Contracts for Difference Explained

When a supplier quotes you 18p/kWh for electricity, approximately half of that figure has nothing to do with the wholesale cost of the electrons. The UK’s Contracts for Difference scheme has underpinned the construction of most of the renewable generation built in Britain since 2014. The cost of supporting those contracts — the Supplier Obligation Levy recovered from electricity consumers — added approximately £12–15 per MWh to UK business electricity bills in 2024. That figure increases as more CfD-backed capacity comes online. It is one of the least understood line items in any commercial electricity contract, and one of the few that behaves differently depending on whether wholesale prices are rising or falling.

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What a Contract for Difference actually is

A CfD is a government contract between a renewable generator and the Low Carbon Contracts Company (LCCC), a government-owned counterparty. The contract guarantees the generator a fixed “strike price” for every MWh of electricity it produces over a 15-year term. When the wholesale market price (the “reference price”) is below the strike price, the government tops up the difference — providing the revenue certainty that makes long-term project finance possible. When the market price exceeds the strike price, the generator repays the excess to the LCCC.

That repayment mechanism matters and is rarely discussed. In 2022 and 2023, wholesale electricity prices regularly exceeded the strike prices on early CfD contracts, triggering substantial repayment obligations from generators back to the LCCC — which were then passed on to consumers as a reduction in the Supplier Obligation Levy. In periods of high wholesale prices, CfDs act as a partial brake on energy costs. In periods of low wholesale prices, they add to the levy burden. The mechanism is symmetrical, but that symmetry is not always visible in how it reaches a business electricity bill.

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How the levy appears on your contract

The Supplier Obligation Levy is collected by LCCC from electricity suppliers and passed through to business customers either as a visible line item on pass-through contracts or absorbed into the unit rate on all-inclusive fixed contracts. On a pass-through contract, the levy is typically expressed as p/kWh and varies quarterly as the LCCC adjusts the rate to match projected CfD payments. On a fixed all-inclusive contract, the supplier has estimated the levy into your unit rate — you don’t see it change, but the supplier carries the risk of any movement during the contract term.

For a business consuming 500,000 kWh of electricity per year at a levy rate of 1.5p/kWh, the CfD element alone amounts to approximately £7,500 per year. Over a 3-year fixed contract, if levy rates rise materially, that all-inclusive structure protects you. If they fall — as they did in 2022–23 when high wholesale prices triggered generator repayments — a pass-through contract benefits you while a fixed contract doesn’t.

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Why CfDs don’t simply mean cheaper electricity as renewables grow

The logical expectation — that more cheap renewable generation should mean lower electricity prices — collides with how the market is actually structured. Renewables on CfDs are price-takers: they sell into the wholesale market and receive or repay the difference against the strike price. They don’t set the marginal market price directly. That price continues to be set by the most expensive generator dispatched in any given half-hour period, which in the UK remains gas-fired generation during periods of high demand or low renewable output.

More CfD capacity does exert downward pressure on wholesale prices over time — as more generation runs below the marginal cost of gas, the frequency and magnitude of gas-price-driven spikes reduces. But this is a slow structural trend, not a short-term cost reduction, and the Supplier Obligation Levy grows alongside the capacity it supports.

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The procurement connection

For businesses on pass-through contracts, the Supplier Obligation Levy is a live variable. LCCC publishes quarterly levy rates, and these can be modelled forward with reasonable accuracy for short-term budget planning. For businesses on all-inclusive fixed contracts, the levy is embedded in your rate — whether your supplier has priced it accurately is part of the competitiveness assessment Telnergy runs when benchmarking quotes against the market. A supplier with an overly conservative levy estimate will be uncompetitively expensive; one that has underpriced it carries a risk that will eventually appear in its financial position. Understanding what’s embedded in a quoted unit rate — and why — is central to making a genuinely informed procurement decision.

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FAQ

Our electricity contract is fixed all-inclusive. Does the CfD levy affect us during the term? No — your supplier has absorbed the levy risk into your unit rate. If the levy rises during your contract term, your rate stays the same. If it falls, you don’t benefit. This is one of the genuine trade-offs in choosing an all-inclusive contract over a pass-through structure: you gain certainty at the cost of upside exposure to levy reductions. For most SMEs that can’t actively manage pass-through variables, this is the right trade.

How do I find out what the current Supplier Obligation Levy rate is? LCCC publishes the levy rate on its website, updated quarterly. For pass-through contract customers it will appear as a line item on your electricity bill or your supplier’s charges schedule. If you’re unsure what you’re currently paying, your supplier’s account management team can provide the current and historical rates applied to your account.

CfDs are supposed to reduce consumer energy costs over time. Why hasn’t my bill gone down? Because the bill is composed of multiple elements, of which wholesale commodity cost is only one. Even as wholesale prices have moderated from their 2021–22 peaks, the non-commodity cost stack — Capacity Market levy, Supplier Obligation Levy, network charges, BSUoS — has grown. The CfD mechanism does provide downward pressure on wholesale prices structurally, but this effect is offset by the growth of the levy required to fund it. The net impact on your bill depends on the balance between these competing forces in any given period.