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Wholesale gas prices are dropping - so how long before your household bills fall too?

The fall in wholesale energy prices has increased speculation that inflation may be peaking - but it may be some time before retail electricity and gas bills actually fall

Do you see the glass half-empty or half-full? Optimists will look at the fall in wholesale gas prices and point out that on the UK market where Ireland sources most of its supply, prices have fallen to around 150p to 160p per therm down from a peak of 800p at their peak in March and a level of 400p to 450p at which they traded for a considerable time, which put sharp upward pressure on retail and business gas and electricity prices. But prices remain three times the 50p per therm level they traded at before the crisis kicked off, and they had been even lower before that for long periods. So how do we make sense of the impact of this on prices in the market? And does the sharp fall spell the end of the big surge in inflation?

The retail market for gas:

The pricing of gas - and electricity, 50 per cent of which is produced from gas - for retail customers is quite opaque. While petrol and diesel prices at the pump tend to rise and fall in tandem with the wholesale market (and yes, there are rows about how quickly falls as passed on), retail gas and electricity prices tend to rise and fall with a lag. This is because the big companies buy forward on the market, in other words they commit to buy a certain amount of gas months in advance, in order to be sure they have a secure supply and are not caught by price spikes. This is known as hedging. The difficulty from the consumer point of view is that it is impossible to know if firms are profiteering during the cycle - at least until we see their annual profits published a year later.

The average “dual” bill for homes using both fuels has increased from around €800 a year to €2,000, with the sharper increase in the gas element of the bill. Discounts on some bills - now less attractive than in the past for " switchers”- and the Government energy credit has reduced the bottom impact on households.

Industry sources point out that the full increases when the wholesale market spiked earlier this year had not been passed on to consumers - and so the rapid fall does not mean an immediate cut. They also argue that suppliers have locked in supplies at higher prices and had to do so to secure supplies - thus a sustained period of lower prices is needed before consumer costs fall. Still, as electricity prices are set off the wholesale gas price, a sustained period of lower wholesale costs should filter through to consumers in time.

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But the key point is that wholesale prices remain a multiple of the levels which prevailed for many years. The same trends are evident in the wholesale electricity market , which is heavily influenced by the gas price. There is no going back to the old level of household bills for the foreseeable future and forward prices on the market - the price supplies pay to lock in future gas purchases - are not signalling any further fall in wholesale gas prices over the summer and there is still nervousness looking towards next winter.

The Government is also looking at interventions in the market, capping the price of wind being inputted into the energy mix. Detailed guidelines here have yet to be spelled out. And the Government had floated the possibility of some kind of a price cap for consumers up to a certain price level. It remains to be seen whether this idea progresses if wholesale prices remain at current, lower levels or fall further. But the likelihood is that less well-off households may need longer term support and business supports may also need to be extended, again depending on wholesale trends.

What about businesses?

Business electricity and gas contracts tend to be based more directly on the wholesale market and experience varies across different companies. An IBEC survey showed average increases in gas and electricity bills of 90 per cent and 60 per cent respectively last year. Many face further rises this year as existing contracts and hedging arrangements run out.

Those whose contracts ended last year had the choice of whether to lock in supplies or go on contracts which rely largely on the ups and downs of the wholesale market. Sources say that some big players, wanting certainty for the year, have locked in at the higher levels of £4 a therm or more which prevailed up to recently. Others who took a chance on more variable arrangements have done better in recent weeks.

With the government support scheme now kicking in, smaller businesses in particular will be supported, but like households businesses could see their bottom line hit if these supports are not extended. With wholesale prices falling back, the prospect of further big increases across the business sector may ease for now - though firms exiting existing contracts negotiated before prices started to spike will still see bills rise sharply. And significant uncertainty remains about the outlook .

Do falling wholesale energy prices signal inflation has peaked?

There has been increased confidence in the last few weeks that the inflation peak may be behind us. Based on lower wholesale energy prices, inflation figures in Germany and France have come in significantly lower than expected. The trend in wholesale prices has been helped by a period of remarkably mild weather which has allowed the EU to maintain a lot of its gas storage and by diversification of energy supply. The threat of another price spike this winter seems to have passed, though it is far from clear what the new " normal” for energy prices will be. An EU Commission paper on separating electricity prices from wholesale gas prices - the two are normally tied together under existing rules, given that gas tends to be the swing provider of energy to the market - is promised shortly.

Government supports across Europe have played their part in the recent fall in inflation figures. If wholesale energy markets do not surge again, then the rate of inflation could fall quite quickly going through 2023, with implications for these support programmes and for interest rate policy at the European Central Bank. Food inflation is also falling internationally and the reopening of China removes a threat to supply chains.

One thing to remember, however, is that as with energy, an issue is that even if inflation falls sharply, the higher level of prices we are seeing will remain. Adjusting to this would take some time both for households and businesses and it remains to be seen how quickly the wider inflationary pressures this has unleashed will ease.