Contracts for Difference, Bid/Offer Incentives and Efficiency in the Balancing Mechanism

A paper by Market Analysis Ltd. 8 May 2024.  CfDs and the Balancing Mechanism

Abstract: The bidding behavior of CfD supported renewable generators in the Balancing Mechanism is under review by Ofgem for potential breaches of the TCLC. Ofgem believes that these generators’ bids should include avoided CfD repayments when day-ahead market prices are high, passing on these benefits to consumers. Ofgem now proposes to codify this with changes to its TCLC Guidance. However, the distortions to bidding incentives created by these CfDs are by now well understood, and these incentives lead to economic inefficiencies which can increase costs for consumers. Adopting Ofgem’s suggested approach to CfD payments and bid prices would likely exacerbate these distortions to incentives, leading to deviations from merit order dispatch and misaligned prices in the BM. In contrast, the NGESO and Elexon have recognized the potentially high costs of these distortions and are proposing changes to BM cash flows for these generators to rectify this.