On the Stability of Energy-Only Markets with Government-Initiated Contracts-for-Differences

Rising levels of variable renewable energy (VRE) in Australia&#8217;s National Electricity Market have been driven by a 20% renewable energy target by 2020. This certificated renewable portfolio standard has successfully driven new investment, allocated risk amongst buy- and sell-side market participants and met overall policy objectives. But a policy vacuum for achieving long-term CO₂ emission targets post-2020 has led to sub-national and, potentially, national governments initiating contract-for-differences (CfDs) to drive further investment activity in new plant&#8212;with virtually no coordination between the jurisdictions. In a gross pool energy-only market setting, replacing <i>on-market</i> transactions between retailers and generators with <i>off-market</i> transactions between governments and generators may have unintended side-effects vis-&#224;-vis market stability. In this article, an energy-only gross pool is modeled with rising levels of <i>off-market</i> government-initiated CfDs, with a specific focus on spot and forward contract market outcomes. Model results show that as VRE plant enters, coal plant exit, and <i>on-market</i> firm hedge contracts historically supplied by coal plant are progressively replaced by <i>off-market</i> CfDs. In the event, while a tractable equilibrium can be maintained in the spot market, shortages of &#8220;primary issuance&#8221; hedge contracts emerge in the forward market. Any shortage of hedge contract capacity is likely to raise forward contract price premiums above efficient levels, force price-elastic customers into accepting unwanted spot market exposures and may unintentionally foreclose non-integrated (2nd tier) energy retailers, all of which harms consumer welfare. A wide-ranging program of government CfDs may therefore not be compatible with an energy-only market design.

Abstract licence: CC BY

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