The fossil gas price rollercoaster witnessed over the last couple of years has underlined the need to get renewables deployed at breakneck speed. At the same time we need tools to protect consumers from big price hikes. Well-designed, two-sided contracts for difference (which we like to call “CfDs”) hit the sweet spot in meeting both of these needs. They are the only support mechanism that protects consumers as well as investors. (For more info, visit our Power System Blueprint deep dives on contracts for difference – Part 1 and Part 2.)
In an effort to make the case for CfDs, Monika Morawiecka (very) patiently outlines RAP’s recommendations to her teenage self.
Snapchatting my hoodies… what do you want?
Hi, little Monika. Time for a quick chat on the topic of contract for differences — you know, CfDs — if you don’t mind.
I’m not little Monika. I’m youthful, idealistic fun Monika.
You’re going to start by telling me what they are, aren’t you? Give me a nudge when you’re done.
Wow, I’d forgotten how obnoxious I was! Anyway… CfDs are when the government organises an auction for a given amount of new renewables — like wind farms — and signs a contract where the government pays top-ups to investors when market prices fall below an agreed price. In return, the renewables investors commit to pay money back when market prices rise above the agreed price. These payments are called “difference payments,” and are why they are called “two-sided.” Competition in the auction is used to identify the lowest price — the ‘strike’ price — that is high enough for investors to go ahead with the renewables investment.
That’s just thrilling, big Monika, we done?
Nope. You see, we think they are great, and we have a few ideas on how we would like governments to put them in practice.
Please, please do tell me more…
First off, they are particularly well suited to addressing challenges we are likely to see over the next few years. By giving investors confidence they can recover the costs of their investments, they lower costs of the massive deployment of renewables. By protecting consumers from scary price hikes, governments don’t have to do things like price caps and other nonsense that do more harm than good. I think it would be great if the European Commission would issue guidelines for good CfD design and consider simplified procedures to get them approved. The aim should be that Member States use two-sided CfDs as the go-to support mechanism for renewables.
Wow! I have just been googling tardigrades. They’re really incredible…
Focus, young Monika.
I am focusing — you see they are really small, like just one millimetre long…
Deep breath. Second, we urge policymakers to resist making CfDs the only route to market. Specifically, this means continuing to allow for investment without any support, and for long-term contracts with (PPAs, aka Power Purchase Agreements). These types of investment do not rely on governments’ auction schedules and can be deployed quicker.
Yay! We’re finished… we are, aren’t we?
Not yet! We have seen recent CfD auctions leading to far fewer contracts for new build than hoped. In part this is because governments set ceiling prices way too low. That’s the maximum price investors are allowed to bid in an auction. If they are set too low, investors just walk away. It’s important that governments take into account real investment costs and interest rates. If those go up – and they have been in recent years, so should ceiling prices.
Finally, we urge policymakers to pay attention to the latest wave of innovative CfD designs that sidestep the pitfalls associated with earlier CfD designs, to help ensure good decisions — of what, where, when and how much — in investment and generation.
Right, so what have you — I mean, we — learned?
That tardigrades can live for centuries — they’re incredible!
Come on, do me proud…
Ok, I have learned that right now there is an opportunity for European institutions and national governments to support the use of well-designed CfDs. These can get renewables out at low cost, and also provide some comfort to consumers in limiting their exposure to wholesale electricity prices when they skyrocket. Grr… I’m looking at YOU, fossil gas! To get these out, European institutions may wish to issue guidelines for good CfD design and consider simplified approval procedures.
Very good, little Monika!
I’m not done. Other routes to market shouldn’t be closed off though — specifically support-free deployment. What you call merchant investment and corporate PPAs should also be encouraged.
Finally, governments should be realistic in setting ceiling prices for auctions — these need to take into account changing market conditions like investment costs and interest rates. But hey — even if we do all this right this does not mean that we’ll get much more renewables quickly, right? We also need to remove obstacles to new build like permitting, grid expansion, and system flexibility etc. Oh, but that’s a different interview?
Right, that’s enough — you big show-off.
*Special thanks for Dominic Scott who inspired these inner dialogues ideas.
**Cover image created with the help of Midjourney AI.