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Carbon In Electricity Markets

Price transparency will drive GHG reductions.

Fortnightly Magazine - August 2009

programs decrease peak electricity consumption. These programs are based on the economic principle that markets perform well if demand is an active participant in the market in addition to supply. Active participation helps prices reflect the true value of consumption and the marginal cost of supply. Restructured markets accomplish this by providing clear, timely, and transparent price signals that serve as a valuable benchmark for consumers deciding when and how to consume electricity. Also, restructured markets enable customers and demand-response aggregators to participate directly in the market and more fully realize the broad regional value associated with improved efficiencies and reductions in peak demand.

Developments in the ISO-NE market illustrate the significant response to the incentives created in that market; the capacity enrolled in ISO-NE demand-response programs increased nearly fivefold between 2005 and 2008 (see Figure 5) .

Even more demand-response capacity will come on line over the next two years in response to ISO-NE’s incorporation of demand-response capacity into its Forward Capacity Market. 12 The 3,424 MW of new and existing demand response that qualified for the 2010/2011 auction represents 12 percent of the forecasted ISO-NE peak load for the summer of 2010. Approximately, 2,554 MW of demand response cleared in the auction. Hence, demand response resources will represent approximately 9 percent of the 2010 peak load. 13

Restructured markets were created largely to provide price signals that encourage more efficient production and consumption of electricity. Likewise, a cap-and-trade system will harness market reactions to a price ascribed to CO 2 emissions in order to induce a change in how the United States produces and consumes electricity.

Carbon cap-and-trade policies are based on the assumption that the dispatch of electricity generators will reflect the marginal costs of CO 2 emissions and therefore cause a market response. In other words, carbon cap-and-trade policies are based on the premise that market-derived price signals accurately reflect the underlying cost of production.

In competitive electricity markets, prices reflect supply-and-demand conditions at the time electricity is generated and consumed. Thus, competitive markets facilitate the trade-off of all scarce resources, including tradable CO 2 emission allowances, on an equal footing. Competitive electricity markets operating in conjunction with market-priced carbon emissions support the relationship between electricity value and carbon prices. This likely will lead to more accurate price signals in the marketplace, resulting in a preference of both generators and consumers to avoid higher costs, which will achieve the intent of climate-change policy—to reduce CO 2 emissions.

However, evaluating the eventual impact of CO 2 reduction policies requires a detailed examination of how carbon markets interact with the electricity market structure and how this dynamic impacts investment decisions about low carbon energy resources and load-management technologies. In competitive markets, investors and developers bear the risk of investment decisions concerning new generating capacity in order to maximize returns. In regulated markets, investment returns are set by regulators and the risk of investment is borne by ratepayers. Ultimately, if a cap-and-trade system is to shift electricity generation to low-carbon sources, investors will need to be adequately compensated for the risk