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Glossary · Energy industry & energy transition

Futures and forwards

futures forwards futures market electricity trading price hedging Hedging electricity procurement risk

Futures and forwards are forward contracts on electricity. Two parties agree today on a price for a quantity of electricity that will only be delivered or financially settled later. A contract can relate to individual days, weeks, months, quarters or years. In the electricity market, such transactions mainly serve to limit price risks. This is called hedging. A supplier secures its future procurement costs, an industrial company makes its electricity costs predictable, and a power plant operator fixes the revenues from its future generation. The contracts are traded on the forward market, either on an exchange or over the counter.

Product, delivery profile and quantity

A forward price in euros per megawatt hour says little on its own. One also needs to know which product it refers to. Base and peak products are common. A base product delivers the same output in every hour of the delivery period, for example 1 megawatt around the clock. For German power futures on the EEX, a peak product covers the time from 8 a.m. to 8 p.m. on delivery days. For the standard peak contracts for week, month, quarter or year, these are Monday to Friday. There are also special products, such as weekend peak or an extended block from 6 a.m. to 10 p.m. At other trading venues, public holidays that fall on working days expressly count towards the peak period.

The amount of energy results from output multiplied by time. A base month with 1 megawatt comprises 672 to 744 megawatt hours, depending on the length of the month. In the months with a clock change, it is 743 and 745 respectively. A peak month with 1 megawatt, with 20 to 23 working days of 12 hours each, has only about 240 to 276 megawatt hours. A forward price is therefore only unambiguous once the time profile, delivery period and market area are fixed, for example the German market area.

Future: standardised, exchange-traded, with a central counterparty

A future is a standardised forward contract traded on an exchange. The exchange determines the product, delivery period, contract size, trading hours, last trading day, settlement and collateral. After the trade is concluded, a central counterparty in the form of a clearing house steps in between buyer and seller. It is the contractual counterparty for each side and thus significantly reduces the default risk of the individual counterparty. In return, market participants must post collateral, known as margins. Open positions are valued daily at the current settlement price (mark-to-market). Gains and losses are settled on an ongoing basis as variation margin. In addition, the counterparty requires an upfront collateral deposit, the initial margin.

Futures can be settled financially or physically. For German power futures, financial settlement is common. The reference value is then the average of the prices from the day-ahead auction in the delivery period. Since the day-ahead market has been settled in quarter-hours instead of hours, some exchanges use the mean of the 15-minute prices for this purpose. However, there are also physically settled futures. With these, the electricity is actually delivered to, or taken from, a transmission grid zone in quarter-hour intervals.

Forward: individual, mostly over the counter

A forward is a forward contract that two parties negotiate individually, usually in over-the-counter trading outside the exchange. It can be tailored more closely to actual needs than a future. The contract can specify, for example, the delivery profile, delivery point, period, quantity, price formula, termination rights, creditworthiness requirements and special offtake conditions. This freedom comes at a price: the risk that the counterparty defaults remains in principle with the contracting parties. They limit it by means of framework agreements, credit limits, guarantees or agreed collateral. The line to the exchange is, however, blurred. Many OTC transactions in standard products are subsequently registered with a clearing house and are thus secured like exchange transactions.

Distinction from the spot market, physical delivery and PPAs

On the spot market, electricity is traded for short-term delivery. This includes the day-ahead market for the following day and the intraday market for deliveries on the same day. The spot price shows the short-term value of electricity in a given time interval. It reacts strongly to weather, power plant availability, demand, fuel prices, grid congestion and feed-in from wind and solar. The forward market, by contrast, concerns future delivery periods. Its prices reflect expectations, risk premiums and the need of market participants to hedge.

A forward transaction is not the same as physical delivery from a specific power plant. With financial settlement, only the difference between the agreed price and the reference price is paid. The electricity itself is then procured separately, for example on the spot market. Physical forward transactions also still have to be implemented operationally: they are notified as a schedule and booked in the balancing group. Futures and forwards differ from the power purchase agreement mainly in their purpose. A PPA is often tied to a specific plant, its financing and a long-term offtake commitment. A forward can also run for a long time, but is mostly used for trading and for the risk management of a portfolio.

