Ofgem’s energy system cost allocation and recovery review – Proposed reforms and impact assessment

Background and objectives:

Ofgem has launched a wide-ranging Energy System Cost Allocation and Recovery Review (opened July 2025) to re-examine how the costs of Britain’s evolving energy system are shared across consumer bills.

Current system overview

The costs of delivering energy to consumers in the UK fall into four broad categories:

• Wholesale costs: the market price of gas and electricity;
• Network costs: building and maintaining transmission/distribution infrastructure and system balancing;
• Policy costs: government-backed schemes for renewables, energy efficiency and consumer support; and
• Supplier operating costs and margin: the running costs of energy supply businesses.

These costs are passed on to consumers via a mix of standing charges (fixed, per-day costs) and volumetric charges (based on energy usage).

Domestic consumers typically face standing charges for infrastructure and variable unit rates for wholesale and policy costs. Non-domestic users pay a combination of banded fixed charges – based on capacity, connection type, and usage characteristics – and volumetric charges that vary with actual consumption, with methodologies differing depending on metering data availability and network connection size.

Proposed reforms to cost allocation and recovery:

Ofgem is considering reforms in three broad areas:

1. Reforming domestic cost recovery

Several options are being explored to make domestic cost recovery fairer and more reflective of actual usage, time of use, location, and ability to pay. These include:

• Charging structure reforms: such as replacing standing charges with rising or falling block tariffs, or varying them based on capacity;
• Time-of-use pricing: adjusting either standing charges or unit rates depending on when energy is used;
• Regional pricing: either preserving current regional variations or moving to uniform national charges; and
• Means-based models: linking fixed charges to income or wealth through pre-distribution or redistribution mechanisms.

These options may be used individually or combined into hybrid models involving multiple charge types to better align cost recovery with consumer usage, location, time of use, and financial capacity.

2. Reforming non-domestic cost recovery:

Non-domestic users currently pay a mix of volumetric and banded fixed charges. Recent reforms under the Targeted Charging Review shifted more costs into fixed bands to prevent avoidance, but some businesses have seen higher charges and reduced flexibility as a result.

Ofgem is now seeking views on how to refine this structure, including:

• Scaling or removing fixed charges;
• Adopting block or time-of-use tariffs;
• Reconsidering regional differentiation; and
• Introducing ability-to-pay approaches for the non-domestic sector.

The aim is to ensure competitiveness and support decarbonisation while fairly distributing costs among diverse business types.

3. Rebalancing costs across consumer sectors:

Currently, roughly 60% of system costs are allocated to non-domestic consumers and 40% to domestic ones, in line with usage.

Ofgem is seeking input on whether this split remains appropriate and whether a rebalancing could deliver fairer or more efficient outcomes, particularly in light of decarbonisation and flexibility targets.

Impact on consumers:

For consumers, reforms could shift the cost burden in ways that favour low users, flexible users, or vulnerable groups but may penalize those with essential high usage. More complex tariffs could improve fairness but reduce transparency.

Impact on energy suppliers:

For suppliers, reforms may require significant billing, metering, and system upgrades. The shift away from simple standing charges toward dynamic or means-based pricing presents both challenges and innovation opportunities.

Conclusion:

Ofgem’s proposed reforms offer the potential for a fairer and more efficient approach to energy cost recovery, but they mark a significant departure from current practices.

While the changes could benefit many consumers through more tailored and affordable tariffs, they also introduce complexity and risk for both consumers and suppliers. As the review remains in its early stages, stakeholder input will be crucial to shaping a system that balances fairness, affordability, and sustainability in support of Britain’s net-zero transition.