Ofgem lowers UK retail cap as wholesale energy prices fall

Author: Christopher Somers

2019/08/07

LONDON (ICIS)--Bearish UK wholesale energy prices mean that the price cap on default retail electricity and gas prices will fall by £75 per year to £1,179 annually from October, regulator Ofgem said on Wednesday.

The level of the cap for customers using a pre-payment meter is also set to fall by £25 to £1,217 per year.

The retail price cap, which is a maximum price suppliers can charge end consumers, impacts the hedging strategies of UK power and gas suppliers.

Companies are incentivised to follow a purchasing strategy that matches the way the regulator assesses the cap in an effort to avoid costs in excess of the wholesale element of the charge.

WHOLESALE COSTS TUMBLE

Ofgem previously raised the level of the cap in April, citing increased wholesale energy prices as the key factor in its decision.

The regulator on Wednesday said that falling wholesale energy prices were the main reason for its move to lower the price cap from October.

“Wholesale energy prices have significantly fallen between February and June 2019,” Ofgem said. “A combination of low demand during the winter, strong gas supply and relatively healthy storage levels have pushed down wholesale prices, resulting in the reduction of both caps.”

The ICIS Power Index (IPI) analysis, which was released in April, correctly predicted that the regulator would take the decision to reduce the cap, given the selloff seen in wholesale gas and power contracts earlier in the year. This bearishness was maintained over much of the summer.

As part of its methodology, Ofgem uses a ‘6-2-12 semi-annual’ rule to calculate weighted average wholesale energy costs.

This model involves a six-month observation period of daily index values for the period before the cap period, a two-month lag to allow the level to be announced and a forward view of contracts for 12 months from the start of the cap.

The regulator uses the midpoints of the front six quarterly NBP gas contracts and the front three baseload and peak UK power seasons as assessed by ICIS.

When Ofgem reassessed the cap for the period from 1 October, it looked at wholesale prices between 1 February-31 July 2019.During this period prices were markedly lower than between 1 August 2018-31 January 2019, when the previous summer cap level was assessed.

The cap calculation also includes other costs, such as allowances for network charges as well as costs associated with environmental and social schemes.

OUTLOOK

The default price cap is due to remain in force until 2023 at the latest.

The level of the cap will next be reassessed in time for the next summer period, which will begin in April 2020.

Movement on UK wholesale energy markets will be key in determining the new level of the cap. Prices could fall further if Britain is subjected to an LNG influx similar to that seen last winter, which may lead to another reduction in the retail price cap.