Contracts for Difference (CFDs): an opportunity for the energy sector

By Gabriela Mancero for the Minas Petróleos & Energía Bar Association

In the Colombian context, Contracts for Difference (CFDs) can be a key tool for encouraging investment in renewable energy and stabilizing electricity prices.

Regulation of CFDs in Colombia

In financial terms, a Contract for Difference (CFD) is a financial derivatives contract. It can be entered into on a number of different products. The largest markets for CFD financial products are currency and interest rate swaps. In derivative contracts, the actual asset, in financial terms, the underlying asset, is not traded. The transaction is purely financial. In CFD contracts, an agreement is established between two parties to exchange payments based on the price of an underlying asset.

The Banco de la República de Colombia is the regulatory authority for foreign exchange matters. As such, it is responsible for supervising the Colombian cross-border derivatives market and the local derivatives market related to foreign exchange transactions. CFDs are generally defined as derivative products that allow investors to take a position on changes in the value of an underlying asset.

In Colombia, CFDs are atypical contracts, not regulated by law. Despite this nature, the Banco de la República has classified CFDs by interpretation as financial derivatives. Investments can be made with both local and foreign agents authorized as so-called authorized foreign agents or online dealers or market makers, as permitted by local regulations.

Foreign agents authorized to carry out derivative transactions with Colombian residents are those non-domiciled entities that have carried out such transactions in the immediately preceding year for a nominal value exceeding USD 1,000,000,000. Despite this requirement, Colombian residents, and not a government entity in Colombia, are responsible for properly assessing compliance with this requirement by foreign agents.

In derivative contracts, the actual asset, in financial terms: the underlying asset, is not traded. The transaction is purely financial.

In Colombia, CFDs can be used to provide stable long-term prices for renewable energy producers, protecting them from the volatility of the electricity market. These contracts allow producers to sell their energy at an agreed fixed price, while the State or a regulatory entity assumes the risk of market fluctuations. It is the movements in the price of the underlying asset that trigger payments between the parties to the contract without the actual asset changing hands, i.e., without physical delivery or transfer of ownership of the electricity. These transactions are carried out on margin, which involves the periodic delivery of money to the agent so that they can continue trading. CFDs can also be used to protect consumers from high electricity prices.

Here are some international examples of the successful use of CFDs in renewable energy:

1. The United Kingdom has been a pioneer in the implementation of CFDs for renewable energy. In the latest round of auctions in 2017, two offshore wind projects were awarded CFD contracts at £57.50/MWh (€64.10/MWh), representing a 50% reduction in the costs of contracts awarded 30 months earlier.
2. The European Commission has proposed a reform of the electricity market that includes the implementation of bidirectional CFDs for new renewable electricity projects and nuclear power plants. These contracts allow the state to compensate the producer if market prices fall below an agreed threshold and to capture the excess revenue if prices exceed that threshold.
3. In Spain, CFDs are used as part of renewable energy auctions to ensure stable long-term prices for renewable energy producers. These contracts are awarded through competitive auctions, where producers bid the lowest price at which they are willing to sell their energy. These examples show how CFDs are increasingly seen as the preferred method for incentivizing investment in low-carbon projects and new technologies, leading to a two-way CFD model being the recommended market mechanism for contracts to be signed in the Colombia Offshore Wind Round led by the National Hydrocarbons Agency (ANH).

When designing CFDs, regulators typically pursue two broad objectives: first, to incentivize investment in renewables in line with the policy objectives of their development plans, and second, to integrate renewables into energy markets with as little distortion as possible. At the same time, the development of the energy system must follow the principles of security of supply and cost minimization. Contracts for Difference can play a crucial role in Colombia’s energy transition by providing price stability and encouraging investment in renewable energy. With an appropriate legal framework and transparent procedures, CFDs can help Colombia achieve its sustainability and energy security goals.