f97.beERIK SCHMIDT’S WORKSHOP
← All terms

Glossary · Energy industry & energy transition

Contract for Difference

Contract for difference CfD strike price electricity market support scheme Investments

Contract for Difference, CfD for short, refers in the electricity market to a contract for differences. An agreed contract price is compared with a market price. The contract price is usually called the strike price. If the relevant reference price is below the strike price, the plant operator receives the difference. With a two-way CfD the opposite direction also applies: if the reference price is above it, the operator pays the difference back. A one-way model only hedges downside. In this way the revenue of a power generation plant is hedged in whole or in part against market fluctuations. EU law broadly describes the two-way CfD as a contract between a plant operator and a counterparty that is usually public. It provides minimum protection of remuneration and at the same time limits excessive revenues.

A CfD does not necessarily sell the electricity physically. The plant can continue to market its electricity on the electricity market; the contract for differences is settled additionally and purely financially. An example with round, freely chosen figures: the strike price is 70 euros per megawatt hour. If the reference price in an hour is 50 euros, the operator receives 20 euros per MWh. If it is 110 euros, the operator pays back 40 euros per MWh under a two-way CfD. If the operator sells its electricity exactly at the reference price, it ends up at 70 euros in both cases. The counterparty holds the mirror-image position. This is a state body or a company commissioned by the state, in Great Britain for example the Low Carbon Contracts Company. When market prices are low it pays the operator; when market prices are high it receives repayments.

Strike price, reference price and actual revenue

The strike price is not a politically set desired price. It is meant to reflect the revenues a project needs to cover investment, operating and financing costs as well as an appropriate return on capital. It is often determined competitively through tenders. Whoever bids a lower strike price is more likely to win an award. However, that bidder then also bears the risk that the bid price does not cover actual costs.

The reference price is the benchmark against which settlement takes place. This choice is not a technical detail. In the British CfD system, the hourly day-ahead price serves as the reference for fluctuating generators such as wind and photovoltaics. For baseload plants such as nuclear power plants or biomass, by contrast, a seasonal forward market price is used. Other systems use monthly or annual averages or technology-specific market values. This matters because a wind farm does not automatically achieve the average exchange price. Many wind plants feed in at the same time and thereby depress prices in windy hours. With photovoltaics the same effect appears in sunny midday hours; this is called the cannibalisation effect. An hourly reference price hedges the operator largely completely. A longer average, by contrast, leaves the operator part of the profile risk and thus also an incentive to generate at more valuable times.

Settlement is usually in euros or pounds per megawatt hour. A classic, production-based CfD therefore refers to electrical energy generated, not to installed capacity. A plant that rarely feeds in accordingly receives fewer payments than an equally large plant with higher electricity production. There are, however, also deviating variants. EU law expressly mentions, among others, CfDs with several strike prices, models with a minimum price and so-called capability or yardstick CfDs. In these variants the payment depends on generation capability or a model variable rather than on the quantity actually fed in. In any case, one point remains important: investment security is not the same as security of supply. A CfD stabilises revenues, but does not guarantee that electricity is available in every hour in which the system needs it.

Distinction from feed-in tariff, market premium, PPA and capacity mechanism

A CfD is often confused with a feed-in tariff. With a classic feed-in tariff the operator receives a fixed price for electricity fed in, regardless of the current market price. Marketing is usually handled by a third party, in Germany the grid operator. With a CfD, marketing on the market remains in place and is supplemented by a financial compensation payment. The market price does not disappear; its fluctuation is distributed contractually.

The CfD is closely related to the sliding market premium. There too, the difference between an applicable value (anzulegender Wert) and a market value is compensated. However, the market premium under the EEG 2023 is one-way. If the market value is above the applicable value, the premium lapses, but the operator may keep the additional revenues. Only the mandatory repayment at high prices turns it into a two-way CfD with a more symmetrical distribution of risk. Questions of design are also decisive: How is the reference price determined? How are negative prices treated? What obligations of direct marketing exist?

A power purchase agreement (PPA) is an electricity supply contract between generator and offtaker. It can likewise hedge prices through fixed prices or price formulas, but is generally a private-law agreement between market participants. A CfD, by contrast, usually serves as a support or hedging instrument with public involvement. Both instruments can coincide. The European Commission recommends designing such combinations so that PPA offtakers are not cross-subsidised and PPA markets are not distorted.

The CfD also differs from a capacity mechanism. A capacity mechanism remunerates the provision of firm capacity. A production-based CfD, by contrast, hedges the price per megawatt hour generated. It thereby reduces investment and revenue risks, but does not automatically solve the problem of sufficient firm capacity in times of high residual load.

