Ofgem announces major review into how costs are allocated across the energy system  

Ofgem will today (30 July) launch a major review into how costs are allocated across the energy system – including looking at a range of potential alternative pricing models for consumers. As part of the review, stakeholders are being asked for their views on what a new pricing model might look like, which would be subject to future consultation.  

The energy system is changing, with maintenance investment and upgrades required. Renewables will help protect billpayers from volatile global fossil fuel prices by allowing us to generate homegrown energy and increase market stability.   

Meanwhile, many domestic consumers have made it clear that they think the current system of a standing charge and a unit rate is unfair – though research indicates there is no consensus on a preferred alternative model. And both domestic and non-domestic customers are changing the way in which they use energy, including by using new technologies to shift their use to different times of the day and in some cases by increasing their use of electricity (for example via electric vehicles and heat pumps).   

With drivers of cost in the system changing, and energy taking up a greater proportion of household bills than has previously been the case, now is the right time to look at potential alternative models in how billpayers are charged, with a clear ambition to develop an overall better system, including to ensure increased fixed costs don’t disproportionately affect vulnerable and low income consumers.  

The Cost Allocation and Recovery Review (CAR) will look at the whole energy system – from energy generation through to household use – and explore the trade-offs involved in different models of cost allocation.   

Ofgem CEO Jonathan Brearley said:  

“As we transition to a more secure, homegrown, renewables-based energy system, unit costs may decrease due to reduced reliance on expensive and volatile gas. However, fixed costs – such as those needed to upgrade the energy network to deliver cleaner and more secure power to our homes – could rise. This shift in the make-up of system costs means we need to review how we pay for energy and carefully consider how these costs are distributed.  

“We know customers have real concerns about fairness and transparency in their bills, especially around fixed costs. That’s why we’re asking big questions about how and where these costs are shared – and whether there are better, fairer ways to do it.  

“The launch of this review is the next step in developing fairer pricing for a changing energy system, ensuring more choice for consumers while protecting those most in need.”  

The regulator is only seeking views at this point and is not recommending any specific option. 

Some decisions, such as how costs are shared through bills or taxes, or who gets extra support, are rightly for the elected government, not the regulator. However, many choices are made jointly by government and regulator, shaping what goes into energy bills and how costs are recovered. Ofgem’s role is to protect all consumers, both now and in the future, and for that reason we are keen to ensure that we look at bills in the round, considering all the costs and options available and how these feed through to the consumer. We’ll work closely with government to ensure our respective approaches are not misaligned.  

As we rely less and less on the price of gas, the variable costs in our system may go down, but the fixed costs of running the system may rise as we invest in upgrading and maintaining it to make the most of cleaner and more secure renewable forms of energy. While we can’t make costs disappear, we know that how costs are allocated and bills are put together can have a big impact on customers, particularly where high upfront fixed costs could pose a barrier to energy use.  

Under the existing arrangements, system costs are paid for by energy system users and consumers through their energy bills, with separate standalone bills for electricity and gas. System costs are the total amount of costs for all the energy, infrastructure and activities that are required to deliver gas and electricity to consumers, then charged to both domestic and non-domestic consumers.