The levels at which a temporary prepayment price cap that's expected to help four million households save about £80/year have been set by energy regulator Ofgem.

The price cap, which will come into effect from Saturday 1 April, will apply to those who prepay for their energy – mostly with prepayment meters – and are among those least able to benefit from competition by switching to cheaper tariffs.

Ofgem announced it would be launching the cap in August last year as a response to remedies proposed by the Competition and Markets Authority (CMA) following its two-year investigation into the energy market.

The energy regulator has today confirmed that the levels of the cap will vary for electricity and gas, by meter type and region.

It's estimated that many prepayment customers are likely to see reductions in their gas bills of about 10-15% from April or around £80/yr based on a typical household's usage.

The cap is due to expire at the end of 2020 when the roll-out of smart meters is set to be completed, which will help prepayment meter customers access better deals.

Commenting on the introduction of the price cap, founder Martin Lewis says: "For years energy firms have used spiel, spin and misdirection to try to pretend that those on prepayment tariffs are getting the same rates as those on a normal billed meter. They get away with this by comparing prepayment costs to the cost of their expensive standard tariffs using the most expensive payment method.

"Yet the real problem with prepay is that there's no real competition. All the cheap deals offered are for direct debit, and they can be £300-£400 a year cheaper than prepay prices for someone on typical use. That is a national disgrace, because most of the poorest people in our society have prepayment meters – the most potent poverty premium possible."

Check out our Cheap Prepaid Gas & Elec guide for tips on how to save.

How will the levels for the cap be set?

To calculate the level of the cap, Ofgem will take the benchmark calculated by the CMA, and update this value using a number of different factors to reflect broad trends in costs – this includes an index of wholesale prices (what energy providers pay for gas and electricity), forecasts of environmental levies, and inflation.

An allowance for network charges is also calculated, based on network companies' published charges – this component of the cap varies by region.

Meanwhile, the cap includes a degree of "headroom", included to help ensure there is room for suppliers to price below the cap.

Who will benefit from the cap?

If you're a prepayment customer, the impact the cap will have on how much you pay as of 1 April will depend on what tariff you're currently on and how much energy you use.

But in a nutshell, Ofgem expects that:

  • The cap will require many suppliers to make significant reductions to their prepayment gas tariffs. For most of the large suppliers, Ofgem expects these reductions to be about 10-15%  (or about £80/yr for a typical prepayment gas customer).
  • The cap will also benefit customers who use electricity to heat their home, such as those on Economy 7 meters. Ofgem says many suppliers will be required to make significant reductions to their Economy 7 tariffs.

    The scale of these reductions will vary a lot by supplier – most of the large suppliers will be required to make reductions in the region of 5-15% (or about £80/yr for a typical prepayment Economy 7 customer).

Why is the cap being introduced?

As part of its investigation into the energy market, the CMA found that prepayment customers are getting a particularly raw deal.

Whereas those on other fixed and standard tariffs are able to make hefty savings by switching energy provider, there are fewer tariffs available to prepayment customers and the tariffs that are available are generally more expensive.

Customers with prepayment meters are also more likely to be in vulnerable situations than those paying by other means.

Martin adds: "Simply regulating that all tariffs should be available to all customers (with a small surcharge allowed for prepayment) would fix this. In the meantime the Government's cap does put a welcome sticking plaster over the problem and will bring bills down.

"More subtly though it is also an admittance that competition isn't working. Politicians have to make a decision. If you want a competitive switching market, you must accept big price differentials – with some paying a lot more than others; if not there's no incentive to switch.

"Alternatively, accept competition isn't the solution and regulate prices – which would mean those who don't switch would see prices drop, and those who do would see them rise. These two stark solutions have benefits. The problem is politicians of all parties have tried to do something in the middle and that's what fails."

What does Ofgem say?

Dermot Nolan, Ofgem chief executive, says: "We want all consumers to enjoy the benefits of a more competitive energy market, regardless of their circumstances. Customers who prepay for their energy are denied the best deals on the market available to those using other payment methods.

"They are also more likely to be in vulnerable circumstances, including fuel poverty. This temporary cap will protect these households as we work to deliver a more competitive, fairer and smarter market for all consumers."