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Carbon In Electricity Markets

Price transparency will drive GHG reductions.

Fortnightly Magazine - August 2009

new electric generation capacity that has come into service since the mid-1990s. 4 Hence, competitive electricity markets will play a vital role in the successful implementation of regional and national CO 2 emission programs. Therefore, it’s important to understand the interaction and synergies between competitive electricity markets and market-based GHG policies. In a competitive environment, market-based environmental policies allow emission reductions to be realized at the lowest possible overall cost to society. