Power prices fluctuate by the second – primarily driven by the availability of renewable energy. Other influencing factors include demand, commodity prices, geopolitics, and regulatory conditions. For market participants such as power producers, consumers, and energy traders, this creates economic risks – especially in terms of market price volatility. Hedging strategies offer a way for them to protect themselves against these risks.
What is Hedging in the Power Market?
Definition: What is Hedging?
Hedging refers to the conclusion of financial or supply contracts that transfer the risk of future price changes from one contracting party - the hedger - to another - the risk taker. For the hedger, the key objective is risk reduction. For the risk taker, hedging represents a method to generate profits by offering a product: risk assumption. Hedges should not be confused with insurance products. One crucial distinction: in hedging, the obligation of the risk taker to perform does not depend on the circumstances under which the insured event occurs. As a result, liability issues with hedges are generally straightforward.
Risk takers generate gains by leveraging their market expertise to profit from buying and selling the relevant products - such as securities, currencies, or power. Typically, a percentage risk premium is added to the volume of the underlying transaction. The term “hedging” has become widely recognized in the context of financial markets (e.g., in stocks, bonds, and foreign exchange), but it is also used for comparable transactions in commodity and energy markets. Here, hedging is particularly relevant in liberalized power markets, where producers and consumers no longer operate at fixed prices and are consequently exposed to market fluctuations to a similar degree.
The term “hedging” is sometimes viewed in a negative light, as so-called hedge funds have at times been used to “hide” high-risk securities in financial markets. In reality, however, hedging can also contribute to market transparency, as risk premiums serve as indicators of market risks. Typical hedging instruments in the power market include long-term Power Purchase Agreements (PPAs) or flexibility purchase agreements (FPAs) - sometimes referred to as virtual batteries - as well as futures market products such as forwards and futures.
We are your trader for renewables and flex assets
Our trading experience and forecasting technology allow us to manage large renewable and flex portfolios at competitive prices.
Who Enters into Hedging Contracts in the Power Market?
In hedging transactions, the contract partners are divided into two sides: the hedgers, who seek to offload a financial risk, and the risk takers, who assume that risk. This process is also referred to as “risk warehousing”..
Hedgers in the PowerMarket
Strictly speaking, hedging means that the hedger does not fully transfer a financial risk, but instead reduces or offsets it through appropriate transactions. Complete price fixes - as were common in the power market for decades - are therefore not, in the strict sense, hedging.
Power Consumers
However, for power consumers, a fixed-price contract does have a hedging effect. This is because, under such agreements, the supplier bears the financial risk of fluctuations in the wholesale power price. Nevertheless, power consumers are increasingly becoming hedgers themselves in genuine hedging transactions. Since the beginning of 2025, power providers have been required to offer - and grant - fully dynamic power tariffs to both commercial and even private customers, provided they have the technical means to support the required measurement frequency.
How a Fixed Price Acts as a 100% Hedge for Consumers
Consumers who signed a fixed-price power contract for two years in mid-2021 could consider themselves fortunate. The market turbulence that would send wholesale power prices to unprecedented highs over the following two years had no impact on their bills. Suppliers, by contrast, were forced to pay exorbitant prices on the exchange to fulfill their delivery obligations - unless they had themselves entered into hedging arrangements.
Looking back, it is not surprising that 2022 saw an especially high number of power providers filing for insolvency. These companies had committed to supplying power at favorable fixed prices, only to find themselves suddenly needing to purchase power at extremely high prices on the exchange. For those suppliers that survived, however, the situation turned into an opportunity: what had been a risk - in business terms, a neutral statistical uncertainty - became a source of profit from mid-2022 onward. High end-customer prices, combined with falling wholesale power prices, resulted in substantial margins for the remaining providers.
With such a tariff, the end customer’s power price is directly tied to the current spot market price and can fluctuate dramatically throughout the day. Consumers with flexible demand can, for example - even without their own PV system - benefit from low power prices on sunny days.
On the other hand, this approach carries the risk of having to pay very high power prices when renewable energy sources are not available and expensive gas-fired power plants must step in to meet demand. With hedged contracts, consumers can determine how much of this price risk they are willing to bear. A partially dynamic tariff - for example, one with upper and lower price limits - would represent such a consumer hedge.
Power Producers
On the other side of the market, power producers face very similar risks. While they generally possess greater market expertise than consumers, even they cannot predict the weather for the coming years - and, in a market with a large share of renewable energy, this is what largely determines future power prices. Consequently, it remains uncertain for producers as well how much revenue they will receive on the spot market per megawatt-hour of power they generate.
