Most certainly certain? The Impact of Contract for Difference Design on Renewables' Strike Prices and Electricity Market Risks

TL;DR

This paper examines how different Contract for Difference (CfD) designs influence renewable energy profits and market risks, revealing a trade-off between risk reduction and investment incentives in highly renewable electricity markets.

Contribution

It analytically and numerically evaluates three CfD designs' effects on wind power profits and price volatility, highlighting the trade-offs involved.

Findings

All CfDs reduce market and consumer price volatility.

Capacity-based CfDs with similar reference prices best reduce investor profit volatility.

No significant difference in consumer prices across CfD designs.

Abstract

Weather, technological and regulatory uncertainties expose actors in highly renewable electricity markets to substantial price and volume risks. Two-way Contracts for Difference (CfDs) can mitigate these risks. They stipulate payments between the government and generators of renewable electricity based on the difference of a strike and a reference price, whose definition and unit of payment differ between CfD designs. We study the effect of three different CfD designs on wind power profit and consumer price volatility under the consideration of uncertain market outcomes in a highly renewable, sector-coupled electricity market. First, we analytically derive optimal strike prices under uncertainty. Second, we numerically determine optimal strike prices based on market expectations retrieved from optimising a set of 36 market scenarios in an energy system model. Third, we study the distribution of ex post market revenues, CfD payments and consumer prices across all 36 scenarios. Compared to purely market-based consumer prices and investor profits, we find all CfDs to significantly reduce volatility. For consumer prices, results show no substantial differences between CfD designs. For investor profits, we identify the highest volatility reduction under a capacity-based CfD with a reference price similar to power plants' individual market revenues. Since such a CfD design is known to diminish the effect of price signals on investment decisions, our results reveal a trade-off between incentivising system-friendliness and reducing investor risk.