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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.

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