Natalia Fabra (CEMFI)
As part of the IO seminar, organized jointly by CREST-IPP, Telecom-Paris, and PSAE, Natalia Fabra will present “The Costs of Buyer Counterparty Risk in Long-Term Contracts.”
This paper examines how market efficiency can be distorted by buyer counterparty risk, arising from the possibility that buyers renegotiate long-term contracts under the threat of default. We develop a theoretical model showing that the prospect of renegotiation raises equilibrium prices in the contract market, further increasing the likelihood of renegotiation, and depresses investment. We then assess several policy interventions to promote contract liquidity, including public subsidies, financial guarantees, and collateral requirements. While these tools can mitigate price distortions and stimulate investment, they also introduce trade-offs such as moral hazard, and reliance on costly public funds. These insights are particularly relevant in sectors with capital-intensive, long-lived assets exposed to price volatility, notably in electricity markets, where insufficient contract liquidity may result in underinvestment in renewable generation, slowing down the energy transition, and hindering decarbonization goals. Finally, we simulate the Spanish electricity contract market for solar PV to quantify the model’s predictions.