Additionally, there is the generation risk - the uncertainty about how much power they will be able to generate. On one hand, this depends on the power demand, which is itself influenced by a wide range of factors, including the overall economic situation and the ongoing electrification of the economy.
On the other hand, the output of individual producers is determined by the weather. Wind and solar power plants can only generate power when these energy sources are available. Conventional power producers must also factor in the price of commodity price and - at least in the EU - the cost of emissions certificates.
Hedges are available to mitigate all of these risks. However, this article focuses on hedging contracts that specifically relate to the trading of power generated from renewable sources.
Suppliers
For a long time, the price risk faced by utilities - such as municipal utilities and private power providers - was comparable to that of large consumers. There is, however, one crucial difference: suppliers have only limited control over their demand, as consumption patterns are largely determined by the behavior of their customers.
Direct control over demand is mostly limited to municipal utilities that operate their own power generation facilities or have significant in-house consumption, for example by running a district heating network with a large-scale heat pump. These utilities can potentially benefit from shifting their consumption to periods with low spot market prices - a strategy known as load shifting.
With the new requirement to offer fully dynamic power tariffs, power suppliers are now able to partially pass on their price risk to customers.
Pumped Storage and Battery Energy Storage Systems
Operators of battery energy storage systems (BESS) and pumped storage power plants also, in a sense, bear the risks of both market sides, since they both buy and sell power. Their advantage is that they have much greater flexibility in choosing when to purchase and store power and when to sell and discharge it. Their main risk is therefore narrow spot market spreads - the difference between power prices at different times of day. However, this is also a price risk that can be limited through hedging.
Risk Takers in the Power Market
Power Producers
Depending on the supply contract, power producers may assume a significant share of price risk. This is the case, for example, when a producer commits to selling a specific quantity of power to a buyer at a predetermined price. If the producer then generates less than the agreed amount, they must purchase the shortfall on the spot market to fulfill their delivery obligations. In doing so, they absorb the spot market price risk on behalf of their customer.
A prominent example of this occurred in 2022 with the French state-owned nuclear power producer EDF. The company had already sold large quantities of power for the year at a low fixed price. However, in that record-high price year, several power plants unexpectedly went offline, forcing EDF to buy the missing volumes at high spot market prices.
Power Traders
Some large energy companies and major consumers have their own power trading divisions - or even dedicated trading companies - that also handle hedging for power production. But aside from these, the main risk takers for hedging contracts in the power market are power traders.
These traders act as intermediaries between producers, storage operators, and consumers, balancing supply gaps from some market participants with surpluses from others. In this way, they not only earn trading profits but also help smooth out balancing groups, ensuring that power supply and demand remain in equilibrium. They leverage their market expertise to take on price risks from hedgers to the extent desired.
One of the most important tasks of traders is thus risk warehousing: they assume price risks from a wide range of parties willing to pay a risk premium, while simultaneously finding other counterparties who are prepared to take on these risks in turn.
What Types of Hedging Exist in the Power Market?
Similar to the securities market, the power market offers a variety of instruments for transferring price risks. Such contracts are typically concluded over-the-counter (OTC), meaning bilaterally, for one or more years. There are also standardized futures contracts traded on power exchanges, which are usually referred to as base load and peak load contracts.
Many market participants combine several types of hedging. These can be part of a single comprehensive contract or arranged in separate agreements with different risk takers.
Base Load and Peak Load
Base load refers to the minimum level of demand that is never undershot over a given period. Accordingly, base load supply contracts involve the delivery of a constant amount of power, supplied every hour of the day over a specified period - such as a quarter or a year. Typically, a fixed power price is also agreed upon, ensuring maximum planning security for both supplier and consumer for this portion of the power supply.
Have Peak and Base Load Tariffs Become Obsolete?
For a long time, a combination of peak and base load was the standard for larger power consumers. This distinction was also crucial for power production, as the operation of power plants was tailored to these patterns. However, with the increasing share of volatile renewable energy sources, the significance of peak and base load has started to fade, while the flexibility of both power consumption and production - particularly through residual power plants (essentially all plants except wind and solar PV) - has become more important.
That said, base and peak load products have not yet become entirely obsolete. This is particularly evident on forward markets, where futures - contracts for future deliveries with lead times ranging from 48 hours up to six years - are still offered with precisely these distinctions.
Similarly, a peak load tariff involves a fixed power delivery during standard business hours on weekdays - typically from 8:00 a.m. to 8:00 p.m. - when commercial and industrial activity is at its highest. Peak load products are generally more expensive than base load products, as demand is greater during these hours and power production must often tap into higher-cost power plants to meet the need. In other words: more expensive generators are activated to cover demand.
