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The UK electricity market reform – which are the CFDs to look out for

A new Energy Act to attract private investment to the UK electricity market passed into law in December 2013, and an Electricity Market Reform delivery plan to transform the country to low-carbon energy generation was published. If you’re considering embarking on some CFD related trading in energy investments in the UK and elsewhere, you may be wondering what the new energy strike prices could mean for your portfolio.

The UK government will need huge extra investment to successfully meet its commitment to both 2020 carbon emissions targets and reliable energy provision. The new mechanism to support this is called the Feed-in Tariff: Contract for Difference (CFD), and works by stabilizing revenues to energy generators, allowing them to commit to long-term investment in new, lower-carbon energy infrastructure. Generators receive a an amount needed to restore revenues to their former level, also knows as a top-up, when the market rate is lower than the strike price, and pay out when it’s higher. The government hopes this will encourage both large and smaller investors in cleaner energy generation by making their returns more reliable. It also creates new opportunities which may appeal to investors with a ‘green’ investment agenda.

CFDs have been around since the early 1990s, and became more popular around the turn of the current century when traders realized the potential in their substantial leverage. A small investment can be used to access a large amount of assets, and trading is done on the margin. This can result in huge gains, but also huge losses, and it’s worth noting most professional traders underwrite their CFDs with more predictable futures trading. Their appeal for newer investors is the comparatively low requirements for both capital and commitment.

The new energy funding mechanism is due to commence in 2014-15 and is intended to replace the existing ROCs (Renewable Obligation Certificates) which currently exist to support cleaner energy technologies – a major difference being the inclusion of nuclear energy generation projects in the CFD scheme.

The UK is a world leader in wind power generation, and based on the strike prices issued in December 2013, research suggests investors can expect offshore wind projects commissioned in 2014-18 to yield up to 12% returns – slightly more favorable than those from ROCs, which will continue to be available until 2017. Prices for onshore wind projects have been fixed somewhat lower. Some commentators believe the strike prices will require further refinement before they create a significantly more attractive investment opportunity.

CFD trading can reap rewards but is notoriously risky. If you’re planning to invest through CFDs, always spread your risk to limit your exposure.

Problem 3: Not Looking at All Sides of a Problem

This problem is usually having a point of view on an investment situation where you may have taken someone else’s word on it or never really given the question serious thought. One common financial example of this the use of a financial advisor to assist you in buying and selling stocks, mutual funds, or other investments. Whenever I consider that advice from this kind of source, I ask several questions about the source of the advice. Some basic ones may include the following:

– Does this advisor have anything to gain or lose by my decision?

– Is this advice based on the advisors own expertise or on someone else’s?

– Is this person following their on advice on that issue?

– Is the advice based on a fair analysis or a biased analysis?

– Is it to my advantage to even consider taking this advice?

– If the advisor makes any performance claim, can the claim be backed up?

– Does the advice make sense?

– After further investigation and research on my part, does the advice still make sense?

– Does not following the advice make better sense?

The current rash of mortgage problems in the US, issues like short sales because of underwater mortgages and foreclosures, is one example of this kind of decision problem in action. Many people got into this situation because they didn’t think about the consequences of taking out a home equity loan to buy expensive toys, or the possible negative consequences of an adjustable rate loan.

There are many more questions that one can ask, but the basic point is that every decision can be looked at in more than one way. It is to your advantage to ask a few questions and do at least a little work to understand what may be behind a piece of advice.

Next Lesson: Being Overconfident In Your Predictions

Money Decision Problem 2: Solving the Wrong Problem

You can have the greatest system in the world for analyzing and solving your personal or business money problems, but you would be wasting your time if you were solving the wrong problem. This usually happens if you do not think through a problem before you start to solve it. To understand how to approach a particular problem you should understand at least these things about the problem:

  1. What are the limits to problem at hand?
  2. How do you define a good or a bad outcome to the decision?
  3. How should you measure the outcomes?
  4. What do you bring mentally and psychologically to the decision table?
  5. What are other ways to look at the problem?

A Mutual Fund Example
One example of solving the wrong problem is to pursue a high rate of return from a mutual fund investments without first deciding what kind of comparison or benchmark you should use to determine if the return is high enough. For example, index mutual funds that are designed to mirror the results of the Standard and Poor’s 500 index consistently outperform rough 80% of all mutual funds. The original problem may have been how to choose mutual funds with high returns. A better problem to solve would be how choose mutual funds which consistently perform better than the S&P 500.

Final Thoughts
Remember that most problems involving money usually involve something else besides money or mathematics. If you focus on the parts of the problem that are objective and that can be measured or solved with common with equations and spreadsheets, you may miss the most important part of the problem.

Next Lesson: Not Looking at All Sides of a Problem