How are UK gas and electricity bills calculated?

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Tory backbenchers have today renewed calls for the government to scrap the “green” policy costs they say add £153 a year to the average home’s annual gas and electricity bills. While it is a significant sum, it is a fraction of the overall cost which stands at just under £2,000 a year. Here’s how your bill is currently calculated.

Wholesale costs

The wholesale market price of gas and electricity plays the biggest role in determining the average energy bill, and following the steady rise in wholesale prices since last August, it now accounts for just under 50% of bills – £1,077 of the average capped bill.

Energy suppliers typically buy their gas and electricity from the market in advance, so Ofgem determines the cost of buying energy from the market by tracking wholesale prices over a period of six months ahead of the next price cap period. The price cap will be increased again in October, and unless wholesale prices fall substantially over the summer – something that looks very unlikely – average household bills are expected to rise to £2,600 a year.

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Network costs

The next biggest cost is that of providing and running the infrastructure of supplying the UK’s homes and businesses via pylons, gas pipelines and all the associated costs. At £371 a year this now accounts for about 18% of the average household bill. Network costs also include the increasing price of having to bail out failed suppliers. Energy companies that take on customers after the collapse of a rival can claim “any reasonable additional, otherwise unrecoverable, costs” of taking on those customers – currently adding about £68 per household.

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Policy costs

While people opposed to this element of the bill have portrayed it as an unnecessary green tax, this is not entirely accurate. Policy costs account for £153 or 8% of the average household capped bill. While this does include the energy company obligation scheme, which pays to upgrade home insulation for households on low incomes, plus the renewables obligation that requires suppliers to source renewable electricity, it also pays for the warm homes discount which will pay vulnerable customers £150 a year next winter and will be opened up to a further 800,000 homes.

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Policy costs also cover the feed-in-tariff payments that were offered to those paying for solar panels to be installed on their roofs and contractually must be made.

If policy costs were removed from bills, these payments would still have to be made in some form or other and would most likely have to come from general taxation. Ofgem figures show that policy costs have fallen from 12% to 8% of bills.

The rest of the bill

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Energy companies were allowed to claim operating costs of £204 from the average annual energy bill under the winter price cap, but that has grown by almost 10% to £220.

The increase is in part because Ofgem’s allowance for supplier profits, which is set at 1.9%, is now included within operating costs rather than shown as a separate allowance. The winter price cap allowed energy suppliers to claim £23 from each default energy tariff as profit. Under the new cap they will make more than £37.

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VAT is set at 5% for energy bills, which equates to £98 a year for the average household – up from £61 before April – or more than £2.1bn in total. The Treasury windfall led to calls before the price cap announcement for the government to offer extra help to hard-pressed families by temporarily cutting VAT, but this has so far been resisted.

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