A government-issued contract for difference (CfD) to support industrial decarbonization is an agreement between two parties in which one party (the government) promotes innovative, low-carbon industrial production, and the other (the producer manufacturing the product) seeks price certainty for the clean product. This report is intended to provide U.S. federal policymakers with background on CfD policy and to outline the core details for policymakers to consider when designing a CfD policy to facilitate clean industrial production.
The core feature of a clean industrial CfD is the “strike price”: the per-unit price—usually determined through auction—that a producer requires to manufacture the clean product (e.g., a ton of clean steel). If the market price for this product drops below the strike price, the government pays the difference between the market and strike prices. In a two-sided CfD, if the market price rises above the strike price, the producer pays the government the difference. In either case, there is no exchange of the underlying asset.
An industrial CfD policy has three key functions: (1) to support low-carbon production in cases where the technology is not yet proven or economically competitive; (2) to help producers manage market risks; and (3) to drive innovation and demonstrations of first-of-a-kind (FOAK) and nth-of-a-kind (NOAK) technologies.
CfDs offer three main advantages: (1) They reduce investment risk, thereby attracting (and lowering the cost of) private capital for the deployment of innovative technology. (2) They facilitate price discovery when suppliers bid for support in auctions. (3) They conserve public funds compared to other financial supports.
CfDs also have challenges: (1) Because they guarantee a price floor, they may weaken market incentives in some cases, especially for industrial commodities that can be stockpiled. (2) They focus on auction bid prices and therefore may overlook other policy concerns, such as social and local environmental benefits. (3) There is a risk of overcompensating producers for payments based on average prices. (4) Because CfDs are long-term contracts, they could reduce adaptability to market changes. (5) They may not be well suited for projects focusing on material efficiency and material substitution.
10 key elements for policymakers to consider in CfD design and implementation
1. Core objectives. Is the purpose of the CfD to demonstrate FOAK and NOAK facilities? To maximize near-term emissions reductions? Or both?
2. Eligibility. Which industries can participate, which products are covered, and what are the criteria for eligible products? Should the CfD be placed on the supply side or the demand side?
3. The strike price index. What is the appropriate standard market price index to compare CfD strike prices to? Should the CfD include mechanisms to adjust the strike price over time in response to changes in inflation or the costs of key inputs (such as energy)?
4. Subsidy terms. How will the strike price translate into a subsidy, especially as both the market price and strike price can change over time? Should the subsidy be one-sided, two-sided, or a hybrid, with early termination or capped payback amount options? What mechanisms should be put in place to manage CfD expenditures?
5. Auction design. How will auctions be structured? For example, should contract awards be allocated based solely on strike price, or according to the cost of reducing a unit of greenhouse gases (GHGs), which requires knowing the emission intensity of the proposed project? Effects on bidder incentives and program outcomes require additional research.
6. Non-price factors (NPFs). Will the CfD consider broader social and environmental criteria (NPFs)? If so, how will these criteria be incorporated into the CfD program and auctions? Will they be minimum standards or bonus provisions?
7. Emissions accounting, reporting, and verification. How will the data, methods, and timelines be used in emissions reporting? Will there be requirements for third-party verification? Will emissions be limited to the product, or will they include the product’s full or partial life-cycle assessment?
8. The implementing agency. Will a new implementing agency or agencies be created or will existing ones be utilized? Likely candidates for existing agencies are the Environmental Protection Agency (EPA) and the Department of Energy (DOE); the latter arguably has the strongest capacity in the essential roles and responsibilities of CfD implementation.
9. Interaction with other subsidies. To what extent should incentives be stackable? How should policies be designed to improve access to multiple incentive programs while avoiding double dipping and ensuring cost-effective support for innovative technologies?
10. Legal considerations. Previous papers on CfD policy have observed that U.S. federal law limits the use of CfDs in a number of circumstances. These limitations, however, are not applicable to a low-carbon industrial CfD program provided by the federal government.
Comparing CfDs to similar policy mechanisms
CfDs can be compared to similar policy mechanisms such as production or investment tax credits; green procurement; tradable performance standards, or TPSs; advance market commitments; and carbon pricing via direct taxation or cap and trade. We compare these mechanisms across three broad criteria: benefit to society, benefit to government, and benefit to industry.
Download the research report
| Suggested Citation |
| Look, Wesley, Seton Stiebert, Yuqi Zhu, William Shobe, Benjamin Longstreth, Alan Krupnick, Aaron Bergman, Chris Bataille, and Pavitra Srinivasan. 2025. Contracts for Difference to Spur Clean and Competitive Industry: Options for Federal Policymakers. Washington, DC: ACEEE. www.aceee.org/research-report/i2501. |
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