To accelerate the development of RES and carbon-neutral generation required for the energy transition, public support schemes will likely continue to play a role in the coming years. The provisionally agreed legislative proposals to reform of European Electricity Market Design, which will enter into force this year, prescribe two-sided Contracts for Difference (CfDs) as the default option for Member States to support RES and carbon-neutral generation.

As recognised by the new European Regulation, the design of such support schemes can significantly impact system operations as well as the functioning of wholesale and balancing markets. ENTSO-E published a position paper that aims to inform policymakers and relevant stakeholders of the potential impact of two-sided CfDs on system operations and market efficiency, and how an improved CfDs design can help mitigate such risks.

The paper describes several designs, which are assessed according to four main criteria:

        • Bidding behaviour and dispatch: to what extent efficient incentives are provided for participation in the day-ahead, intraday and balancing market.
        • Asset design and siting: to what extent efficient incentives are provided to maximise the market value of electricity rather than maximise production volume to earn higher return from subsidies.
        • Risk hedging: to what extent price and volume risks for generators can be hedged.
        • Regulatory risk: to what extent changes in the design of support schemes/instruments bring about changes for market parties

From­ a­ system­ operator­ point­ of­ view,­ the­ first­ criterion­ carries the most weight. Good performance in this aspect ensures efficient behaviour by the generator, which should make such assets valuable contributors to a secure and cost-efficient system. Designs that do not satisfy this crite- rion will require counter measures, that may be costly and must ultimately be paid for by consumers. Production based CfDs take the actual injection of the supported generator as reference volume. It is the most common metric for existing support schemes. Within this category, it is possible to further distinguish based on refer- ence price calculation. However, any of the options retain important market distortions.

The paper also investigated strike price, and revenue cap and­floor­models. It concludes no tangible advantage for a strike price cap and floor. The revenue cap and floor might avoid market distortions, but seems complicated to put in place as it requires an exhaustive view on revenues for each generator. This is expected to come at a high regulatory risk. In addition, it will not incentivise efficient asset design or siting.

The effect CfDs have on forward markets can also be reduced by providing an opportunity for commercial Power Purchasing Agreements in a CfD tender. That way, consumers with an interest in such hedging products have the opportunity to establish them before the developer enters into a long-term CfD with the state and this volume is excluded from the commercial PPA market. The paper presents two possible models for coexistence: the Carve-Out and the Two-Stage Tender. Both should inherently favour volumes developed under commercial PPAs, but either option should carefully assess the end goal of the tender as well as potential gaming risks (which is a matter of the detailed design). Volume developed under commercial PPAs should not lead to bidding/dispatch distortions and incentivise effi- cient asset design, since the full cost of inefficient choices falls on commercial actors. The latter is, however, an essen- tial prerequisite. If the project continues to receive some form of support (even though it is branded as a commercial PPA), elaborate consideration on potential distortions is required, as for the two-sided contracts for difference design discussed in this paper.

Read more insights here.

Source: ENTSO-E