ICIS ANALYST VIEW: The potential of two-way CfDs in the market reform

LONDON (ICIS)–One of the key policies in the European Commission electricity market design reform proposals is for two-way CfDs to be the exclusive form of government support for new renewables.

This will mean many support schemes in Europe (which use predominately feed-in premiums [FIPs]) will have to switch to offering two-way CfDs for new renewable projects.

ADVANTAGES
• Consumer protection against price rises
A CfD can increase consumer protection by allowing the government to capture the difference whenever the market price rises above the strike price, with the revenues returned to consumers.

Since the policy applies only to new renewables, it will not provide any consumer protection in the short-term but can help guard against any high-priced events later in the decade.

• Promotion of subsidy-free capacity through PPAs
Since a CfD prevents the generator from capturing the current upside to prices, many generators may increasingly look for routes to market outside of government auctions to earn higher revenues.

This can help with the development of subsidy-free renewables. Since the full merchant route is still too risky for most, we could see an increasing number of generators wanting to sign PPAs with corporate or supplier buyers.

• Avoids “winner’s curse”
Under a fixed FiP, the generator’s view on future market prices can dictate bidding behaviour in an auction, with those with the most bullish view potentially willing to enter the lowest bids.

This can lead to the “winner’s curse” where market prices turn out lower than expectations, leading to projects being unprofitable.

Under a CfD, the key determinant of bidding behaviour is the strike price needed to make a project profitable compared to costs, which could optimise bidding behaviour.

DISADVANTAGES

• Potential for increased long-term consumer costs
The flip side to the winner’s curse is that fixed FiPs can lead to lower long-term consumer costs than CfDs.

This is because the generator’s ability to capture short-term high market prices can reduce the subsidy level required to make a project profitable.

In the below theoretical example (which uses ICIS capture price forecasts), a wind project in Germany signing a CfD in 2025 at a strike price of €68/MWh would receive the same 20-year income as a fixed FiP project signing at a price of €60/MWh.

The CfD would protect customers between 2025 and 2030, but would then begin to cost consumers more after 2030.

• Reduces auction response to high priced events
If market prices rise, this should incentive increased renewable build-out to benefit from the high prices.

This can still happen via subsidy-free renewables, but since CfDs do not allow generators to capture short-term price increases, there would not necessarily be a market response to a future high-priced event in terms of an increased number of generators entering renewable auctions.