Eurelectric issues guidelines for optimising CfDs to implement EU market reform

The EU electricity market design reform is weeks away from formal adoption. Rapid implementation is now crucial to boost investments at speed to reach net zero and safeguard our energy security, but further guidance is needed on the design of two-way contracts for difference (CfDs). Today, Eurelectric and Compass Lexecon will present guidelines to optimise two-way CfDs to (1) support clean and renewable energy build out, (2) protect consumers while more directly transferring renewables’ benefits, and (3) preserve liquidity in forward markets.

The electricity market reform sets two-way CfDs as the single direct price support mechanism for new clean and renewable capacity. As Member States have different energy mixes, there cannot be a one-size-fits-all contract. This raises questions on how to optimally design this hedging instrument.

“Two-way CfDs are a win-win for both producers and consumers. They can be a very powerful hedging tool but also a risk if not properly designed. Our guidelines aim to make sure these long-term instruments remain market-based, voluntary and balanced in a way that does not drain liquidity from forward markets nor distort the efficiency of short-term markets” – says Eurelectric’s Policy Director Cillian O’Donoghue.

As a long-term contract based on a fixed strike price, two-way CfDs can provide stable revenue streams to generators but leave few incentives to adjust production to short-term prices and demand. To create dispatch incentives, CfDs can leave a degree of exposure to short-term price signals, introduce a floating variable to determine the strike price or link remuneration to other factors besides actual generation such as the capacity or reference production profile of the power plant.

When establishing contractual terms such as strike price, duration and termination, a key challenge lies in effectively distributing risks among generators and consumers. A botched determination of the fixed price can hamper achievement of policy objectives or increase costs for consumers. Balancing risks among parties should be carefully considered.

CfDs are not the only long-term hedging instrument available. Power purchase agreements (PPAs) and bespoke market-based arrangements are other tools that should be used complementarily. Developers should be able to choose which volumes are covered by CfDs through voluntary, competitive and market-based participation.

Eurelectric calls on EU countries to consider these guidelines for a speedy implementation of the electricity market reform.

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Note to Editors:  

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