EU urged to preserve merchant wind, solar in market reforms

EU rule changes that dictate wind and solar support mechanisms will provide stability but they must not displace commercial contracts and merchant projects that are critical to growth, industry officials said.

Draft power market reforms laid out by the European Commission (EC) on March 14 will require EU members to distribute any state support for renewable energy projects through Contracts for Difference (CFDs). Countries will also be required to make it easier for all business customers to sign long-term power purchase agreements (PPAs) with generators.

CFDs are long-term fixed price contracts where the generator pays the state if wholesale markets rise above the agreed price. The UK has used CFD contracts to soar ahead on offshore wind deployment and France and Spain have rolled out similar schemes in recent years.

The EC's reforms aim to encourage wind and solar growth while also protecting consumers from rocketing energy prices seen since Russia invaded Ukraine. The EU aims to install 39 GW of new wind capacity annually up to 2030, but only 11 GW was built in 2021 and 18 GW per year is expected between 2022 and 2026.

EU leaders have already implemented a temporary EU-wide limit on revenues from renewable energy generation after some operators on other types of contracts yielded windfall profits during unprecedented market volatility.

Germany and several other EU members have also imposed lower national price limits, denting investment in new projects. The EC’s market reforms would block countries from continuing these unilateral caps beyond June 2023 unless it declares an EU price crisis.

Wind industry officials welcomed the reforms but warned the overuse of CFD contracts could hamper market growth and the development of new technologies.

CFDs should remain just “one tool in the toolbox of supporting renewable energy investments,” Christoph Zipf, spokesperson for industry group WindEurope, said.

CFD impact

The market reforms would impose a significant change on Germany's onshore wind market, where the state has instead offered feed-in tariffs that allow operators to capture wholesale prices above tariff levels.

Germany aims to accelerate annual onshore wind installations five-fold to 12 GW by around 2025 and supply 80% of power from renewables by 2030.

                                  New wind installations in Europe in 2022

                                                                     (Click image to enlarge)

Source: WindEurope, February 2023

The stable revenues offered by CFD contracts help attract investment in wind and solar projects. CFDs de-risk the upfront capex required for wind projects by guaranteeing income for a defined period. This helps lower the cost of finance which can represent 80% of project costs, Zipf said.

Developers warn however that a variety of contract options are required to efficiently allocate resources.

Extensive use of CFDs can dampen the market price signals needed to build new capacity on commercial terms, a spokesperson for Norwegian developer Statkraft said.

This can hamper the development of a liquid PPA market and reduce the incentive to develop projects in the best locations or build energy storage, since operators with CFDs are paid whether the power is used or not, the spokesperson said.

Overuse of CFDs also means governments steer the volume and timing of new projects and also the types of technologies, rather than allowing the market to allocate new capacity, the spokesperson warned.

The state support of CFDs also passes more downside price risk onto consumers. Soaring wholesale prices over the last year have seen CFD payments flow towards the state, but prior to recent market disruptions, electricity prices in Europe fell below zero for some hours on the back of rising wind and solar capacity.

Developers may wish to consider whether states might renege on their CFD commitments if electricity prices fall back over the coming years, Georg Zachmann, Senior Fellow at think tank Bruegel, told Reuters Events.

Commercial contracts

Alongside the CFD rules, EU members will have to ensure all customers have access to fixed-price contracts and provide business customers with access to market-based PPA guarantees that address credit risks.

Long-term PPAs provide wind and solar investors with revenue certainty and consumers with a clear price outlook. Estimates vary but around 60% of Europe's current wind and solar capacity may be based on CFDs, state-backed feed in tariffs or long-term commercial PPAs, with around 40% based on short-term PPAs or a 'merchant' arrangement based on spot wholesale prices, according to indicative figures from research group Rystad Energy.

Merchant wind and solar projects play an important role, allowing developers to take advantage of market opportunities and technology innovations and giving them more flexibility in their generation portfolio. By assuming price risk, developers are incentivised to deploy efficiently and drive down project costs.

Developers like different contract options as mandatory CFDs "reduce their options to optimise their cash flows," Zachmann said.

According to Zachmann, overly simplified CFDs may not be the best way to deploy new power generation.

If the system encourages overinvestment in renewable energy, or underinvestment that pushes up wholesale prices, consumers will end up paying more, he said.

Reporting by Neil Ford

Editing by Robin Sayles