EPRG 1112

Giorgia Oggioni and Yves Smeers

Investment Equilibrium Models under Emission Regulation and Different Energy Price Regimes

EPRG 1112 | Non-Technical Summary | PDF

Abstract: We consider an electricity market with two consumer segments subject to different price regimes. We formulate the problem of operations and investment in this market as a spatial equilibrium model where generators can invest in new capacity subject to different regional constraints. Transmission is organized according to a “flow based” approach as foreseen by Regulatory Authorities and System Operators in Europe. CO2 emissions are ruled by an overall cap and trade system where tradable allowances are auctioned. The consumer market in each region is decomposed in two segments: Energy Intensive Industries (EIIs) that participate in the cap and trade system and the rest of the market (N-EIIs). EIIs purchase electricity from dedicated base-load power plants at average cost prices, while N-EIIs are supplied at marginal cost. This organization, currently foreseen in some national laws in Europe, reflects a demand of European EIIs to partially mitigate the burden of emission charges and higher electricity prices due to CO2 regulation. We study two different types of long term average cost based contracts that differ by the organization of transmission. We present the models and discuss their policy implications through a case study applied to the Central Western European electricity market. Their mathematical properties are provided in Appendices. We first assess the impact of the EU-ETS on EIIs and other consumers. EIIs complain about its impact and argue that it can be mitigated through a combined action of the application of average cost based contracts, the elimination of the restrictions on nuclear plants and an improved access to the grid. We first investigate the impact to this better access to the grid by considering a first case with unlimited network resourses. In this case, both EIIs and N-EIIs benefit from investments in nuclear. When inglobing transmission constraints, the situation changes. Average cost based prices decrease generators’ profits in a way that should reduce EIIs’ electricity costs and also decreases overall welfare compared to pure marginal cost pricing. Possibly unexpected for EIIs, the application of long term average cost based contracts does not compensate them for the impact of the EU-ETS. This depends on the investment policies applied at national level. Only harmonization of nuclear investment policies at the European level could relieve EIIs from the EU-ETS burdens.

Keywords: Average Cost Based Contracts, Energy Intensive Industries, EU-ETS, Investments

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