Energy price cap methodology: backwardation deadband

What this is about

Ofgem consulted on whether to keep the "backwardation deadband" inside the default tariff cap's wholesale cost allowance. The consultation ran from 27 August to 26 September 2025; the decision was published on 21 November 2025 and removes the deadband entirely, with implementation in cap period 16b (July-September 2026).

The mechanics matter because they govern how much wholesale risk suppliers absorb and how much flows through to billed customers. The cap's wholesale allowance assumes suppliers hedge a year of demand on the forward curve. When the upcoming three-month cap period is more expensive than a full year of forward purchases (backwardation), suppliers carrying that period-specific cost are under-recovered against the cap. Contango is the mirror case: the upcoming period is cheaper than the annual strip, so the hedging-implied allowance over-recovers. The deadband set a threshold: small backwardation or contango stayed with suppliers; only costs or benefits beyond the threshold were passed through to consumers via the cap. Ofgem proposed to remove the threshold and let those costs and benefits flow through in full, recovered on a rolling 12-month basis. Nine suppliers, one consumer group and an individual consumer responded. Industry was broadly supportive; debate focused on timing rather than principle.

The trigger is the persistence and scale of backwardation since 2022. The deadband was calibrated for an era of low, stable wholesale prices, when small deviations between the period cost and the annual cost were noise. Post-invasion volatility turned those deviations into structural features of the curve, and the deadband became a one-sided risk transfer: suppliers absorbing real losses when the curve was backwardated, with no symmetric upside in calm markets. That risk has to be priced somewhere. Either it sits in supplier hedging premia (and ultimately in cap headroom and the EBIT allowance), or it sits with the cap and is recovered explicitly on customer bills. Ofgem's decision is to do the latter: remove the implicit insurance and put the cost on the meter, transparently and time-smoothed.

Options on the table

Remove the deadband, recover over rolling 12 months (decision)

This is what Ofgem consulted on and has now adopted. The threshold is deleted. All backwardation costs and contango benefits flow into the wholesale allowance and are recovered (or returned) over a rolling 12-month window rather than period-by-period. Suppliers get full pass-through of the hedging cost the cap methodology assumes; consumers get the full benefit when the curve flips into contango. The 12-month smoothing prevents single-period spikes from showing up as headline cap movements and reduces the volatility customers see on their direct debits.

Winners: suppliers, who shed a one-sided risk that became material after 2022 and which they were pricing into their cost of capital anyway. Smaller suppliers benefit disproportionately because the deadband risk was harder for them to hedge or to absorb on a thin balance sheet. Consumers, in aggregate over a full cycle, because the symmetric pass-through returns contango benefits they previously did not see, and because lower supplier risk should compress the implicit risk premium baked into other parts of the cap.

Losers: consumers in the specific quarters where backwardation costs are being recovered and the curve has not yet flipped. The rolling 12-month mechanism dampens this but does not eliminate it. The deadband used to act as a small implicit subsidy from supplier balance sheets to billpayers during backwardated quarters; that subsidy is gone.

Keep the deadband (status quo, rejected)

The alternative was leaving the threshold in place. The argument for it is that the deadband forced suppliers to manage small wholesale deviations themselves, which keeps a sliver of pricing discipline inside supplier operations rather than passing every wiggle through to bills. The argument against, which Ofgem accepted, is that since 2022 the "small deviations" assumption has not held. Backwardation has been persistent and large enough that the deadband functioned as a one-way transfer rather than a noise filter, and the resulting risk was being priced into supplier financing and into wider cap allowances anyway. Removing it is cleaner and more transparent.

Remove the deadband on a different timetable

A secondary question in the consultation was when to implement. Ofgem proposed cap period 16b (July-September 2026). Some respondents argued for earlier implementation so suppliers stop carrying the deadband risk through another winter; others argued for later to give time for hedging strategies to adjust. The decision sticks with 16b, which gives roughly seven months of lead time from the November 2025 decision to the July 2026 start.

Questions being asked

The published consultation did not enumerate questions in a numbered list in the public summary text captured here. The consultation invited views on the proposal itself and on implementation timing. The substantive themes respondents engaged with were:

Principle of removing the deadband

Whether removing the threshold is the right response to persistent backwardation, and whether the 12-month rolling recovery is the right smoothing mechanism. (Reading between the lines: this is asking whether the residual risk Ofgem still wants suppliers to absorb is correctly drawn, or whether full pass-through implies the wholesale allowance should be recalibrated elsewhere.)

Customer impact

Whether the bill profile under the new mechanism, with backwardation costs spread over 12 months rather than landing in one quarter, is acceptable in the current cost-of-living context. (This is really asking how much variance reduction is worth versus the loss of the implicit deadband subsidy in backwardated periods.)

Supplier impact and hedging behaviour

Whether removing the deadband changes the optimal hedging strategy under the cap's notional methodology, and whether suppliers can implement the change cleanly by July 2026. (This is asking whether the cap's notional hedging assumption is still a reasonable proxy for what suppliers actually do, given that the deadband was one of the friction points where the notional and the actual diverged.)

Implementation timing

Whether cap period 16b (July-September 2026) is the right start date, or whether implementation should be brought forward (to reduce supplier carry of the deadband risk through another winter) or pushed back (to allow more hedging adjustment time).

Interaction with other cap workstreams

How the deadband decision sits alongside the operating cost review, the debt-related cost allowance work, and the broader question of whether the cap continues to be the right consumer protection vehicle as the retail market normalises. (This is the implicit structural question: every targeted refinement makes the cap more accurate and harder to remove.)

How to respond

The consultation is now closed. It ran from 27 August 2025 to 26 September 2025 and the decision was published on 21 November 2025. Implementation falls in cap period 16b, covering July to September 2026.

For follow-up or accessibility queries on the decision documents (including an alternative format of the wholesale cost allowance methodology annex 2 spreadsheet, which is flagged as not fully accessible), the contact is `priceprotectionpolicy@ofgem.gov.uk`.

The decision documents and full set of consultation responses are published on the Ofgem consultation page:

- *Energy price cap methodology: backwardation deadband decision* (PDF, 237 KB) - *Wholesale cost allowance methodology annex 2: backwardation deadband decision* (XLSX, 9.67 MB) - *Responses to the Energy price cap methodology: backwardation deadband consultation* (ZIP, 3.11 MB) - Original consultation document and the marked-up methodology annex remain available alongside the decision.

The next live workstreams to track are the implementation detail for cap period 16b (any modelling tweaks to the rolling 12-month recovery as the first observations come in) and any consequential changes to the wholesale allowance methodology that follow from removing one of the cap's longest-standing risk-sharing mechanisms.