Energy price cap operating cost allowances review

What this is about

Ofgem is reviewing the operating cost allowances built into the energy price cap — the amounts that suppliers are assumed to need for billing, metering, customer service, and debt management. These allowances were last set using data that predates the energy crisis. The review updates them using 2023 actual cost data collected directly from suppliers.

The timing is driven by Ofgem's wider pricing reforms programme, which aims to make the retail market "investable and resilient" — code for the fact that several suppliers have gone bust or are barely viable under the current cap methodology. Operating cost allowances sit at the centre of a tension: set them too low and suppliers cannot maintain service quality, cannot invest in systems, and cannot absorb the cost of rising bad debt. Set them too high and consumers pay more than they should for what is, in effect, the administrative overhead of being supplied with energy. Every pound added to the operating cost allowance flows directly through to the cap level and onto every domestic bill in the country.

The review covers four cost categories: general operating costs (customer service, billing, IT), smart metering costs, debt-related costs (bad debt write-offs, working capital, debt management), and payment method adjustments. Each has its own methodology questions. Debt costs are the most politically sensitive — they have risen sharply since 2021 as arrears ballooned, and the question of how much of that increase should be passed through to all consumers is genuinely difficult.

What happened

This consultation closed on 14 June 2024 and has since reached a decision. Ofgem received 19 responses — 9 from suppliers, 9 from consumer groups and industry bodies, and one from an individual customer. The balance of respondents matters: suppliers argued for higher allowances (reflecting their actual post-crisis costs), while consumer groups pushed back on pass-through of costs they see as partly driven by supplier inefficiency.

Following the initial consultation, Ofgem took several further steps:

- Collected 2023 actual cost data via a formal Request for Information to all suppliers. This is the evidential base for resetting the allowances — moving from modelled or outdated benchmarks to what suppliers actually spent.

- Ran targeted engagement on debt costs, including quarterly RFI submissions since April 2024 and direct conversations with regulatory directors. Debt is where the numbers are largest and most contested. Post-crisis bad debt levels are structurally higher than pre-crisis, and suppliers argue the allowance must reflect this. The question is whether 2023 debt levels represent a new normal or a peak that will subside.

- Published a smart metering working paper (August 2024) exploring a simpler modelled approach to the smart meter cost allowance. The current method is complex and arguably over-compensates suppliers whose rollout has stalled.

- Issued a final consultation on updated operating cost and debt allowance proposals, incorporating all the data and engagement from the preceding months.

Why this matters

The operating cost allowance is one of the quieter but more consequential components of the price cap. It does not attract the headlines that wholesale costs or network charges do, but it directly determines the margin available to suppliers — and therefore the quality of service consumers receive, the viability of smaller suppliers, and the degree of competition in the retail market.

Three dynamics are worth watching:

1. The debt cost spiral. Energy debt has risen dramatically since 2021. Suppliers who cannot recover bad debt costs through the cap either cross-subsidise from other customers (which the cap is supposed to prevent) or cut costs elsewhere (typically customer service). Ofgem's choice on how much debt cost to allow through the cap is effectively a choice about who bears the cost of the arrears crisis — all bill-payers via a higher cap, or suppliers via squeezed margins. Neither answer is comfortable.

2. The efficiency benchmark question. Setting allowances based on actual 2023 costs risks rewarding inefficiency — if a supplier spent more than it should have, baking that into the allowance passes the cost to consumers. But setting allowances below actual costs, on the theory that an "efficient" supplier would spend less, risks the same hollowing-out of service that characterised the pre-crisis period. The choice of benchmark (median, upper quartile, frontier) is where this tension plays out.

3. Smart metering transition costs. The smart meter rollout is behind schedule and over budget. Suppliers face ongoing costs for installation, maintaining legacy meters, and operating dual systems. A "simpler modelled approach" could mean lower allowances if the model assumes a rollout pace that suppliers are not achieving — effectively penalising them for a programme whose targets were set by government, not by them.

How to respond

This consultation is closed. It closed on 14 June 2024 and Ofgem has issued a decision. The non-confidential stakeholder responses are published on the Ofgem website. A subsequent final consultation on operating cost and debt allowances followed, incorporating the 2023 cost data and stakeholder feedback from this initial round. Any changes apply from the April 2025 cap period onwards.