How to interpret the year-on-year change in the Supplier Cost Index
The breakdown is calculated by combining the percentage change in each category of expected costs, with an estimate of the importance of that cost to suppliers' total costs. Adding the bars together gives the overall change in the index.
Note, therefore, that the percentages shown are not the same as the percentage change in the individual categories of costs. For example, if the chart shows a one percentage point contribution for wholesale gas this does not mean that wholesale gas costs have risen by 1%, rather that there has been an increase in wholesale gas costs which has caused the overall cost index to rise by 1%. As wholesale gas costs make up only one part of suppliers' overall costs, the percentage increase in these costs would have been significantly higher to result in a 1% increase in the overall cost index.
It is important to bear in mind that the contributions shown relate only to the direct charges to suppliers associated with the different types of costs, and do not take into account the relationships between the categories.
For instance, trends in network charges to electricity generators are not included in the ‘network charges’ component of the breakdown, as they are not paid directly by suppliers – and will instead affect wholesale electricity prices. To give another example, a reduction in wholesale prices (and so the wholesale cost component of the index) will be associated with an increase in supplier payments to fund Contracts for Difference, which support low carbon electricity generation.
For this reason, the contribution of different types of costs to the index cannot be interpreted as showing the totality of the impact of government policies or network charges on consumers’ bills.
We calculate the Supplier Cost Index by estimating trends in network charges, wholesale prices and the charges to suppliers associated with government programmes (note that in some cases, these government charges only apply to large and medium-sized suppliers).
These estimates are then combined with information on the relative scale of each of these categories of cost to calculate the trend in the overall Supplier Cost Index. The weights given to each category of costs are based on the most recent financial statements (2016) from the six large suppliers, and are as follows:
- wholesale electricity: 26.7%
- wholesale gas: 35.9%
- networks electricity: 15.4%
- networks gas: 14.4%
- government obligations electricity: 6.7%
- government obligations gas: 1.0%.
The index reflects estimated expected annual costs, covering the 12 months from the time of each update, based on the best information available at the time. So, for example, the value of the index for January 2018 will reflect estimated costs for the period 1 January 2018 to 31 December 2018, expressed relative to estimated expected annual costs as of the base period (1 January 2015 to 31 December 2015).
As the estimates are forward-looking, they therefore rely on forecasts and assumptions, and so will be subject to uncertainty. Information on suppliers’ realised costs is available in the financial statements published by the six large energy suppliers. See Understanding the profits of the large energy suppliers.
The index does not include suppliers' ‘back-office’ operating costs (such as the costs of billing or metering – including the costs of the smart meter rollout) or their profit margins, which suppliers will seek to cover when setting their prices. We are working to facilitate a more competitive, dynamic energy market, with more engaged consumers. Over time, we expect the changes we make to put more pressure on suppliers to keep such back-office costs down.
The index is based on trends in the average prices of wholesale gas and electricity forward contracts in the month prior to the update. Suppliers will take different approaches to purchasing their wholesale energy, and many will buy their energy over an extended period. The index does not seek to estimate any impact this may have on a supplier’s costs.
Other elements of costs are also likely to vary across individual suppliers. For example, suppliers may have some flexibility in how they meet their obligations under government programmes. This could mean, for example, that suppliers see different year-on-year changes in costs than indicated by the index where they have chosen to meet their obligations under the ECO scheme at the start of the delivery period (the forecasts used in the index are based on a flat delivery profile). Network charges will also vary between suppliers depending on things like the regional profile of their customer base.
The index is calculated for a customer with typical consumption. We have held consumption fixed over time to increase comparability with trends in suppliers’ prices (which are also typically expressed for a given level of consumption). In practice, energy use will vary from one year to the next, depending on temperatures. Energy use is also subject to long-run trends, for example as a result of increasing energy efficiency. Trends in consumption will also have a significant impact on the size of customers’ bills.
Capacity market payments were included in the index from winter 2017. In contrast to the methodology document published in March 2017, we have categorised these as wholesale electricity costs. We consider that this allocation best reflects the nature of these costs, although we note the close relationship that exists between the different categories. We intend to keep under review what further detail might be provided on the costs associated with different government programmes.
Since the August 2017 update, we have included the additional costs associated with the expected exemption of Energy Intensive Industries from the costs of the Renewable Obligation scheme, following the Government’s announcement in December 2017. The Government’s decision on implementing the same exemption for the Feed-in Tariff scheme has yet to be published, and so the possible impact of a similar change to the way this programme is funded is not currently included.
Further details of how we calculate the index are provided in our methodology document.
This chart is part of our quarterly update to the Supplier Cost Index. For further details, see Understanding the profits of the large energy suppliers.