Why Are Gas Bills So High and What’s the Energy Price Cap?

It’s hard to open a newspaper, turn on the news or listen to a phone-in radio station without coming across coverage and discussion of the dramatic rise in the cost of energy we’ve been told to prepare for.

The big price hike is coming in April 2022, but we’ve already had a taste of increasing costs in October of 2021. There are two main reasons for this huge change in the cost of living. One is the wholesale price of gas on a global scale, which is soaring, and the other is the series of adjustments being made to the UK’s energy price cap by the Office of Gas and Electricity Markets (Ofgem). Together they are creating a perfect storm for domestic customers.

The Global Picture

After years of relative stability, in 2021 the wholesale price of gas around the world rose by over 250%. The UK imports over two-thirds of its gas which means we are particularly vulnerable to events in other countries. At least four major causes have been identified and they all contribute to the scarcity of supply.

The first is the world’s gradual emergence from the most restrictive days of the pandemic. If industries such as construction, manufacturing and aviation haven’t quite returned to normal, they have certainly resumed operations to a degree that has significantly increased the need for gas.

This has coincided with similarly high demand in China and Asia, parts of the world which emerged earliest from lockdowns and managed to gain a stronger foothold in the market for gas as their industrialisation programmes continue.

At the same time, supplies from Russia, one of the world’s biggest providers of gas, have been exceptionally low while the unexpected lack of wind across the UK has starved the wind turbines of the power they need to help meet our energy needs.

Consumers first felt the impact of these shortages late in 2021 with the first big rises in gas bills when Ofgem raised the energy price cap by 12%. This was several times the level of inflation at the time but in April of 2022 the cap will rise again, but this time by an incredible 54%. A further rise in October has not been ruled out.

What is the Energy Price Cap?

Essentially, this is a measure introduced by the government to ensure the energy companies charged their customers fairly. When the utilities were privatised under the government of Margaret Thatcher, Ofgem was established to protect the interests of customers against potential exploitation by the new private-sector owners.

However, Ofgem’s powers to control prices across the sector were limited. In 2013 the leader of the opposition Labour Party, Ed Miliband, first proposed a price freeze on rising bills but this was rejected as unnecessary state interference. Four years later, the Conservative Prime Minister Theresa May nevertheless announced something similar, in the form of a pay cap, beyond which the utilities were legally forbidden to increase their prices. The cap came into force in 2019.

Why is the Cap Being Raised?

At first sight, it seems that a massive cost increase is exactly the sort of situation that the cap is designed to deal with. Households on fixed or tight budgets are going to find it extremely difficult to accommodate prices that reflect the true cost of gas.

However, maintaining the cap at its present level could be disastrous for the energy industry. Gas and electricity companies sprang up by the dozen after privatisation and, as in any industry, not every company could survive. In 2018 seven went bust, in 2019 nine and in 2020 four. However, even though 2021’s 12% rise in the cap gave companies much more scope in their prices, an astonishing 28 companies went out of business.

Many energy companies use a technique called ‘hedging’ which is a way of buying gas supplies at an agreed cost to avoid unexpected price rises. However, when the market goes through the kind of turmoil we’ve seen in the past year, it gets much harder to use this process, because suppliers no longer have any reason to sell supplies cheaply. A large number of the companies that went bust did so because their hedging wasn’t effective enough and they ended up supplying UK customers at a loss – paying more themselves than they could legally pass on.

The reason for this huge rise in the price cap is that virtually every company could be at risk of collapse now that they have no way of securing gas at the low rates they once enjoyed. The energy cap which was designed to protect ordinary householders becomes unworkable when worldwide economic conditions get out of control.

What Can You Do?

The rise in the cap is estimated to represent an average increase in annual energy bills for an average household of £693 to about £2,000. Pre-payment customers could face an even bigger rise.

There is very little individuals can do. There is no point switching suppliers because there are no better deals available. The Treasury has outlined some assistance but it falls far short of what many households will need.

Firstly, in October every customer will receive what is being called a rebate of £200. The Chancellor called this a discount but in fact, it is nothing of the sort because it is repayable at £40 a year over five years.

Secondly, people in England with homes in tax bands A to D will receive a one-off non-repayable £150 payment. There will be a fund which councils can use to help lower income households in higher tax bands. Funds will also be available to help the hard-pressed in Scotland, Wales and Northern Ireland. The warm house discount will also be expanded.

Despite these measures, there’s really no way around the fact that gas prices in 2022 are going to increase the cost of living further and faster than we’ve ever seen.