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Glossary · Energy industry & energy transition

Contract for Difference (CfD)

Contract for difference CfD strike price electricity market support scheme Investments

A contract for difference is a contract that financially settles the deviation between an agreed price and a reference price. In the electricity market it is commonly called a Contract for Difference, or CfD for short. As a rule, the plant operator continues to sell its electricity on the market itself. If the relevant reference price is below the agreed contract price, the operator receives a compensation payment. Under a two-sided contract, the operator pays the difference back if the reference price is above the contract price. Under a one-sided contract, this repayment does not apply. It then works only like a price floor.

The agreed contract price is usually called the strike price. It is not a physical delivery price but a calculation parameter for hedging revenues. The reference price can be, for example, a spot market price, an average market value of a technology, or another index defined for the purpose. Which price variable is chosen is not a technical side issue. It determines which risks remain with the operator and which pass to the counterparty.

A contract for difference thus separates two levels that are often mixed up in the debate: the physical marketing of electricity and the financial hedging of revenues. The electricity continues to be fed into the electricity market and sold there. In addition, the contract ensures that revenues are stabilised around an agreed value. A CfD therefore does not automatically mean an offtake guarantee, nor that the plant is taken out of the market entirely.

Strike price, reference price and compensation payment

The basic calculation of a two-sided contract for difference is simple. Assume the strike price is 70 euros per megawatt hour, which corresponds to 7 cents per kilowatt hour. If the reference price is 50 euros per megawatt hour, the operator receives 20 euros per megawatt hour as compensation. If the reference price is 90 euros per megawatt hour, the operator pays back 20 euros per megawatt hour. Under a one-sided contract, the operator would likewise receive 20 euros in the first case, but in the second case would have nothing to pay back. It would thus keep all the additional revenue. A two-sided contract therefore smooths revenues both downwards and upwards.

The important point is that only the reference price is hedged, not necessarily the revenue that the individual plant actually achieves. If an operator sells its electricity at times with worse prices than the reference value, this difference remains with the operator. If it achieves better prices, it may keep the advantage. If an hourly or quarter-hourly market price is used as the reference, the settlement closely follows actual price signals. With a monthly or annual average, short-term market incentives remain more strongly with the operator. A technology-specific market value shifts the distribution of volume and profile risks. This is particularly relevant for wind and solar power, because many plants of the same technology produce at the same time and thus lower their own market value. This effect is called the cannibalisation effect.

The strike price can be set by the administration or determined in auctions. In auctions, project developers bid the price at which they want to build and operate a plant. As a rule, the lowest bids win, provided the projects meet the requirements. The contract for difference thus becomes both a support instrument and a procedure that translates investment costs, capital costs and expected market revenues into a competitively determined price. Design parameters such as inflation adjustment, term and volume limits influence which bid a bidder considers viable.

One-sided and two-sided, using the EEG as an example

The German market premium under the EEG 2023 is an example of a one-sided, sliding difference mechanism. The operator markets the electricity directly. The market premium results from the value to be applied (anzulegender Wert) minus the energy-source-specific market value. If the calculation yields a negative value, the premium is set to zero. No repayment therefore takes place. For plants that entered operation or received an award before 2023, the monthly market value generally applies as the reference, and for other plants the annual market value. For wind and solar, this is a spot market price weighted by the generation profile, for example the market value solar. The premium is paid on electricity that is directly marketed and actually fed in.

Distinction from feed-in tariff, PPA and forward market

A contract for difference must be distinguished from a classic feed-in tariff. There, the operator receives a fixed rate per kilowatt hour fed in, regardless of the market price. Marketing is usually handled by the grid operator. A CfD, by contrast, can be designed so that the operator participates in the market itself, for example via direct marketing, and responds to price signals for dispatch, availability and marketing. Whether this succeeds depends on the contract details, however, not on the term alone.

A power purchase agreement (PPA) is also something different. A PPA is a supply or offtake contract, usually multi-year, between generator and buyer. It governs price, volume, term and often the transfer of guarantees of origin, either as physical delivery or on a financial (book-entry) basis. A contract for difference does not require delivery to the counterparty. It can work purely financially, while the electricity is sold on the exchange or under other contracts. Where state CfDs are combined with PPAs, the European Commission recommends a design that avoids cross-subsidisation of the PPA offtaker and distortions in PPA markets.

The state CfD differs from the forward market above all in its institutional role. Futures and forwards can also hedge prices. However, they are traded between market participants and usually run for only a few years. A politically organised contract for difference for new generation plants, by contrast, serves to promote investment. It transfers part of the long-term price risk to a public body, a levy or another central counterparty. The European Commission names forward products, PPAs and two-sided CfDs as the most common long-term instruments in the electricity sector.

Why contracts for difference facilitate investment

Many plants in the power system cost a lot at the outset and comparatively little to operate. This applies in particular to wind power, photovoltaics, nuclear power and large hydropower. For investors, therefore, it is not only the expected average electricity price that matters. What is also decisive is how strongly revenues fluctuate and whether banks regard them as reliable. A project with uncertain revenues has to offer higher returns or obtains worse credit terms.

