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On Thursday, November 29th 2012, the Secretary of State for Energy and Climate Change presented the Introduction of the Energy Bill to the House of Commons.  The Energy Bill has been proposed to facilitate the changes required under the Energy Market Reform (EMR). In chapter 15, in the case study, we discussed the lack of investment in the UK energy generation electricity market due to uncertainty that existed within the regulated market. The new Energy Bill will hopefully resolve some of these uncertainties by providing an opportunity for the industry to use ‘Contracts for Difference’ (www.decc.gov.uk).

 

Contracts for Difference are still under development but the basic idea is that generators will be provided with a set price for electricity, this will be known as the strike price. If the price of electricity is higher than the strike price then the generator will give the incremental back to the government, if the price is lower than the strike price then the government will give the generator the incremental.  The idea behind such contracts is to encourage more investment; this will help to resolve the 110 billion investment gap in the industry in the UK.

Chapter 15 briefly discusses real options theory and this industry is a prime example of real options being used.  With the current uncertainties regarding future policy the investors have, in many cases, made the initial applications for investment but have then decided to sit and wait to see if more certainty will be introduced before making the financial commitment. The Contracts for Difference are part of the certainty the industry was hoping to see to satisfy their future investment in the UK.