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Ofgem confirmed this morning that the energy price cap will rise by 4% from October, taking the typical household's annual bill from £1,663 to £1,723. That is £60 more a year, or roughly £5 a month, modest in isolation, but arriving in the middle of a cost of living squeeze that has run for three years and shows no real sign of easing. In real terms, when you adjust for inflation, the October cap is 7% higher than the equivalent period last year. This is not relief. It is another increment.
The reason for the rise is gas. Wholesale gas prices have climbed 11% over the past three months, driven largely by continued instability in Middle East markets. Higher gas prices push electricity bills up too, and would have done so sharply this quarter, except that the government's decision to remove VAT from domestic electricity has kept electricity costs broadly flat. Ofgem estimates the VAT change saves the typical bill around £45. Without it, the cap would have landed at closer to £1,768. Gas bills are still rising by 8%. For around 11 million households currently on fixed tariffs, none of this applies directly. For the roughly 20 million still on default tariffs, it does.
What I find genuinely frustrating and I think most people would, if the mechanism were better explained, is the structural mismatch that sits underneath these quarterly announcements. The UK grid is generating more renewable electricity than at any point in its history. Offshore wind now supplies a majority share of generation across large portions of the year. Onshore wind, solar, and interconnector imports have all expanded. The marginal cost of producing electricity from these sources is close to zero once the infrastructure is built. Yet household electricity bills remain tightly coupled to whatever gas costs on a given day.
That is not an accident. It is the direct result of the marginal pricing model used in the UK wholesale electricity market. The way the system works is every generator dispatched to meet demand in any given half hour period receives the same price, the price of the last and most expensive unit called upon. In practice, that unit is almost always a gas fired power station. So a wind farm generating electricity for near zero marginal cost sells that electricity at the gas market price. The difference between the wind farm's production cost and the market price flows to the generator not to the household. Estimates vary, but around 40% of the average electricity bill is tied to this wholesale pricing mechanism. It was a sensible design when gas was the backbone of the grid. It is a much harder case to make now.
The Contracts for Difference scheme deserves some credit here. It was designed precisely to decouple renewable generators from the worst of gas price volatility, guaranteeing a strike price and returning excess revenue to consumers when market prices exceed it. In periods of very high gas prices, CfD holders have paid back significant sums. But the mechanism was designed for a time when renewables needed subsidy to attract capital investment. The conversation about whether CfD architecture still makes sense, whether it could be reformed to pass savings from low cost generation directly and consistently to consumers rather than absorbing them into market clearing prices is one the UK has been slow to take seriously.
The grid is also about to look different in another way. The government signed contracts with Rolls Royce SMR earlier this year for the development of small modular reactor technology. With that agreement in place, and planning for deployment underway, the medium term generation picture includes new firm, low carbon baseload capacity with predictable costs. That is exactly the kind of generation the current pricing model struggles to reward properly and exactly the kind that could anchor a reformed system around long run cost rather than short run gas market volatility.
There are other ideas circulating that rarely make it into mainstream coverage. Floating photovoltaic installations on reservoirs, for instance, are a technology already in commercial use elsewhere in Europe. A panel array floating on a reservoir generates electricity, reduces water evaporation which matters in a warming climate and can improve water quality by limiting algal growth. Some UK water companies have explored the concept. The question is who owns it and who benefits. If the asset is publicly owned, the revenue stream flows back into public services. If it is privately owned under a contract, the returns go elsewhere. That distinction matters more when energy prices are under pressure.
I find myself thinking that the October announcement reveals, once again, how much of the energy debate in this country takes place within a very narrow frame. We discuss whether the cap is too high or too low. We welcome VAT cuts and warn about gas prices. What we do less often is ask whether the underlying market architecture built in the 1990s for a fossil fuel dominated grid still serves households in a system that looks almost nothing like what it was designed for. With renewables dominant, SMR capacity on order, and bills still rising in real terms, that question is becoming harder to defer.