What is the energy price cap and why are gas and electricity prices going up?

Energy prices uk energy cap crisis - Martin Prescott/Getty Images
Energy prices uk energy cap crisis - Martin Prescott/Getty Images

Energy regulator Ofgem's new price cap increase came into effect on October 1. The average household bill will rise from £1,971 per year to £2,500.

It comes after April's price cap rise, which increased the average bill from £1,277 to £1,971 per year.

Here, Telegraph Money explains everything you need to know about the price cap and why it has caused your bills to rise.

What is the energy price cap?

The energy price cap limits the amount a provider can charge you per unit of gas and electricity you use on a standard variable tariff.

Ofgem brought in the price cap in 2019 to prevent energy providers from ripping off customers who did not shop around for the best deals. In January that year, it was first set at £1,137.

The price cap is quoted as an annual average figure for a typical household. This is because the cap only limits the rate at which you are charged and does not cap your annual bill, meaning you will still pay more if you use more energy.

The cap does not apply to fixed rate deals, for which quotes are now almost always far higher than what you would pay on a variable tariff.

Standing charges – the daily rate billed to customers regardless of how much energy they use – are also limited by the cap. These caps vary by region, however, meaning households in areas where electricity is more expensive to transport, such as the South West, will pay more on their standing charge than those living in London.

Why has the UK's energy become so expensive?

During the pandemic, demand for energy plummeted. As the industry ground to a halt, so too did supply. But when demand surged after lockdown lifted, supply did not.

This caused wholesale prices of gas in Europe to soar by 300pc, which in turn pushed up the cost of electricity. In the UK, around 30 energy providers went bust as a result of this abrupt shift.

When a provider goes bust, its customers are automatically moved onto another one.

Providers eventually pass the admin costs of this process onto consumers in the form of increased standing charges. This was reflected in April’s price cap increase, which saw the standing charge for electricity jump 80pc, from 25p a day to 45p.

Is Russia affecting gas prices?

Russia’s invasion of Ukraine has often been cited as the main contributing factor in why energy bills have soared everywhere else in the world, but how true is this for British households?

The UK has vast reserves of its own gas, making it less reliant on Russian gas and oil than the EU, which imports more than 40pc of its gas and 29pc of its oil from Russia.

Russia remains an important player in the international energy market, however, so strict sanctions on Russian imports have had a knock-on effect for prices everywhere else.

The EU has banned most Russian oil imports by the end of the year, while the US has banned Russian oil completely. The removal of Russian oil from the market has caused prices to skyrocket.

Even with its own gas supplies, the UK still imports 40pc of its gas from Norway, which has become much more expensive as a result of the aforementioned drop in supply.

The price of electricity is tied to the price of gas – and the UK still generates the majority of its electricity from gas. In 2020, 35pc of the UK’s electricity generation came from gas, according to the Office for National Statistics.

Renewables such as wind, solar and nuclear power make up the rest of the UK’s supply, but as these are temperamental the UK often has to rely on gas.

The issue is exacerbated by the UK’s low gas reserves, limiting the country’s capacity to stockpile gas.

Centrica, which runs British Gas, closed its Rough gas storage facility in Yorkshire five years ago, citing its £2bn-£3bn cost. The Government declined to subsidise the facility.

What impact do green levies have on energy bills?

The term “green levies” loosely refers to policies added to energy bills. Some commentators use it only to refer to environmental policies, while others include social policies such as the warm homes discount.

Money generated by green levies is put towards green initiatives such as renewable energy projects and home insulation.

Under the current price cap, green levies represent 8pc of energy bills.

The cost of living crisis has prompted calls from some – particularly climate change sceptics – to scrap green levies and push bills down.

Why can’t the UK just use its own resources?

The UK exports a small fraction of the amount of gas it imports from other countries.

According to Office for National Statistics data, Britain exported £3.4bn worth of gas in 2021, up £1.3bn (167pc) from the previous year, as domestic renewable energy plummeted due to less favourable weather conditions.

However, Britain also imported far more gas than in 2021 – £19.6bn in 2021 – over three times as much as the year before.

Prices paid by households in the UK are largely influenced by the global energy market and only partly by domestic supply and demand.

Following the pandemic, increased demand from Asian countries – particularly China – limited the wider availability of liquified natural gas.

The UK is still predominantly dependent on gas – 85pc of British homes use gas for their central heating and over a third of our electricity comes from gas.

Renewable energy from wind and solar is far cheaper than fossil fuels, however low wind output in 2021 meant the UK was more reliant on gas, exacerbated by the shutdown of the Rough gas store under the North Sea in 2017.

British Gas owner Centrica closed the Yorkshire facility in 2017, claiming it was too uneconomic to reopen it after it was temporarily closed due to safety concerns.

Shadow Energy Minister Ed Miliband has said the decision to close the facility left the UK with “close to zero storage stocks”.

“All other European countries have been filling their storage over the summer to prepare for the critical winter to come, but Tory decisions over the last 12 years have left us insecure and families exposed to higher bills,” a Labour spokesman added.