A contract for difference can reduce this risk. If future revenues are partly hedged, financing costs fall. For capital-intensive technologies, this has a strong effect, because capital costs make up a large part of the levelised cost of electricity. The CfD then works less through higher remuneration than through a different distribution of risk. This can relieve consumers or taxpayers if public hedging is cheaper than private risk premiums.

This effect is not free, however. The price risk does not disappear; it is merely shifted. At low market prices, the counterparty has to pay compensation. At high market prices, repayments flow under two-sided CfDs. For an assessment, the entire term therefore counts, not a single year with particularly high or low prices. A strike price that is too high leads to overcompensation. If it is too low, projects may not be built or may later come under economic pressure.

Market incentives and typical misinterpretations

A common mistake is to see contracts for difference as a complete solution for investment security and market design. A CfD stabilises revenues but does not resolve questions of grid connection, permits, land, supply chains or system integration. A wind plant with a CfD still needs a grid connection, must be integrated into a balancing group and affects the residual load. A solar plant with hedged revenues can also feed in when the local grid is overloaded or the exchange price is very low.

It is equally imprecise to equate contracts for difference with an abolition of the electricity market. The market remains important for dispatch decisions, short-term scarcity signals and balancing supply and demand, as long as the contract rules do not shield these signals. However, a CfD can weaken market signals if operators bear hardly any economic responsibility at negative prices or grid congestion. Support rules therefore often contain provisions on negative prices, direct marketing, availability or curtailment. EU law expressly requires that two-sided CfDs preserve the incentives of comparable unsupported plants to behave in a market-oriented way.

It is particularly important whether compensation is paid on volumes actually generated or on a reference production. Payments on actual feed-in can tempt operators to produce even at a low or negative market value. Payments on a reference volume can prevent this but are more complex and require reliable data. In addition to feed-in-based contracts with one or more strike prices, the EU legislator expressly names minimum prices as well as so-called capability or yardstick models. Under such models, the payment depends on possible generation or on a comparative benchmark. The technical design determines whether a contract for difference facilitates flexibility or creates perverse incentives for rigid feed-in.

Legal framework in the EU and in Germany

With the reform of EU electricity market design through Regulation (EU) 2024/1747, Article 19d was added to the Electricity Internal Market Regulation (EU) 2019/943. Accordingly, from 17 July 2027, direct price support schemes for investments in new plants generating electricity from wind, solar, geothermal, hydropower without a reservoir and nuclear energy must be designed as two-sided contracts for difference or as equivalent schemes with the same effect. For offshore plants connected via hybrid interconnectors, 17 July 2029 applies. The obligation concerns only new contracts with direct price support. Investment grants, tax benefits or storage support are not covered. Member States may pass on the revenues from repayments to final customers. Whether support is permissible under state aid law continues to be examined by the European Commission under state aid law. In December 2025, it published guidance on the design of two-sided CfDs.

In Germany, this requirement is to be implemented with the EEG amendment 2027. The Federal Cabinet adopted the draft on 29 July 2026. The Bundestag debated it as Drucksache 21/7867 in first reading on 24 September 2026, and the Bundesrat has issued its opinion. Under the government draft, the market premium for newly supported plants with an installed capacity of 100 kilowatts or more is to be supplemented by a skimming mechanism, the so-called refinancing contribution (Refinanzierungsbeitrag). If the market value is above the value to be applied, operators must repay additional revenues. The previously one-sided model would thus become a two-sided contract. As of the end of October 2026, the law had not yet been adopted. Section numbers, thresholds and transitional rules may still change in the parliamentary procedure and through state aid approval.

Institutional significance in the power system

Contracts for difference touch several areas at once. They are a support instrument, a financing mechanism, a market rule and a distribution of risk. In the EU, they must be compatible with state aid law, electricity market design and national support laws. In addition, the question arises whether payments run via the state budget, via levies, via a special account or via another settlement body. This determines who bears price risks and how transparently the costs are reported.

For consumers, a CfD is not automatically a burden or a relief. At low market prices, support payments arise. At high market prices, repayments can reduce the costs of the system or be passed on to consumers. Whether the mechanism actually has a smoothing effect depends on the contract volume, price developments, settlement rules and the political use of the returns. Anyone who looks only at the payouts overlooks that two-sided contracts work in both directions.

For generators, the contract for difference changes how revenue risks are handled. It makes them less dependent on long-term electricity price forecasts but can create new regulatory risks. Auction design, indexation, inflation adjustment, term, exit and termination rights as well as sanctions for non-performance become key project parameters. For banks and investors, therefore, it is not only the level of the strike price that matters but the reliability of the entire contractual framework.

In the power system, a contract for difference therefore does not describe a simple fixed price but a rule-based distribution of market price risks. Its effect results from the interplay of strike price, reference price, volume definition, repayment rule, marketing obligations and public settlement. Used precisely, the term shows how investment security can be organised without replacing short-term market coordination. Used imprecisely, it obscures exactly the contract details on which costs, incentives and system effects depend.

Sources

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Edited by eCMS on 11.11.2026 19:03

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