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Highlights

Ceiling to rise by GBP117 to GBP1,254/year from April 1

Cold weather, oil price rise in 2018 pushed up wholesale cost

'Observation window' for new cap was August 2018-January 2019

London — The cap on domestic UK energy bills will be increased from April due to a hike in wholesale gas and power prices last year, regulator Ofgem said Thursday.

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Ofgem introduced the price cap system -- designed to protect more than 11 million households on poor value default tariffs from being overcharged -- from the start of 2019.

From April 1, the levels of the default tariff price cap will increase by GBP117 ($151) to GBP1,254/year.

The new cap will remain in place for the summer period until the end of September.

"Under the caps, households on default tariffs are protected and will always pay a fair price for their energy, even though the levels will increase from April," Ofgem CEO Dermot Nolan said.

"We can assure these customers that they remain protected from being overcharged for their energy and that these increases are only due to actual rises in energy costs, rather than excess charges from supplier profiteering," Nolan said.

WHOLESALE COSTS

Ofgem said that higher wholesale energy costs pushed up the level of the cap.

"Last year higher oil prices, among other factors like the higher demand for gas from the 'Beast from the East,' led to a rise in wholesale gas prices," Ofgem said.

"Because of the importance of gas as a source of electricity generation, this also led to higher wholesale electricity prices."

Ofgem said that while the prices of wholesale energy contracts used for calculating the cap had fallen in recent months, overall the costs remain 17% higher than the last cap period.

The default tariff price reflects suppliers' costs because Ofgem uses the wholesale prices of the relevant forward contracts that were sold in advance during an "observation window" before each six-month price cap period.

Ofgem adjusts the level of the caps twice a year to reflect the estimated costs of supplying electricity and gas to homes for the next six-month period.

The observation window for the summer price cap period (April-September) is the previous August-January, Ofgem said.

The observation window for the winter price cap period (October-March) is the previous February-July.

OBSERVATIONS

In the observation window prior to NBP Summer 19 gas delivery, the average price for the contract was to 57.43 p/th, according to S&P Global Platts price assessment data. In the previous observation period, pricing data indicated an average of 45.13 p/th. Therefore, in pure pricing terms, the value of gas in summer has actually increased by 27% in between the two periods.

Following the "Beast from the East," a buying rally for NBP Winter 18 as the front month ensued, helping drive up the price for seasonal contracts further out. The majority of Winter 18 trade occurred in the immediate aftermath, between April and June, with markedly lower liquidity in the two months prior to delivery.

As prices rose, seasonal contracts for summer 19 saw increased levels of trade, too, with 18% of total traded value for the contract taking place during this second quarter of 2018, but crucially not considered during the assessment window for the price cap. Between August and January, 72% of the traded value for Summer 19 occurred, and occurred at a higher price.

January saw the highest value of trade for the contract, also accounting for 18% of the total, although trading at an average price of 52.525 p/th. Had a greater volume been purchased in Q2 2018, it would have cost an average of 46.36 p/th. The current long-term trend for British gas prices is downward, reinforced by continued high LNG sendout, although later price reductions in the two months prior to summer delivery will not be considered for the latest cap, irrespective of whether these months see the highest level of trade.

The majority of seasonal natural gas liquidity has historically occurred as the seasonal contract in question becomes the front season. With the exceptional circumstances of the "Beast from the East," trade in the second season atypically increased.

If the regulator's observation period had taken place over 12 months instead of six, the average price would have been 51.30 p/th. If calculated using the cash value percentages for the individual six-month periods, the overall average traded price would be would be 53.04 p/th, constituting a theoretical rise of 17%.

-- Stuart Elliott, Stuart.Elliott@spglobal.com; Neil Hunter, neil.hunter@spglobal.com

-- Edited by Annie Siebert, newsdesk@spglobal.com