Analysis of CfD Contracts for Low-Carbon Generation Technology
Governments worldwide are actively pursuing the promotion of low-carbon power generation in response to concerns regarding global warming, energy security, and the volatility of fossil fuel prices. Within the United Kingdom (UK), the primary support mechanism employed to achieve these objectives is the utilization of Contracts for Difference (CfD). Under CfD arrangements, renewable energy asset owners are guaranteed a fixed price for the electricity they generate over a contract period of 15 years. Payments are determined by the disparity between the fixed strike price and the reference market price, with the government providing compensation to producers if the strike price exceeds the reference price, and producers reimbursing the government if the strike price falls below the reference price.
Although conventional CfDs are generally considered as an effective mechanism to provide certainty to investors, bring down the cost of capital, stimulate investment in low carbon technologies and protect consumers from price volatility, they are burdened by certain limitations. One of the most important ones is lack of incentive to respond to price signal and this implies they may not dispatch in the most optimal way for the system. This lack of price exposure also limits the incentive for renewable assets to act more flexibly, for example by co-locating with storage, or providing system services like synthetic inertia.
This research analyses these issues by conducting an extensive literature review of previously proposed solutions to improve CfDs, with a specific focus on incentive compatibility, locational signals, and price responsiveness. Through this review, the strengths and weaknesses of these prior proposals will be identified. Furthermore, the paper aims to explore alternative solutions that effectively decouple payment from actual energy production to enhance the incentive for efficient siting and dispatch of low carbon technologies with CfD contract.
