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Don’t let the energy price cap fool you – higher prices are coming

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Back in August, we wrote about changes to the energy price cap, which was being lowered. In theory, this reduced bills for millions of homes, but it may inadvertently have put them off switching. Here’s why – and what you should do about it if you’re affected.

A reminder – what is the energy price cap?

The price cap is a limit on how much suppliers can charge you per unit of energy you use. It only applies to customers who are on a certain type of tariff, known as a ‘standard variable’ or ‘default’ tariff. Homes are placed on ‘standard variable’ tariffs if they don’t actively choose an alternative tariff. Because standard variable tariffs are usually much more expensive than other tariffs, the price cap was introduced in January 2019 to try to reduce the amount households on these tariffs were overpaying for their energy. 

How the price cap is set

The price cap is set by the UK energy industry regulator, Ofgem. Ofgem has to perform a juggling act, setting the cap at a level that is high enough to ensure suppliers don’t make a loss from the energy they sell, but low enough to ensure they’re not making excess profits at households’ expense.

This is made more complicated because the amount suppliers themselves are paying for the energy they sell on to us fluctuates a lot. As a result, a price cap that is set at a particular level may end up being financially unsustainable for suppliers if the amount they pay for energy rises. Equally, if the price they pay falls, their profits may increase.

To tackle this, Ofgem usually adjusts the price cap twice a year – once on 1 October and once on 1 April. The level of the price cap normally reflects the cost of the energy bought by suppliers in the preceding 6 months. This is because Ofgem assumes suppliers are thinking ahead, and buying energy ahead of when they sell it to households.

So, if the cost in the previous six months was low, the price cap will be low. If the cost of energy for suppliers was higher, the price cap will be higher. Here’s how the price cap has changed since it was first introduced:

Energy price cap - changes over time

What jumps out immediately is that the current price cap is very low. This reflects the huge drop in commercial energy consumption that occurred in the first part of 2020 during the first COVID-19 lockdown. As demand fell, so did prices.

Why homes need to look beyond the price cap

Here’s why that’s important: Since the most recent price cap was set in summer 2020, the price paid by suppliers for the energy they buy has been rising.

As that has happened, suppliers have been responding by increasing the price of their non-default tariffs. In the past these have often been at least £200 per year cheaper than a standard variable tariff for a typical household.

And as energy prices have risen, the alternative tariffs available to homes looking to switch away from standard variable tariffs have begun to look much less competitive relative to the price cap. The right hand columns in the chart below show the cheapest tariff available through Big Clean Switch in August, vs the cheapest tariff available right now.

While there are still significant savings, these now appear to be less than £100 a year for a typical home.

Here’s why that matters…

We know from experience that when savings fall below £100 a year, households can often be put off switching. Most people expect switching to be way more hassle than it is and as a result, decide not to go ahead, even though they’ll save money.

Unfortunately, the level of projected savings isn’t necessarily accurate. Because wholesale prices have been rising, the next price cap is set to rise too, which means that customers on standard variable tariffs in April are likely to see the amount the pay increase significantly.

This is likely to be accentuated by a proposed additional increase from Ofgem to allow suppliers to price in the costs they’re facing as a result of more homes failing to pay their bills as the financial pain from COVID-19 continues.

Update: On 5 February 2021, Ofgem announced that the price cap would increase by £96 from 1 April 2021. It is very likely that most big suppliers will increase their standard tariffs accordingly, effectively adding almost £100 to any projected savings from that day on.

What you should do

Above all else, if you’re on a standard variable tariff then there is one rule to remember – you are almost certainly paying too much. Even if your projected saving looks to be less than £100, that is still £100 that you could be using for other things. So, switch now, and come April when the price cap goes up, take a moment to congratulate yourself on having dodged that particular bullet!

Note: This article was updated on 5 February 2021 to reflect Ofgem’s announcement on the price cap level from 1 April 2021 onwards (which is even higher than we’d previously expected).