PPAs and CfDs - The EU strategy to make electricity bills less dependent on fossil fuel prices by boosting the renewables deployment

Around mid-March this year, the European?Commission published its proposals for the electricity market design reform in response to the record-high wholesale electricity prices experienced across the bloc during 2022 - Reform of the EU electricity market design (europa.eu)

Here, it stays clear that in order to make electricity bills less dependent on short-term fossil fuel prices and boosting the deployment of renewables, two complimentary financial instruments will have an even more important role than before in the European electricity market: long-term Power Purchase Agreement (PPA) and Two-Way Contracts for Difference (CfDs).

What is a Power Purchase Agreement (PPA)?

PPAs are contracts between electricity buyers (typically utilities or corporations) and renewable energy generators. These agreements outline the terms of electricity purchase, including the quantity, price, and duration. PPAs are typically long-term contracts, often spanning 10 to 20 years.

How they help the deployment of renewables?

Providing long-term revenue certainty, mitigating market risks and enhancing project bankability. PPAs enable developers to secure financing at competitive rates, attracting investors and facilitating the implementation of renewable energy projects. By establishing fixed prices and long-term off-take commitments, PPAs provide stability and encourage market access.

What are Two-Way Contracts for Difference (CfDs)?

CfDs are also a financial agreements between renewable energy generators and electricity buyers. Different from PPAs, these contracts focus on providing long-term price stability and reduce investment risks for renewable energy developers.

How do Two-Way CfDs Work?

• Revenue Stabilization: Under a CfD, the renewable energy developer receives a fixed strike price for each unit of electricity generated over a specified period (basically a fixed price at which the electricity will be bought or sold). This ensures a predictable revenue stream, shielding developers from market price fluctuations and taking the uncertainty out of the equation.
• Market Price Adjustment: If the market price of electricity exceeds the strike price, the renewable energy developer must pay the difference back to the buyer. On the other hand, if the market price falls below the strike price, the buyer compensates the developer for the difference. This two-way adjustment mechanism balances the risks and rewards associated with electricity price fluctuations.

Which are the advantages that Two-Way CfDs bring to Renewable Energy Developers?

• Risk Mitigation: By guaranteeing a stable revenue stream, CfDs help reduce the investment risks associated with renewable energy projects. This attracts flows of capital to be invested and encourages developers to pursue ambitious and innovative ventures.
• Project Viability: CfDs enhance the bankability of renewable energy projects. The long-term revenue certainty enables developers to secure financing at competitive rates, fostering the realization of ambitious renewable energy targets - more GWh of capacity installed.
• Technology Progression: The long-term nature of CfDs provides renewable energy developers with the confidence and financial stability required for research and development of new technologies.

Can PPAs and CfDs compliment each other?

Definitely YES, they can be seen as complementary financial instruments that serve different purposes but work together to facilitate renewable energy deployment, for example in areas like:

• Revenue Certainty: PPAs provide long-term revenue certainty to renewable energy developers by securing fixed prices for their electricity, while CfDs further enhance this certainty by offering price stabilization mechanisms.
• Risk Management: CfDs mitigate market risks associated with price fluctuations, reducing investment uncertainty for developers. PPAs, on the other hand, establish direct buyer commitments, minimizing off-taker risks.
• Policy Framework: Governments often implement CfD schemes to incentivize renewable energy investments, while PPAs provide a mechanism for developers to sell their electricity directly to buyers, aligning with sustainability goals.

Overall, long-term PPAs and CfDs are distinct financial instruments, each serving a specific purpose. While PPAs provide revenue certainty and direct buyer relationships, CfDs focus on price stabilization and risk mitigation. Together, they can contribute to creating secure and stable investment conditions for renewable energy developers, enabling the growth of sustainable energy projects.

The next question that comes to my mind is, will this electricity market reform be enough to make renewable investment globally attractive and consequently, reduce the oil price fluctuations in the end-consumer final electricity bill?

Or a more aggressive subsidy scheme support, like the Inflation Reduction Act (IRA) in USA, will be needed to attract and retain renewable developers within Europe?