Price cap amended to reflect CfD paybacks to suppliers

Ofgem has decided to amend the price cap methodology to reflect the return of Contracts for Difference (CfD) payments to suppliers as a result of high wholesale energy prices.

The Energy and Climate Intelligence Unit (ECIU) said its analysis suggests the change could cut energy bills by £25 this winter and £45 next winter if prices remain at current levels.

Under the Contracts for Difference scheme, low-carbon generators are awarded a guaranteed price for the electricity they produce, known as the strike price.

If wholesale electricity prices are below the strike price, as has generally been the case previously, then generators receive top-up payments from the Low Carbon Contracts Company (LCCC) to make up the difference.

The scheme is funded by suppliers, which make advance payments through a levy on each unit of consumption by their customers to cover the expected costs of the top up payments. Although suppliers are charged on a daily basis, the interim levy rate is fixed in advance for each quarter.

They are also required to make lump sum contributions to a reserve at the beginning of each quarter to cover potential shortfalls.

If wholesale electricity prices are above the strike price, generators return the excess to the LCCC. Upon reconciliation, this money is initially offset against any top-up payments to generators.

Any remaining excess is offset against suppliers’ future contributions to the reserve. If the sum of the excess and the current reserve is higher than the target reserve for the next quarter, the difference is returned to suppliers.

The price cap methodology includes an allowance for CfD costs, which is currently based on the interim levy rate.

Under the regulations governing the CfD mechanism, the LCCC cannot set an interim levy rate lower than £0/MWh. The floor is intended to ensure the LCCC does not make payments to suppliers in advance and has sufficient funds to cover the costs of the scheme. However, this also means payments to suppliers cannot currently be reflected in the price cap.

In January, the LCCC revealed that it expected to return £39 million to suppliers after the final quarter of 2021 became the first in the scheme’s history in which generators returned more money than they received due to rising wholesale energy prices.

Ofgem said the LCCC is also forecasting suppliers to receive payments from the CfD scheme over period nine of the price cap running from October 2022 to March 2023.

After proposing several options address the issue in a consultation in April, the regulator has now decided to remove £0/MWh floor from the price cap allowance by amending the methodology to replace the interim levy rate with an expected levy payment, calculated using the LCCC’s payment forecasts and energy demand. Ofgem said it has also decided against introducing a mechanism for reconciling the allowance with outturn costs.

Ofgem estimated that the change would reduce the price cap levels by more than £11 during period nine.

However, the ECIU said it expected the amendment to reduce energy bills by £25 over 12 months from the beginning of October, and by £45 over the following year if wholesale energy prices remain at their current high levels.

“With the high gas price pushing up the average energy bill by at least £2,000 this wind power saving is modest, but with gas prices predicted to stay high for many years, we are reaching the turning point where renewables subsidise bills rather than the other way around,” said ECIU senior analyst Jess Ralston.

Conservative MP John Penrose commented: “This is a net zero dividend that bills payers have earned through subsidising early renewables that have in turn helped us build a thriving offshore wind industry. In the coming years with a target of 50GW and more giant offshore wind farms plugging into the grid, this bonus should grow.”