Risks and Incentives Trade-off in Contracts for Difference Design in EU Power Markets

Authors

Kevin Favre, Fabien Roques, Vincent Rious

Abstract

The electricity market design reform presented in Europe reinforces the role of longterm contracts to ensure revenue stability for private investors and hedge consumers from high electricity prices. Contracts for Differences (CfDs) are long-term contracts signed between a private entity and a public entity on behalf of consumers. CfDs have been historically used to deploy renewables in the power system, but they have shown limitations in terms of incentives. To promote market-based incentives, academics and industry experts have proposed adapted CfD designs based on the disconnection between contractual and generation volumes. In this regard, the paper examines how the volume adjustments to classical CfDs modify incentives and affect the trade-off between incentives and risks for investors. The analysis is realized with a realistic power system modelling of 2030. The paper shows that the split between effective and contractual volume restores market-based incentives in the short and medium term. Furthermore, it shows that incentives come at the cost of a higher exposure to short-term price signals at the expense of a potential higher volatility in revenues. It means that risks are allocated differently between parties. Modelling results highlight a clear trade-off between incentives and risk, depending on the contract investigated and the considered technology. The analysis shows that incentives can be returned in the contract design without significantly increasing producer risks within the limits of the paper. Consequently, depending on the parties.