Rolling Hedges
Most long-term supply contracts are concluded over-the-counter (OTC). However, futures are also traded on exchanges. This allows to observe how prices evolve over time. Thanks to the law of large numbers, these prices are much less volatile than spot market prices, as they reflect forecasts for future average prices.
Nevertheless, regulatory interventions, economic developments, or geopolitical events can still have a significant impact on futures prices. For example, in the course of 2022, futures for 2023 briefly surged to nearly 1,000 EUR per megawatt-hour (EUR/MWh), following Russia’s large-scale attack on Ukraine.
The price development of baseload futures during 2022 and 2023 clearly shows why rolling hedges are suitable for risk diversification. | Source: EEX via Energy Charts / Fraunhofer Institute für Solare Energiesysteme ISE
A key strategy to mitigate the impact of such developments is the use of "Rolling Hedges." In this approach, market participants do not secure a price hedge for an extended period in one go, but rather in tranches, which they gradually and regularly renew.
For example, a supplier could purchase one-fifth of the baseload demand for the same quarter over the next five years at the start of each quarter. This means they would secure the demand for Q3 2025 by purchasing 20% of it on trading days in July from 2020 to 2024.
Although Rolling Hedges increase the effort involved in procuring power, they significantly reduce the risk of locking in the entire demand at an unfavorable time—something that becomes clear in hindsight. In the example above, the supplier would only have purchased 20% of its baseload demand for July to September 2025 at the extremely high prices in July 2022. While this would still be painful, it could have prevented a potentially catastrophic situation.
Power Purchase Agreement (PPA)
A Power Purchase Agreement (PPA) is an power purchase contract between an operator of a wind or solar plant and a buyer. The buyer could be, for example, a large consumer, an energy supplier, or a direct marketer who resells the power - possibly also as part of another PPA.
The term of a PPA usually spans several years or even decades, offering many opportunities for customization. Almost always, the price risk that inherently affects both parties in the contract is reallocated.
Plant operators enter into PPAs to hedge their investment against market price risks - such as declining market prices for wind and solar power - or to take advantage of high prices. Often, external financiers, such as banks or private equity firms, require these agreements.
An important tool for shifting the price risk is the Contract for Difference (CfD). A base price (underlying) is agreed upon, which then essentially becomes the power price for one of the contract parties. This works in such a way that the hedger pays the hedging party the (positive or negative) difference between the market power price and the base price.
Alternatively, a CfD can be agreed with a price corridor, which runs between a minimum and maximum price. For the hedging party (usually the buyer), the market price applies as long as it stays within the corridor. If the spot market price moves outside the corridor, the minimum or maximum price applies.
This mechanism allows, for instance, solar park operators to protect themselves against negative power prices during midday hours. However, it also means they miss out on lucrative deals when parts of the grid area experience cloud cover or low winds. In a CfD-PPA, both parties act as hedger and risk taker. Several EU countries use this approach to encourage the use of renewable energy.
Another distinguishing feature is the type of power delivery, which can be either physical or syntheti
Physical PPAs
Physical power deliveries can occur "onsite," where there is a direct connection between the generation and consumption facilities, bypassing the public power grid.
However, more commonly, power is not generated where it is consumed. Even if the generation and consumption occur simultaneously according to a schedule, this is still referred to as a physical PPA - though, from a physical standpoint, it is somewhat misleading to call it a physical delivery, since once power flows into the public grid, it becomes indistinguishable.
The power deliveries are then accounted for in a balancing process. This allows industrial companies in North Rhine-Westphalia, for example, to source power from an offshore wind farm.
Synthetic or Virtual PPAs
With synthetic PPAs, generation and consumption are also accounted for in a balancing process. However, the generation and consumption are not directly linked in this case.
Liquid or Tradable PPAs
For all the mentioned types of hedging, a power trader may act as an intermediary. In many cases, they also serve as the hedger for both the generator and the consumer. A special form of hedging, which is essentially only possible with intermediaries, is liquid PPAs. These are long-term power supply agreements that can be traded on trader platforms (such as enmacc) and sometimes on power exchanges.
This can be likened to securities: the underlying values/PPAs remain the same, but they can be easily transferred from one market participant to another without the need to terminate, renegotiate, or sign new contracts. Similar to securities, deliveries can occur "physically" or synthetically.
What are Renewable Shapes?
Renewable Shapes refer to the typical feed-in profiles of renewable energy sources, specifically wind and solar power:
- The nearly daily, more or less bell-shaped generation of solar energy, with a larger "bell" in summer and a smaller one in winter.
- The curve of wind energy generation that rises and falls throughout the year, generally with slightly more feed-in during the winter months than in summer.
