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Ofgem to consult on price cap methodology amid ‘challenging times’ for the market

The price cap is designed to protect customers from shocks in the wholesale market. Image: Getty.

The price cap is designed to protect customers from shocks in the wholesale market. Image: Getty.

Given the rising wholesale energy prices, Ofgem is to consult on the price cap methodology.

In an open letter from the regulator, it has laid out the steps it is taking to protect the interests of consumers in both the short and long term.

As well as consulting on the price cap methodology to ensure that it reflects the costs, risks and uncertainties facing suppliers appropriately, Ofgem is to take an enhanced approach to monitoring, compliance and enforcement of licence conditions, to ensure suppliers pursue a sustainable business model.

Some criticism has been leveled against suppliers who had offered below-market rates, and the impact of such a business strategy when power prices surged recently.

“While the recent rise in gas prices is unprecedented, we must plan on the basis that shocks like this could happen again,” Jonathan Brearley, chief executive of Ofgem wrote in the letter.

“We intend to respond by ‘raising the bar’ of what we expect from suppliers with regards to financial risk management: utilising existing licence conditions; reviewing where those licence conditions might need to be strengthened and guidance updated; and considering where new licence conditions may be needed. And we will continue to take robust action against any suppliers that fail to meet licence conditions.”

The regulator pointed to previous strengthening of the regulatory regime in 2019 and in January 2021, and the Financial Responsibility Principle consultation run earlier in 2021, the suggested changes from which Ofgem intends to publish in the New Year.

Ofgem also emphasised its expectation that suppliers continue to comply with their licence obligations, in particular with regards to providing support for vulnerable customers.

To recognise the increased volatility in the market – which is expected to continue through winter – the regulator is set to do more regular assessments of supplier finances, set firmer capital investment expectations and take a more robust approach to the assessment of operational capacity, pricing and hedging.

As it is reviewing licence conditions to restore the stability of the sector, Ofgem is temporarily pausing assessment of applications for new supply licences by extending the reasonable period of assessment initially to six months.

The price cap consultation is expected to be published in November, following which Ofgem will consider stakeholder response and publish a decision in February 2022. This would allow enough time to implement changes ahead of the next price cap period, which will start on 1 April.

In the longer term, Ofgem will also look to further develop its regulatory approach to risk, examine how the design and operation of the price cap might evolve and work with the government and across the energy sector to build a retail market that supports the transition to net zero.

“These are challenging times, requiring bold action,” finished Brearley. “We welcome continued constructive and collaborative engagement with our stakeholders to ensure we can, together, achieve the shared goal of protecting consumer interests on the road to a net zero energy system.”

The letter follow comments made by Brearley at an Energy UK conference at the beginning of October, in which he said that there was a need for Ofgem to “regulate the energy market differently”.

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