Price cap forecast to hit £4,200 following Ofgem update

Allowing suppliers to recover additional wholesale costs due to the energy crisis could result in the price cap increasing to more than £4,200, an industry analyst has predicted.

Martin Young of Investec issued the forecast following Ofgem’s announcement it would update the price cap methodology to include an allowance for backwardation costs, which suppliers will recover over a six-month period.

To smooth out seasonal fluctuations in energy prices, allowances for wholesale costs are set based on forward prices over a 12-month reference period starting at the beginning of the relevant price cap. This results in the under-recovery of costs during the winter, a situation referred to as backwardation.

These backwardation costs have previously been assumed to be offset by over-recovery during the summer, referred to as contango. However, this may not happen during period of high price volatility. Ofgem is therefore introducing a specific allowance under the cap for exceptional backwardation costs.

Investec calculates that overall backwardation costs will be around £296 per dual fuel customer over the coming winter, slightly above Ofgem’s estimate of £271.

Young said Ofgem’s decision to recover these costs over six months, rather than the original proposal of 12 months, will have “a material impact” on the level of the cap, particularly in January 2023.

As a result of the changes, Investec’s estimate for the October cap has increased to £3,523, an almost 80% jump from its current level of £1,971. It then expects the cap to rise by a further £687 to £4,210 in January.

“We understand why Ofgem wishes to provide greater market resilience, but the pressure on households grows. It is imperative that the two candidates for PM reach a common position on help, and quickly,” said Young.

Ofgem will reveal the level of the October price cap on 26 August, while January’s cap figure will be announced on 24 November.

The regulator’s announcement yesterday (4 August) included confirmation of its decision to update the cap quarterly, as well as the announcement of an additional £41 uplift to reflect wholesale costs incurred by suppliers as a result of millions of customers shifting onto standard variable tariffs.

This topic will be discussed in more detail at Utility Week Forum this November. For more information and to book your place, see our website.