Standardized Renewable Shapes are based on weather models from the European Centre for Medium-Range Weather Forecasts (ECMWF) and provide daily forecasts for the power production of an average German wind or PV system for the following day. From these forecasts, indices for price predictions on the Day-Ahead market can also be derived.
Liquid PPAs often adopt the pricing structure of Contract-for-Difference (CfD) PPAs. The underlying assets are indices that reflect the forecasted revenue opportunities for different types of generation, as predicted in the Day-Ahead market.
Such revenue forecast indices for wind and solar power are derived from a transparent methodology based on recognized weather and consumption forecasts. The key models used for this are the so-called Renewable Shapes (see box above) - these represent the typical generation profiles of solar and wind power - as well as empirical grid load profiles for demand forecasting. By combining these, power price predictions can also be derived.
CfDs based on such an index as the underlying significantly reduce the price risk for hedging parties. Simultaneously, the standardization creates competition among hedging providers, ensuring better prices for the hedging party. Additionally, these agreements offer a transparent basis for differential payments.
FPAs - Flexibility Purchase Agreements or Virtual Batteries
A Flexibility Purchase Agreement (FPA), also referred to as a virtual battery, is not a physical energy storage system. Instead, it simulates storage effects by shifting loads through the network and control of numerous decentralized energy installations. These installations can include physical energy storage systems, although this is not a requirement for operating an installation pool as a virtual battery.
From the operator's perspective, a virtual battery is a tool for achieving arbitrage profits, which can also be used as a hedging instrument. Through the flexibility management of the pooled installations, the operator can mathematically shift actual power consumption from customers across different time frames. This allows for the avoidance of very high power prices. However, to compensate for this, the customer must also forgo extremely low prices. Therefore, the price effect for the hedging party is similar to that of a CfD.
Example of Combined Hedging for a Utility
The Stadtwerke Neustadt utility supplies around 50,000 households and businesses with power. They have a base load of 20 megawatts (MW), which corresponds to a total power consumption of 175.2 gigawatt hours (GWh) over 24 hours, 365 days a year. On weekdays, consumption regularly rises to up to 30 MW. The peak load tariff applies on weekdays from 8 a.m. to 8 p.m. The additional 10 MW during this time equates to around 31 GWh.
To cover the demand, the procurement management has used quarterly futures in the base load tariff for 20 MW and the peak load tariff for 10 MW.
The balancing responsibility has been outsourced to an external power trader. The trader’s task is to buy or sell any deviating amounts of power on the power exchange at spot market prices.
Together, baseload and peak load supplies roughly cover demand. Any supply gaps or surpluses must be balanced elsewhere.
Base and Peak Futures are relatively expensive due to their fixed prices and the associated risk premiums. As a result, the company is considering a change in its procurement strategy: moving forward, it intends to take advantage of more affordable wind and solar PPAs while using virtual batteries to hedge against the remaining spot market price risk. Furthermore, the growing flexibility of power demand is becoming evident.
Baseload Coverage: Fixed-Price Hedge with Wind PPA
As a public-sector company, Stadtwerke cannot afford significant price exposure. Therefore, to cover its baseload, it chooses a wind PPA for 70 MW over three years, with a fixed price of 60 EUR/MWh.
Such wind farms deliver a total of 2,500 full-load hours over the year. This would cover the baseload power consumption of the Stadtwerke, which amounts to 175 GWh. However, there will naturally be situations where the wind farm actually generates 70 MW, significantly more than the 20 MW needed by Stadtwerke. Conversely, there will be times when the wind farm produces too little power to cover the baseload.
In these instances, it is the responsibility of Stadtwerke’s power trader to balance the load profile through purchases or sales on the spot market.
Although the amount of power consumed may not always match production, this approach protects Stadtwerke from the risk of market prices rising in the medium term. Any increase in price levels is offset by buying and selling on the spot market.
Peakload Coverage: Fixed-Price Hedge with Solar PPA
To cover the daily peak load, the responsible parties choose a solar PPA for 31 MW with pay-as-forecast deliveries over a three-year term. The PPA includes a fixed price, with a base price of 45 EUR/MWh. For such a PV system, an estimated 1,000 full-load hours are assumed.
This precisely matches the peak load period of the year (12 hours x 5 days x 52 weeks = 1,000 hours). Therefore, the solar PPA should cover the required amount of power. However, solar power does not always come in the right quantity at every moment. The power trader hired by Stadtwerke will need to fill gaps and sell excess power at the spot market.
