and affordability, and future price protection1. Ofgem notes that operating costs are the second largest single contributor to the standing charge after network costs, and that it wants to explore whether these costs continue to be appropriately allocated to the standing charge or whether a unit-rate based approach could be more appropriate1. On debt, it says the operating cost allowance is the primary route through which it assesses and captures the costs suppliers incur to manage debt efficiently1.
"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 sets out several existing adjustments. 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. It also refers to the temporary debt-related cost adjustment known as the Float, implemented in April 20241. On benchmarking, Ofgem says that in 2018 it set a stringent operating cost benchmark at lower quartile minus £5 to focus on customer protection and incentivise suppliers to make efficiency improvements1. It cites a cost of capital from its EBIT decision of 12.26%1.
The consultation follows a working paper on benchmarking published in October 2023, a request for information issued in July 2023, a second draft request for information issued on 18 April 2024, and a call for input in May 20231. Ofgem also notes that in its February 2024 levelisation decision it said it could potentially consult on the levelisation of Standard Credit and Direct Debit debt-related costs1. The cap moved from six-monthly to quarterly updates from October 2022, with licence condition SLC 28AD and Annex 2 updated in August 2022 to reflect that change1.
Why it matters for households
The operating cost allowance is one of the building blocks of the price cap, so changes to how it is calculated feed through into the standing charge and unit rates that households pay. Because operating costs are the second largest contributor to the standing charge, how they are allocated matters for homes that use little energy, since a higher standing charge is paid regardless of consumption. Ofgem's question about whether a unit-rate approach could be more appropriate therefore bears directly on the split between fixed and per-unit charges.
Debt-related costs are also in scope. The allowance is the route through which suppliers recover the cost of managing customer debt, and Ofgem has made separate uplifts for these costs over time1. How debt costs are measured and allocated across payment methods affects the difference between what direct debit and prepayment customers pay. The consultation also covers smart metering costs, which are recovered through the SMNCC, and pass-through industry charges.
What happens next
Ofgem intends to issue a decision in February 2025, which it says should allow it to implement any updates to the operating cost allowance in April 20251. It expects to implement any decisions from this review for the April 2025 cap period1. In the meantime, Ofgem proposes to use the current model to set the allowance between October 2024 and March 2025 without carrying out an update1. Non-confidential responses will be published alongside a decision on next steps1.
Sources1 cited
- Energy Price Cap: Operating cost allowances review, consult.ofgem.gov.uk