In mid-October 2023, the EU energy ministers were able to agree on a Reform of the electricity market agree. In light of the enormous rise in electricity prices in 2022, such price explosions are to be cushioned in future and the expansion of renewable energies is to be driven forward at the same time. Politicians hope to achieve long-term stability on the electricity markets through the uniform and binding introduction of the Contracts for Difference (CfD), the containment of Market premium modelsimproved liquidity on the futures market and a further revival of private power purchase agreements (PPAs).
Contracts for difference (CfD) become mandatory for the expansion of renewable energies
At the heart of the preceding discussion between Germany and France was the handling of the proceeds from the existing contracts for differences. As the nuclear power plants in France are state-owned and have long-term contracts for differences, the German delegation feared that the revenue could be used to subsidize electricity prices - similar to a bridge or industrial electricity price. The compromise that has now been negotiated provides for a European control mechanism before. CfDs are special contracts that serve to manage the risk of fluctuations in electricity prices and stabilize the revenues of renewable energy producers. They are often used by governments or energy regulators in various countries to promote the development of renewable energy projects. In Germany, the generation of electricity from renewable energies is still being promoted via the so-called sliding market premiums and not through contracts for difference, which will now change in the future.
What are contracts for differences?
The basic principle of contracts for difference is that an energy producer, usually a producer of renewable energy such as wind or solar energy, agrees with a fixed price per unit of energy generated (e.g. megawatt hour) is rewarded. This price is called Reference price or strike price, at the start of planning for a renewable energy power plant Fixed in the long term and is generally higher than the current market price for electricity.
If the market price for electricity is lower than the reference price, the producer receives the difference as financial support from the government or another contractual partner. Conversely, if the market price is higher than the reference price, the producer must repay the difference.
In many cases, contracts for difference are awarded as part of tendering procedures in which energy producers submit bids to conclude such contracts. This promotes competition and enables governments to obtain the most favorable conditions for the promotion of renewable energies. CfD systems are currently used in the UK, France and Spain, for example, and have terms of between twelve and 25 years.
Advantages of contracts for difference (CfD):
Long-term planning capability: CfDs enable project developers and energy producers to conclude long-term contracts, which makes it easier to plan and finance energy projects. They protect electricity producers from low prices and consumers from rising prices.
Price certaintyCfDs usually offer a certain price guarantee, as they often contain fixed or index-based prices for the energy supplied. This helps to reduce the price risk for energy producers and end consumers.
Financing-friendlyCfDs facilitate the financing of energy projects as they offer a stable source of income that is attractive to lenders. Overall, this also reduces financing costs.
What is the German "sliding market premium"?
If a system is subsidized by the sliding market premium or the market premium model, the procedure at the start of the project is similar to that for contracts for differences. The electricity producer markets its own electricity itself and receives a market premium as a minimum price. However, it differs in that Possible additional revenue due to increased electricity prices remain with the generator. This means that when electricity prices fall, the system operator is guaranteed a minimum price and when electricity prices rise, he can opt out of the feed-in tariff and market the electricity himself at a profit.
A sliding market premium therefore means that higher prices inevitably also to the be passed on to the end consumer. The more speculative market premium model is currently used to finance around 75 % of all wind power and photovoltaic systems in Germany. Investors do not necessarily only consider the pure investment costs of a plant. They set rather to rising electricity costs and higher profits in the future. These are then included in the overall calculations for the RE plants with the further effect that projects are offered extremely favorably in tenders when electricity prices rise and may not be implemented when electricity prices fall. The volatile electricity prices therefore ensure a Higher investment risk and higher financing costs. Market premium models with feed-in tariffs still exist in France, for example, for offshore wind farms and larger PV systems.
European subsidy models: contracts for difference, market premiums and hybrid forms
There are currently still various subsidy models in Europe, which cannot always be clearly distinguished from one another. In addition to market premium models, there are Quota and certificate models (as in Sweden and until 2021 in Norway) and Investment contributions. For example, Finland and Austria support photovoltaic and hydropower projects through one-off investment grants, while Sweden offers investment contributions for photovoltaics in addition to the certificate system.
There are also differences in the design of the market premium models. For example, market premiums can also be Fixed amounts be structured. In such a model, which Germany, for example, uses for technology-neutral "innovation tenders", the plant operator receives a fixed contribution per kilowatt hour produced. Taking discounting into account, this model approximates to an investment contribution.
With so-called asymmetrical premiums the premium never becomes negative. Plant operators can thus hedge against low electricity prices, but retain the potential for profits if prices rise. This sounds attractive at first, but can lead to more aggressive bidding at auctions as investors focus on profit opportunities and consciously take risks. Indeed, offshore wind projects, for example, have seen bids of zero.
Although some European countries pay Moving market premiums but only for a limited period of time. This means that the investments are exposed to the free market after just 10 or 12 years. In extreme cases, such a premium model is similar to an investment contribution: If the premium is theoretically only paid for one year, it is roughly equivalent to an investment contribution.
Reform of the EU electricity market through contracts for difference and not through market premium models
The upcoming trialogue between the EU Commission, the Parliament and the Council of Ministers on the further development of European energy legislation will therefore promote the expansion of contracts for difference to promote renewable energies and restrict market premium models. This approach is also in line with the recommendation of the German Institute for Economic Research, which was published in a Study from 2022 came to a similar conclusion. According to the final report, consumers could reduce their electricity costs by 800 million euros per year by 2030 and would have saved almost 15 billion euros in 2022 through contracts for difference.
The handling of subsidies for European nuclear and coal-fired power plants will nevertheless lead to further discussions in the trialogue. Cheap nuclear power in particular can quickly lead to distortions of competition on the European electricity markets and coal subsidies should no longer exist. In addition to contracts for difference, the Parliament plans to enable equivalent direct support mechanisms for renewable energies. It also calls for at least 50% of contracts for difference (CfDs) to be awarded via public tenders.