Ofgem price cap to influence UK supplier hedging

LONDON (ICIS)–British energy regulator Ofgem expects its methodology for assessing the wholesale costs contributing to a new cap on UK gas and electricity retail tariffs to influence the hedging behaviour of suppliers.

The regulator announced details of the price cap on Thursday morning following powers granted by the UK parliament in July. This included  a detailed methodology behind the calculations Ofgem will use to assess wholesale costs contributing to the price cap, which will be adjusted every six months.

Ofgem admitted wholesale costs will be the most challenging aspect of setting the price cap, which will last until 2023 at the latest but could be removed sooner by the government.

“Suppliers have strong incentives to follow a buying strategy that matches the valuation given by the way we assess wholesale costs,” Ofgem said in the appendix on wholesale costs.

“This is to reduce the risk that they incur costs that exceed the allowance included in the level of the default tariff cap.”

Ofgem said it will use a “6-2-12 semi-annual approach” to calculate the weighted average wholesale cost of gas and electricity over a 12-month period.

This model involves a six-month observation period of daily index values in the lead up to the cap period, a two-month lag before the cap level is announced and a 12-month forward view of contracts delivering during 12 months following the start of the price cap.

The regulator will take the midpoint of the front six quarterly contracts, as assessed by ICIS, on the British NBP gas hub as its input for wholesale gas prices. The midpoint of the front three peak and baseload seasons, also assessed by ICIS, of the UK power market will do the same for wholesale power prices.

The wholesale costs methodology also accounts for network, administration and balancing charges incurred by stakeholders.

Ofgem said a new value for the wholesale index will be calculated in line with the price cap being updated twice a year.

Trade body EnergyUK’s chief executive Lawrence Slade warned the price cap will pose a ‘significant challenge’ for many suppliers.

A consultation on the proposed methodology will last four weeks. The regulator is aiming to confirm the cap level in November ready for it to come into force at the end of the year.