The future DM FER X: key points and issues about the new massive CfD tool for Italian renewables

Tommaso Barbetti, partner of Elemens

Published on Quotidiano Energia in Italian on the 4th of October, 2023

Some consider it dirigiste. Others the pivot around which much of the transition will revolve, “still an improvement over the past.” Still, others see it as a “necessary evil,” and some view it as a pointless measure.

It is excessive to label it divisive, but the future DM Fer X, the significant “incentivization” measure for renewable energy sources that will be approved in the coming months, seems to have stirred various reactions, at least in the debate. We’ve enclosed the term “incentivization” in quotes because access to the mechanisms of DM Fer X won’t necessarily guarantee economic incentivization (meaning access to a higher selling price of energy compared to the market price) to the producer. However, it will certainly offer the producer the opportunity to fix a portion of their revenue with the state, although this price may, in some cases (and reasonably so, at least in the initial years), be lower than the market price.

The mechanism through which this will happen – the two-way contract for differences – is well-known in Italy, having been used, specifically for renewables, in the 2019 DM Fer (also during the crisis with the controversial measure on extra renewable revenues). However, compared to the previous DM Fer, this measure is at least ten times larger. The indicative volumes shown in the consultation (60 GW to be included in the mechanism over the next 5 years) suggest that the majority of the renewable market will pass through here – perhaps even agricultural photovoltaics, which was excluded until now.

So, was this measure really necessary in the “age of market parityā€¯? Is this dirigisme?

With DM Fer X, the system seems to express the concern – explicitly mentioned on multiple public occasions by the authorities – that the market alone may not be able to handle all the risks arising from such rapid and massive growth of renewable sources. In other words, market parity is a dynamic concept, and what seems to be in market parity today might not be tomorrow, due to changes in energy prices triggered by renewables themselves or even by a potential increase in Capex.

It’s also possible that, regarding Power Purchase Agreements (PPAs), the growing pool of potential buyers might not be sufficient, at least in some market phases, to follow the growth trajectory leading to the objectives. This is a risk the government evidently does not want to take.

Paraphrasing the institutions’ possible thought process: if the objective is set by regulation and is not the market equilibrium point, how can the market alone lead to the objective? In this sense, it can’t be said that DM Fer X comes “out of the blue.” Instead, it is the result of a debate that has been ongoing for years and accelerated during the energy crisis.

Some level of regulatory intrusiveness is undeniable (here, as in other provisions such as the decree on suitable areas). However, it seems excessive to speak of dirigisme. Dirigism would be the appropriate term, on the other hand, if DM Fer X were a precursor to future measures aimed at ensuring the state’s “physical” availability of energy to pursue its industrial policy objectives (e.g., energy release). In that case, market space would be compressed significantly.

Once DM Fer X will be approved, will it still be possible to do PPAs?

Certainly, the auctions for CfDs will represent a though “competitor” for the merchant world, especially considering that projects participating in the mechanism will have some competitive advantages over PPAs, such as inflation-adjusted tariff arrangements and almost zero curtailment risk. However, the actual competitiveness will depend on auction base values and the level of participation in the procedures. In our expectations, it’s unlikely that we’ll see 12 consecutive procedures closing with under-subscription again, partly due to the system’s new possibility to adjust tariffs and volumes year by year to adapt to the context.

Furthermore, the possibility is introduced to register only a portion of the plant’s capacity in the CfD procedure, allowing the producer to manage the remaining part in the market. Without going so far as to say that this element could even provide a boost to PPAs, we can state that coexistence on the same project between a CfD, which would facilitate bankability aspects, and a PPA, which would allow for potential market-driven opportunities, would become possible.

Considering the failure of DM Fer – reiterated by the results of the last auction – was it necessary to persist on the same path?

DM Fer X seems better than its predecessor for several reasons, mostly attributable to its greater flexibility, with some elements favoring operators and others favoring the system. Among the former, we’ve already mentioned inflation adjustments, the option to register only a portion of the plant in the auction, and the reduction of curtailment risk. Among the latter, the ability to review volumes and tariffs year by year to avoid over-remuneration and failed auctions. Additionally, DM Fer X will include several location-based signals aimed at directing operators to areas where the system needs them most. These are not zone-based volumes, as many expected (or understood), but rather coefficients (also updated annually) that will prioritize certain areas over others in the ranking. This element could improve the mechanism’s efficiency but is also susceptible to “regulatory errors,” as is inherent in such instruments.

Between the two proposed models (the classic and the “standard profile” model), which will prevail?

In addition to the classic model discussed earlier, DM Fer X introduces an alternative model where the operator accesses the CfD not for all the energy produced but only for the part that fits within a profile chosen by the system (e.g., baseload). In this mechanism, the photovoltaic producer, to access the CfD, would need to produce even at night, using other resources in addition to their own facilities, primarily storage (their own or third-party through time-shifting products resulting from procedures organized by Terna under Article 18).

This mechanism, while more refined, is also more complex and appears to have left many renewable operators cold, as they seem to prefer the certainties offered by the classic model over the standard profile model, which brings with it the initial features of a completely new market design. The consultation document also hints at its gradual integration into the system, to test its actual functioning in the market.