Using CfDs, PPAs and liquid wholesale markets to combat volatility and high electricity prices

On the night of 13 December 2023, the European Parliament and the Council reached an agreement on the reform of the EU electricity market design: in future, bilateral contracts for difference (CfDs) and long-term power purchase agreements (PPAs) will be used to protect consumers from high and volatile electricity prices. In addition, liquidity on the wholesale electricity markets is to be improved. Consumer protection has also been strengthened with regard to household customers and SMEs. Axpo welcomes the fact that the European Commission has chosen an evolution and not a revolation as part of the reform and generally supports the expansion of liquid wholesale markets in combination with PPAs for renewable energies and appropriate CfDs.

In response to high and volatile electricity prices since summer 2021, but also to a large number of interventions at EU member state level, the European Commission presented plans for a reform of the electricity market design on 14 March 2023. This was supplemented by proposals published on the same day by the European Commission for a reform of REMIT and the ACER-Regulation. Initial fears of the European electricity industry that the existing electricity market design could be subject to radical reform, including the abolition of the merit order principle, have not materialised. The political compromise must now be formally adopted by the European Parliament and Council and could enter into force in June 2024. The reform contains extensive work assignments for the European Commission and ACER, which will need to be completed in the coming years.

Contracts for Difference / CfDs 

CfDs are the core element of the reform. According to the reform, EU member states will in future only be allowed to subsidise electricity production with the help of bilateral contracts for difference (CfDs). The Government gets in between the producer and the consumer and secures a fixed electricity price. If the market price is higher than the agreed electricity price, the revenues above the agreed price go to the state, which must re-distribute them back to the end consumer. However, the state can also invest this money in electricity grids or use it to strengthen the competitiveness of energy-intensive industries. If market prices fall, the state covers the electricity producers' losses up to the agreed price (strike price).

CfDs can be used to subsidise new plants in the areas of wind, solar and hydropower (without storage), geothermal energy and nuclear power. The originally planned exclusivity of CfDs as a means of support was extended to «equivalent» support mechanisms during the legislative process; the European Commission is responsible for determining equivalence. 

Nuclear power as a bone of contention

Particularly in the final phase of the negotiations, the debate within the EU member states was dominated by the question of whether the repowering of existing plants or lifetime extensions could also be subsidised by means of CfDs. This was triggered by France's desire to use CfDs to finance the upcoming investments in the existing nuclear power plant fleet. The compromise reached allows this but provides for the subsidies to be monitored by the European Commission, which is supposed to prevent intra-EU market distortions.

Coal subsidies

In the final phase of the negotiations, Poland was able to push through its request to extend the exemptions for subsidising coal-fired power plants by means of capacity mechanisms, which expire at the end of 2025, by a further three years until the end of 2028. Background: An upper limit of 550gCO2/kWh was introduced as part of the Clean Energy Package in 2019: Fossil-fuelled power plants with emissions above this level are in principle excluded from payments based on capacity mechanisms.

Power purchase agreements / PPAs

In addition to the introduction of CFDs, the reform also provides for the promotion of long-term purchase agreements for renewable electricity; these are also to be made accessible to smaller market participants by giving them access to state guarantees. In addition, the reform provides for the introduction of standardised PPAs contracts, which should also increase their marketability; standardisation remains voluntary.

Liquid wholesale markets

The reform also provides for measures to improve electricity trading; in particular, the supply of long-term, cross-border capacity bookings is to be increased. In future, there is to be an improved range of capacity bookings with a term of up to three years and a respective secondary market.

The reform also includes the possible introduction of so-called "regional virtual hubs": following the Nordic model, synthetic prices are to be introduced across bidding zones. The regional virtual hubs - originally planned as mandatory - are now only intended as an option following a prior impact assessment due to criticism from the electricity industry.

Short-term electricity trading is to be opened up to renewable energies by reducing the gate closure time (GCT) to 30 minutes from 2026. In the area of short-term products, the introduction of so-called peak-shaving products by the transmission system operator is envisaged - limited to the event of a crisis. The peak-shaving-products are intended to remunerate market participants who reduce their consumption at short notice in times of high prices.

Stronger consumer rights

In response to the distortions associated with the sharp rises in retail prices, consumers are now to be given the right to electricity supply contracts with a one-year fixed price guarantee. This supplements their existing entitlement to dynamic supply contracts. The obligation to offer one-year fixed contracts only applies to suppliers with more than 200,000 customers.

From the point of view of the electricity industry, the ban on supply interruptions, even in the event of non-payment, is particularly critical. An earlier clause that provided for companies to claim compensation from the public sector in such cases was cancelled.

The reform introduces the concept of the electricity price crisis as a compromise between the European Commission's long-term goal of exclusively market-based pricing and the numerous interventions by EU member states in price setting during the energy crisis (and before). At the proposal of the European Commission, the Council decides about the existence of a price crisis. The following conditions must be met: (1) the wholesale electricity price is above average, (2) exceeds €180/MWh and (3) household retail prices rise by more than 70% over a certain period. During the electricity price crisis, the electricity price for vulnerable customers may be regulated below the market price; however, this affects a maximum of 70% of the electricity consumption of SMEs and a maximum of 80% of the electricity consumption of households.

As a further element of consumer protection, the reform introduces stress tests through which the electricity supply companies prove to the national energy regulatory authorities that they have suitable hedging strategies in place to (1) fulfil their supply obligations and (2) limit the risk of supply failures as far as possible.

Preliminary wording of the reform of the EU’s electricity market design: