Interactions between carbon and power markets in transition

Abstract

In this research, several improvements to the European Union Emissions Trading System (EU ETS) were analysed. The EU ETS is a market for emission allowances and the European Union's main instrument for reducing greenhouse gas emissions (of which CO2 is the main component). However, the CO2 allowance price in this market has been highly volatile and generally too low to stimulate significant long-term reductions in CO2 emissions.

National and system-wide price floors and ceilings were investigated, prompted by the UK’s implementation of a CO2 price floor through a supplementary CO2 tax. The effects of the "backloading" of CO2 allowances and the proposed Market Stability Reserve were also investigated. While the latter measures may increase dynamic efficiency, this research showed that a well-designed price corridor is even more efficient, while still achieving the long-term abatement targets and stabilising prices. Furthermore, different methods for adjusting the CO2 emissions cap in response to changes in renewable energy policies were investigated. Finally, the impact of investors' risk aversion on the functioning of the CO2 market was evaluated.

The analyses were conducted with the use of EMLab-Generation, an agent-based model that simulates two interconnected electricity markets with a joint CO2 emissions trading system. In this model, the companies have limited knowledge about the future, which makes it possible to investigate the impact of public policy instruments on long-term investment dynamics.