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The enduring role of contracts for difference in risk management and market creation for renewables

Subjects

Abstract

Governments procure renewables through a variety of mechanisms. Contracts for difference (CfDs) have been used for more than 50% of the global offshore wind supply. The payments awarded through CfDs are sometimes labelled subsidies, suggesting that they support uneconomic activity. Here, we argue that the primary role of CfDs is rather risk management by creating a market for electricity supply at stable long-term prices. Similar to its use in other sectors of the economy, this contract type transforms a variable to a fixed price to reallocate volatility risks. Such long-term contracts are often necessary for renewables financing due to limited hedging options in existing markets. Our perspective could imply a shift in perception towards CfDs as a fundamental and lasting market feature. We hope to stimulate a timely discussion about the impact of greater CfD diffusion on electricity market mechanisms, risk allocation and the potential for combining fragmented streams of energy finance, market and policy research.

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Fig. 1: Capital cost intensity of fossil, solar PV and wind assets, and its impact on the merit order.
Fig. 2: Costs of wind and natural gas assets.
Fig. 3: Price exposure and payment flows of common procurement instruments and merchant operations.

Data availability

The data that support the findings of this study are included directly in the figures and table of this article or can be retrieved from the cited studies.

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Acknowledgements

This work constitutes a contribution to the research in the international working group International Energy Agency Technology Collaboration Programme (Wind Task 53: The economics of wind energy). We thank all members of the group for their extraordinary collaboration and essential comments on our work that formed this article. The manuscript was also presented as a working paper during the 2022 Fall Research Conference of the Association for Public Policy Analysis & Management (APPAM), and we appreciate all the valuable feedback from panel participants.

This work was authored in part by the National Renewable Energy Laboratory, operated by Alliance for Sustainable Energy, LLC, for the US Department of Energy (DOE) under contract DE-AC36-08GO28308. Funding was provided by the DOE Office of Energy Efficiency and Renewable Energy Wind Energy Technologies Office. The views expressed in this Perspective do not necessarily represent the views of the DOE or the US Government. The US Government retains and the publisher, by accepting the article for publication, acknowledges that the US Government retains a non-exclusive, paid-up, irrevocable, worldwide license to publish or reproduce the published form of this work, or allow others to do so, for US Government purposes.

The work has been funded in part by the Danish Public Energy Technology Development and Demonstration Programme (EUDP), project number 134-22007.

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P.B., J.G. and L.K. conceived and conceptualized the study and wrote the initial manuscript. M.J. and E.W. edited the manuscript and provided feedback.

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Correspondence to Philipp Beiter.

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Nature Energy thanks Paul Simshauser and the other, anonymous, reviewer(s) for their contribution to the peer review of this work.

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Beiter, P., Guillet, J., Jansen, M. et al. The enduring role of contracts for difference in risk management and market creation for renewables. Nat Energy 9, 20–26 (2024). https://doi.org/10.1038/s41560-023-01401-w

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