Significance for electricity prices and investment

Suppliers often buy electricity in stages over months or years. They secure partial quantities in advance, buy further quantities later and balance short-term deviations on the spot market. The electricity price for end customers therefore also depends on when and with what strategy procurement took place. If the spot price falls, the supply price does not necessarily fall immediately. Part of the quantity may have been secured earlier at higher forward prices. Conversely, transactions concluded early protect customers for a time against sudden price spikes.

For generators, forward transactions work in mirror image. Anyone who secures future revenues can plan loans and operating costs more reliably. In return, they forgo additional profits if prices rise later. Forward prices also influence investment decisions. High prices for future delivery years can show that the market expects scarce firm capacity, high fuel and CO₂ costs or political risks. Low prices can point to overcapacity, cheap fuels or large amounts of renewable feed-in. Forward prices are not a reliable forecast, however. They are tradable prices based on today's knowledge.

Hedging is not a cost reduction for the system as a whole

Forward transactions make individual prices more predictable. They do not, however, reduce the actual costs of electricity supply. If fuel or CO₂ prices rise or capacity becomes scarce, this also shows up in forward prices. Anyone who buys today takes on today's market price and thereby avoids later uncertainty. Bottlenecks and costs do not disappear as a result. Hedging therefore does not eliminate price risks, but distributes them among different market participants and over time.

The forward price and the future spot price are also not the same thing. The forward price additionally contains risk premiums, the cost of collateral and the liquidity of the market. The ratio of hedging demand to hedging supply also matters. If many suppliers want to secure quantities at the same time but only a few generators sell, the forward price can rise without the expected generation having changed correspondingly. Both forms of contract tie up capital: exchange-traded futures through margins, OTC forwards through credit lines and collateral.

In crises, this becomes very concrete. An example: a supplier sells electricity for the coming year at a fixed price to its customers and buys futures as a hedge. A distinction is needed here. If market prices rise, the supplier gains on the futures it has bought and receives variation margin. The liquidity risk then hits mainly the seller side, for example a generator that has hedged its production through sold futures. It has to post cash immediately, even though it will only sell the electricity later at the then higher price. For both sides, moreover, the initial margin rises if the exchange raises its requirements because of greater price volatility. In the energy crisis year of 2022, the sharply increased margins led to liquidity bottlenecks at some energy companies. The European securities regulator ESMA therefore expanded, for twelve months, the collateral that central counterparties may accept, such as bank and public guarantees. In such cases the risk often lies less in the final loss than in bridge financing. Price risk is therefore always linked to liquidity risk and credit risk.

Standardisation, liquidity and profile risk

Standardised futures make trading easier: many participants trade the same product, prices are visible, and positions are easier to close out. Actual demand, however, rarely matches a standard product exactly. A factory consumes according to its production schedule, households consume more or less depending on temperature, and a wind farm generates according to the weather. The deviation between the standard product and the real profile is called profile risk. It becomes more important as the shares of wind and solar power grow. A base future secures the average price of a period, but not every quarter-hour. The rest is covered by short-term trading, forecasts, balancing energy, storage and flexibility.

Negative prices do not change this either. A forward product can be traded at a positive average price even if individual time intervals later have negative spot prices. The forward market smooths short-term price fluctuations. The task of balancing generation and consumption in every quarter-hour nevertheless remains.

Supervision and legal framework in the EU

In the EU, electricity futures and forwards generally fall under the REMIT Regulation (EU) No 1227/2011, which was amended in 2024. It applies to wholesale energy products, regardless of where and how they are traded. It covers supply contracts and derivatives relating to electricity produced, traded or delivered in the Union. The regulation prohibits insider trading and market manipulation and sets out reporting obligations. Supply contracts to final consumers count as wholesale products only if the consumer exceeds the threshold set out in the regulation. For electricity derivatives that qualify as financial instruments, financial market law also applies, for example EMIR for clearing, margins and reporting. Which obligations apply in an individual case depends on the type of contract and of market participant.

Classification

In the electricity market, the spot and forward markets share the work. The spot market matches generation and consumption in the short term. The forward market enables price hedging and makes expectations about future scarcity tradable. Technical grid stability is ensured by the grid operators through system services, not by the forward market. This matters for political debates. If end-customer prices fall more slowly than exchange prices, this may be due to procurement timing, contract terms, risk surcharges, grid charges, taxes or levies. Futures and forwards replace neither power plants nor grids or storage. They are neither a forecast nor a guarantee, but contracts with which market participants fix or financially hedge future electricity prices today.

Sources

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Edited by eCMS on 12.11.2026 05:05

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