Under the Knowledge for Reform Action in the Western Balkans (K4R) Programme, supported by the Kingdom of Norway, UNOPS has been providing technical support to Serbia in enhancing its Contracts for Difference (CfDs) for renewable energy generation. These strategic improvements aim to align Serbia's energy support mechanisms with EU market design reforms and international best practices, supporting a more sustainable and efficient energy future.

According to the recent EU Electricity Market Design reform* Contracts for Differences (CfDs) are becoming the main price-support mechanism for electricity produced from renewable energy sources (and in nuclear power plants). As conventional CfDs are currently used to support the deployment of renewable-based generation in the Republic of Serbia, International Partnership Advisor, engaged by UNOPS, has been providing strategic guidance to  the Ministry of Mining and Energy of the Republic of Serbia on how to enhance the design, in line with international best practices.

CfDs are long-term contracts between the electricity system - typically a publicly-owned entity or a private entity entrusted with public functions - and private investors in renewable production capacity (RES producers). CfDs are used to promote investments in renewable-energy generation capacity characterised by a high incidence of fixed sunk costs and long depreciation periods. In fact, CfDs ensure more stable revenue streams in the medium-long term for RES producers, which facilitates the bankability of their projects. CfDs also protect consumers from the volatility of spot market prices, and, more generally, from excessive market prices.

CfDs are not new: they have been used for many years, to support the development of renewable energy, in several European countries - Denmark, France, Greece, Hungary, Ireland, Italy, Poland, Portugal, Spain and the United Kingdom – and elsewhere – Australia and Canada. 

In their conventional design, CfDs incentivise RES producers to maximise the production of the contracted generation plant, regardless of the value for the system of the energy injected into the network. The design of CfDs has therefore increasingly emerged as a crucial aspect in avoiding problems and potential systemic inefficiencies, both at the investment stage and at the operation stage.

At the investment stage, conventional CfDs incentivise the RES producer to choose the type of plant and its location that maximise injections at the lowest cost, even if the chosen solution is not the one that maximises the value of the plant for the system. In fact, conventional CfDs provide no incentive to the RES producer to locate the plant in the areas in which it has a greater value (e.g. wind turbines that produce less energy, but in a deficit area and in a more stable way, or plants associated with storage systems).

At the operation stage, the design of conventional CFDs has been found likely to result in the following inefficiencies:

• promoting a ‘produce and forget’ attitude among RES producers, in the sense that:
• Their production decisions are taken independently of energy market prices, with the sole aim of maximising production volumes (as the net revenue from each unit of electricity produced is fixed at the strike price). In this regards, RES producers may be induced to offer on the market the energy produced by their plants at negative prices, to maximise the likelihood of being dispatched and therefore to be able to produce and inject into the grid as much electricity as possible, as the CfDs protect them from the impact of negative market prices on their revenues;
• they have no incentive to schedule maintenance during periods when the energy value is lower;
• distorting, in certain situations, the next market phases: intraday and balancing markets;
• failing to reduce, and in fact possibly increase, volume risk for the RES producers.

The impact of the conventional design of CfD schemes operating in Europe on the frequency of negative market prices was already highlighted by the EU Agency for the Cooperation of Energy Regulators (ACER) in 2019 - “the increasing number of negative prices is related to the increasing penetration of intermittent RES, […] as long as part of these generators are still subsidised with payments that do not depend on the instantaneous needs of the system”* - and again in 2020 and 2021: “In general, the increasing number of negative prices is related to the increasing penetration of variable RES. This is true especially when part of these generators is subsidised with payments that do not depend on the instantaneous needs of the system. Such situations should be avoided”*. Already in 2014, the European Commission, in establishing conditions for new aid schemes for electricity from renewable energy sources, required that “measures are put in place to ensure that generators have no incentive to generate electricity under negative prices”*. A more general formulation, but to the same effect, was used by the European Commission in its more recent State Aid Guidelines, where, with respect to aid for the reduction and removal of greenhouse gas emissions including through support for renewable energy and energy efficiency, it required that: “The aid must be designed to prevent any undue distortion to the efficient functioning of markets and, in particular, preserve efficient operating incentives and price signals. For instance, beneficiaries should remain exposed to price variation and market risk, unless this undermines the attainment of the objective of the aid. In particular, beneficiaries should not be incentivised to offer their output below their marginal costs and must not receive aid for production in any periods in which the market value of that production is negative”*.

In recent years, therefore, several adjustments have been made to the design of CfDs in various countries aimed at mitigating some of the issues mentioned above. For example, the following design improvements have been introduced:

• The use of reference prices for determining payments under the CfDs based on daily, monthly or annual averages of hourly spot prices. On the one hand, this has mitigated distortions regarding operators' production decisions, but, on the other hand, it has created additional distortions in bidding strategies on the DAM.
• limits on CfD payments in the case of negative prices on the DAM. On the one hand, this has mitigated distortions in producers' bidding behaviour, but on the other hand, it has exacerbated volume risk for the same producers.

Even though the academic literature* agrees that the measures implemented so far in different countries to improve the design of conventional CfDs are not sufficient fully to address the root causes of the identified drawbacks, a number of improvements to the CfD design could be implemented at least to avoid the main distortions.

*Article 19d of Regulation (EU) 2019/943 of the European Parliament and of the Council of 5 June 2019 on the internal market for electricity (recast) as amended by Regulation (EU) 2024/1747 of the European Parliament and of the Council of 13 June 2024 amending Regulations (EU) 2019/942 and (EU) 2019/943 as regards improving the Union’s electricity market design.

 *ACER/CEER, Annual Report on the Results of Monitoring the Internal Electricity and Natural Gas Markets in 2018, Electricity Wholesale Markets Volume, November 2019, Section 2.1, para 58, available at:https://acer.europa.eu/sites/default/files/documents/Publications/ACER%20Market%20Monitoring%20Report%202018%20-%20Electricity%20Wholesale%20Markets%20Volume.pdf. 

 *ACER/CEER, Annual Report on the Results of Monitoring the Internal Electricity and Natural Gas Markets in 2020, Electricity Wholesale Markets Volume, October 2021, Section 3.2, para 117, available at:https://acer.europa.eu/sites/default/files/documents/Publications/ACER%20Market%20Monitoring%20Report%202020%20–%20Electricity%20Wholesale%20Market%20Volume.pdf. 

 *Communication from the Commission, Guidelines on State aid for environmental protection and energy 2014-2020, (2014/C 200/01), Section 3.3.2.1, para 124(c), available at: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52014XC0628(01)&from=EN.

 *Communication from the Commission, Guidelines on State aid for climate, environmental protection and energy 2022, (2022/C 80/01), Section 4.1.4, para 123, available at: https://eur-lex.europa.eu/legal-content/EN/TXT/PDF/?uri=CELEX:52022XC0218(03). 

*See, for instance, Newbery D. (2023). “Efficient Renewable Electricity Support: Designing an Incentive-compatible Support Scheme” The Energy Journal; or Kitzing L., Held A., Gephart M., Wagner F., Anatolitis V., and Klessmann C. (2024), “Contracts-for-Difference to support renewable energy technologies: Considerations for design and implementation”, Research Report, Robert Schuman Centre/Florence School of Regulation, March 2024.