The cost of living has played a huge role in everybody’s lives in the last year.

Energy prices have risen faster than ever as well as inflation.

People in the UK’s wages have sadly not risen in line with this.

Citizens are earning less and spending more on bills.

Is there a reason for this?

There is not one hard and fast reason for energy price rises in the UK.

However there are a few different things that are having an impact on this.

In April, gas and electricity bills rose sharply for most households in the UK. The main reason is that the cost of importing gas has gone up. But how are household energy bills determined – and why are we seeing such a large increase in them? This article sets out some of the key issues.

How are UK energy prices determined?

The price that we pay for electricity has to cover a range of costs. These include the costs of buying gas and electricity in wholesale markets, getting it to customers through pipes and wires, and a range of government policies that seek to help vulnerable consumers and to reduce carbon emissions.

Prices in the wholesale spot market are for next-day delivery and depend on what is happening now: as a result, they can be very volatile and affected by world events, such as the war in Ukraine.

Companies can also buy in a forward market, whereby they are able to lock in prices for future delivery, months or even years ahead.

Most households are covered by price caps set by Ofgem, the industry’s regulator (explained in more detail below).

But these caps rose sharply in April. For individual households, the size of their bills and the amount by which these rose depends on how much energy is consumed.

The increase in the price cap means that a household buying the ‘typical’ amount is seeing its bills rise by 54% from £1,277 a year to £1,971. Pre-payment bills are going up by £708, from £1,309 to £2,017 (Ofgem, 2022).

How does Ofgem’s price cap work?

The price cap for consumers on pre-payment meter energy tariffs was introduced in April 2017, followed by the cap on default energy tariffs (including standard variable tariffs) in January 2019. Collectively, these cover around 15 million energy consumers (Ofgem, 2020).

The regulator announces the maximum amount that companies can charge in each six-month period, a couple of months before it starts.

While to date, these caps have limited costs for consumers, overall energy costs have gone up. When setting the price caps, the regulator has to predict energy suppliers’ costs, including those of buying energy over the last four months for delivery over the next 12 months.

These forward market prices essentially doubled between the summer months of 2021 used to set the price cap from October 2021 and the recent period used to set April’s new prices. The annual wholesale cost for an average household rose from £528 to £1,077.