Despite the PPA at 45 EUR/MWh, Stadtwerke still bear a certain price risk. The cost of power that the trader needs to buy - typically for early morning and evening hours - will be determined only on the spot market. The same applies to the prices that excess power will fetch, particularly when selling during midday hours.
Residual Load Coverage: Spot Market + Virtual Battery
With their hedges in the form of two PPAs, Stadtwerke have already secured a significant portion of their market price risk. The wind PPA covers the baseload annual requirement of 175 GWh, while the solar PPA covers the peak load requirement of 31 GWh per year - both at lower prices compared to conventional futures market products.
Therefore, if the general power price level were to double, Stadtwerke would not be impacted. They would need to purchase power to cover shortages at higher prices during certain times, but would also receive higher prices for excess power generated at other times.
However, even if the general price level remains unchanged, Stadtwerke still face what is known as residual price risk. This is the risk that they will have to sell the overproduced quantities from their PPAs at lower market prices than what it costs to buy back the power they need during other times.
This risk is hedged using a virtual battery. The 20 MW virtual battery draws 20 MWh of power during the cheapest hour of the day (often when there is plenty of sunshine) and supplies it back to Stadtwerke during the most expensive hour. For this flexibility service, providers of the virtual battery charge a fixed price of 140 EUR/MWh.
Example Calculation: The Impact of the Hedges
On a sunny but not very windy day, the PV park generates 20 MWh between 1 p.m. and 2 p.m., and the wind farm contributes another 30 MWh. In total, Stadtwerke receive 50 MWh — 20 MWh more than they need at this time. The electricity price is 0 EUR/MWh due to the high renewable generation.
In the evening, between 7 p.m. and 8 p.m., the demand is still 30 MWh, but the wind has calmed, and only 10 MWh is produced. The sun has already set, so the PV provides no power. Stadtwerke are now short 20 MWh for that hour, and the spot market price is 340 EUR/MWh.
Without the virtual battery, the trader would have to "give away" 20 MWh on the spot market at midday to later buy the same amount back in the evening at a price of 340 EUR/MWh. The total cost of the sales and purchases on the spot market would therefore be 6,800 EUR for the day.
With the virtual battery, however, Stadtwerke "charge" the battery at midday with 20 MWh at 0 EUR/MWh. In the expensive evening hour, they sell the 20 MWh for 340 EUR/MWh (6,800 EUR). They only need to pay the fixed price of 140 EUR/MWh for the virtual battery, plus the 45 EUR/MWh from the solar PPA - a total of 185 EUR/MWh, or 3,700 EUR. The trading profit on the spot market of 6,800 EUR is offset against this cost. Therefore, Stadtwerke make a profit of 3,100 EUR during these two hours.
Komponente | Coverage | Hedging effect |
|---|---|---|
Wind PPA with fixed quantity and fixed price | 70 MW | Baseload |
Solar-PPA (pay-as-produced) | 31 MW | Peakload |
FPA (virtual battery) | 20 MW | Residual load |
Conclusion: Hedging Enables Demand-Driven Risk Management in the Power Market
Hedges are designed to allocate market price risks between parties in such a way that everyone can focus on their core business without jeopardizing their solvency due to unpredictable price risks.
Traders act as intermediaries, assessing risks and, in competition with other market participants, redistributing or assuming those risks to meet the needs of all involved, in exchange for a risk premium.
From Action to Zuccess
Knowledge is Key
Achieving 100% Renewable Energy is a generational task which requires innovation and knowledge on an unprecedented level. We will get faster to 100% Renewable Energy when we as a generation share as much information as possible with each other. This is what we strive for with our School of Flex.
Flex Index
"How much money can I make with a battery?", we get asked a lot. To answer this question, we created the Flex Index, which is a transparent reference for the value of flexibility on the German power market. Check it out...
Videos & Podcasts
Nothing beats first-hand knowledge from experts. Our energy traders and engineers give insights into their job, the market environment they operate in, and what we are working on.
Speaker wanted?
You are on the hunt for a speaker on topics such as power trading, battery energy storage, or the need to balance renewables?
Ask for a speaker and we will send one of our experts to your lecture or conference.
Do you have it in you to be an energy trader?
Find out by taking the ultimate power trader's quiz and answer questions on energy markets and trading strategies!
Discover our Services
FLEXPOWER helps you to bring your portfolio to the energy market. We combine over 25 years of experience in renewables trading in our seasoned team of short-term energy traders. We manage large-scale renewable portfolios and flexible assets with our lean and fully digitized approach.
Say Hi!
CFP FlexPower GmbH
CFP FlexPower GmbH
Lippmannstraße 8
22769 Hamburg
Tel: +49-(0)40-60778-6155
© 2025 CFP FlexPower GmbH