Contracts-for-Difference and Nuclear Flexibility: A Path to Complementing Renewables

Contracts-for-Difference (CfDs) shift the electricity price risk from producers to third parties, typically governments, and have been instrumental in fostering renewable energy investment in liberalized electricity markets. As Western countries turn to CfDs to support new nuclear power plant (NPP) investments, concerns arise regarding their impact on short-term dispatch. By shielding producers from real-time wholesale prices, CfDs can distort dispatch incentives, leading to inefficiencies. Innovative CfD designs have been proposed in the literature to mitigate these effects, some of which have already materialized in some countries. This paper assesses how different CfD designs influence nuclear dispatch decisions in a projected 2040 Central Western Europe electricity market. Using a partial equilibrium model formulated as a Mathematical Program with Equilibrium Constraints (MPEC) and solved as a Mixed Integer Quadratically Constrained Program (MIQCP), we reveal unintended consequences. Notably, a CfD with negative-price interruption can induce NPP operators to reduce availability in moments of soaring prices, resulting in higher general prices than the first-best solution. This results from nuclear plants' limited flexibility: operators must balance producing at low output levels during negative prices with maximizing production at other times to secure the strike price. We show how a non-production-based CfD design can partially alleviate this problem and improve NPPs' short-term dispatch, although we show the latter cannot restore the optimal dispatch either. These findings emphasize the critical importance of careful CfD design and ongoing regulatory oversight as governments expand CfD applications to nuclear power.