What is a contract for difference?
Definition
In the energy world, contract for difference is a subsidy model in which both positive and negative deviations from a fixed reference price are paid out to the contractual partner. Contract for difference is also called symmetrical market premium.
Table of Contents
What is the best way to counter price fluctuations on the electricity market with a subsidy system? How do you ensure that asset operators get by in times of low prices, but at the same time do not benefit unduly from the subsidy system in times of high electricity prices? A possible option, as currently used in the UK and France, is the promotion via a so-called contract for difference. This subsidy model defines a fixed minimum remuneration per MWh of electricity. The level of this subsidy rate is usually determined by a tender procedure - similar to the procedure used in the tender for the market premium model in Germany. The subsidy amount determined this way is usually granted for a defined period such as 20 years.
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How does the implementation of the Contract for Difference work?
The operator promoted by this support mechanism feed their electricity into the grid as usual. If the price they achieve on the exchange is below the amount that was specified in the auction, the operator receives the difference from the fixed subsidy amount. If the price is above this reference price, the operator has to pay the difference to the contracting party. In contrast to the German market premium model, this subsidy model is also described as a symmetrical market premium model.
There is currently a discussion as to whether contract for difference solutions might also be a conceivable alternative to PPAs. They would reduce the investment risk and possible costs – which can occur especially with long-term PPAs. Such a support measure would primarily reflect the actual electricity production costs since the projected prices are based on the project and operating costs of a plant rather than market forecasts being used for price formation. This way, a symmetrical market premium would ensure better market integration than a fixed market premium, since it already confronts the operator with price fluctuations during the subsidy period but at the same time still guarantees the market premium for financial security. Both the incentives with regard to system design (revenue optimization) and the incentives with regard to feed-in behavior thus play a more important role in this subsidy model.
