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Designing contracts for the energy transition

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  • Fabra, Natalia
  • Llobet, Gerard

Abstract

This paper examines the limitations of spot markets in providing adequate investment incentives to support zero-carbon investments in electricity markets. In contrast, properly designed long-term contracts have the potential to mitigate price volatility and facilitate the funding of the investments. A theoretical model is developed to analyze contract design under conditions of moral hazard and adverse selection, emphasizing the trade-offs that arise when exposing firms to price and quantity risk. The findings inform optimal contract design for nuclear and renewable energy projects, offering policy recommendations to enhance investment incentives while minimizing productive inefficiencies and excessive rents.

Suggested Citation

  • Fabra, Natalia & Llobet, Gerard, 2025. "Designing contracts for the energy transition," International Journal of Industrial Organization, Elsevier, vol. 102(C).
    • Handle: RePEc:eee:indorg:v:102:y:2025:i:c:s0167718725000396
    DOI: 10.1016/j.ijindorg.2025.103173
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    References listed on IDEAS

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    1. Fabra, Natalia, 2018. "A primer on capacity mechanisms," Energy Economics, Elsevier, vol. 75(C), pages 323-335.
    2. Natalia Fabra & David Rapson & Mar Reguant & Jingyuan Wang, 2021. "Estimating the Elasticity to Real-Time Pricing: Evidence from the Spanish Electricity Market," AEA Papers and Proceedings, American Economic Association, vol. 111, pages 425-429, May.
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    5. Lebeau, Alexis & Petitet, Marie & Quemin, Simon & Saguan, Marcelo, 2024. "Long-term issues with the Energy-Only Market design in the context of deep decarbonization," Energy Economics, Elsevier, vol. 132(C).
    6. Natalia Fabra & Gerard Llobet, 2025. "The Costs of Counterparty Risk in Long-Term Contracts," Working Papers wp2025_2523, CEMFI.
    7. Fabra, Natalia, 2023. "Reforming European electricity markets: Lessons from the energy crisis," Energy Economics, Elsevier, vol. 126(C).
    8. Mats Kröger & Karsten Neuhoff & Jörn C. Richstein, 2022. "Discriminatory Auction Design for Renewable Energy," Discussion Papers of DIW Berlin 2013, DIW Berlin, German Institute for Economic Research.
    9. Kira R. Fabrizio & Nancy L. Rose & Catherine D. Wolfram, 2007. "Do Markets Reduce Costs? Assessing the Impact of Regulatory Restructuring on US Electric Generation Efficiency," American Economic Review, American Economic Association, vol. 97(4), pages 1250-1277, September.
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    Keywords

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    JEL classification:

    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities

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