Evaluating the Cost-Competitiveness of Low-Carbon Energy in Future EU Power Markets The Role of Flexibility and Contracts for Difference

Rafael Finck, Derck Koolen, Arnaud Mercier, Marija Miletic, Gonçalo Terça and Andreas Zucker

No 236, European Economy - Discussion Papers from Directorate General Economic and Financial Affairs (DG ECFIN), European Commission

Abstract: The European Union’s goal of achieving climate neutrality by 2050 requires substantial investments in low carbon electricity generation, particularly wind, solar and nuclear power. By 2040, the EU aims for over 90% of electricity to come from low-carbon sources. This study examines the cost-competitiveness of various low carbon technologies in different market environments and the influence of two key mechanims that support their investment and integration in the market: flexibility and long-term contacts. Overall, the cost-competitiveness on a market basis of low-carbon electricity generation is possible but it is sensitive to the cost of capital and the commodity cost of price-setting technologies. Flexibility, which is the ability of assets to adjust energy consumption or production, plays an essential role in the integration of electricity from renewable sources. While flexibility has in general a positive effect on the profitability of low carbon technologies and reduces price volatility, the analysis highlights the clear need to ensure coherence across policies supporting the integration of renewable energy and flexibility. Contracts for Difference (CfDs) are long-term contracts between an electricity generator and a public entity, providing a stable revenue for the generator and protection for consumers from volatile and extreme prices. The strike price of a CfD contract is a key parameter determining the profitability for producers and the cost-effectiveness of the instrument for the public counterparty. The analysis shows that CfD revenues and cash flows largely depend on the potential for the technology to capture (high) market prices, and the level of the agreed strike prices per technology, indicating the importance of competitive auctions to allocate these CfDs.

JEL-codes: Q40 Q42 Q47 Q48 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2025-12
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