Why CfDs are relevant in the electricity system

Wind energy, photovoltaics and nuclear energy have high investment costs and comparatively low variable costs. Such projects are sensitive to revenue uncertainty. If investors do not know what prices they will achieve over twenty or more years, they demand higher risk premiums or do not invest at all. These financing costs ultimately end up in project, support or electricity costs. A CfD can reduce risk premiums by shifting part of the market price risk to a counterparty that can bear this risk more cheaply. The reason for this is not a technical failure of electricity trading. It concerns the gap between long-term investments and short-term price signals.

For consumers and public budgets, the repayment side matters most. A two-way CfD prevents supported plants from keeping windfall profits at very high market prices while being hedged at low prices. Under EU law, Member States may distribute such returns to final customers without this counting as regulation of retail prices. Whether and how this actually happens is governed by the respective national law. A CfD does not generate free electricity; it distributes price risks and payment flows over time.

Legal framework in the EU and in Germany

With the electricity market reform of 2024, Article 19d was inserted into the EU Internal Electricity Market Regulation (EU) 2019/943. The basis is amending Regulation (EU) 2024/1747. Under Article 19d, direct price support schemes for investments in new plants must be designed as two-way CfDs or equivalent schemes with the same effect. This applies to electricity from wind, solar, geothermal, hydropower without reservoir and nuclear energy, from 17 July 2027. For offshore installations at hybrid interconnectors, 17 July 2029 applies. The obligation concerns only direct price support. Investment grants or tax benefits are not covered. The regulation does not prescribe a particular CfD variant. However, the Commission's guidance of December 2025 requires that the plants behave in a market-oriented way. Their incentives should come as close as possible to those of comparable, unsupported generators.

In Germany, this framework is to be implemented with the 2027 amendment of the EEG (Renewable Energy Sources Act). The government bill is before the Bundestag as Drucksache 21/7867. For supported new plants from 100 kilowatts it provides for two-way contracts for difference. Operators remain hedged downside but must hand over part of their additional revenues in high-price phases. According to the sources reviewed, the law had not yet been adopted at the end of October 2026. It also requires state-aid approval from the EU Commission. Details such as thresholds, clawback rate and exit options may therefore still change. Until entry into force, the existing EEG with its one-way market premium applies.

Incentives and misinterpretations

It is often said in shorthand that CfDs make electricity prices predictable. What becomes predictable, however, is above all the revenue of the plants covered. The exchange price continues to fluctuate, shaped by demand, fuel prices, weather, grid congestion and marginal costs. Whether final customers' electricity bills become more stable depends on further rules: on the passing on of returns, on tariff design and on grid charges, taxes and levies.

For market integration, too, design matters. CfDs preserve market incentives if operators must continue to respond to prices, for example in maintenance planning, in combination with storage or in feeding in during hours with negative electricity prices. If, by contrast, the payment compensates every loss, it pays to keep producing even at negative prices. Many designs therefore suspend or limit payments in such hours. Something similar applies to location. A uniform reference price does not recognise whether a plant is located in a grid area with frequent congestion. The consequences can be additional redispatch and curtailment. A CfD does not replace grid planning or locational signals.

In industry the term is used more broadly. Carbon contracts for difference do not hedge the electricity price but the additional costs of climate-friendly production compared with a fossil reference, often including the CO₂ price. The mechanism resembles the electricity CfD, but the underlying benchmark is different.

Institutional design

The effect of a CfD depends on rules that often appear as side issues in the debate. These include the term, adjustment for inflation, the treatment of outages and the obligation of direct marketing. Equally important are the calculation of the reference price, the financing of payouts, the use of returns and contractual penalties for non-realisation. Each of these rules shifts risks. A long term lowers financing costs but ties up fiscal room for manoeuvre. A high strike price makes projects possible but increases the burden at low prices. A very low strike price makes tenders look cheap but carries the risk that projects are never built. Strict repayment rules protect consumers but can make private hedging transactions such as PPAs more difficult.

A contract for difference is thus not a technology but a rule for hedging revenue. The term is used precisely only when strike price, reference price, settlement basis, repayment obligation and risk bearer are named. Without these details, "CfD" remains a collective label for very different interventions in investment incentives and price risks.

Sources

Related glossary entries

Edited by eCMS on 11.11.2026 17:57

© 2026 Erik Schmidt. All rights reserved. Quotations with a link to the source are welcome.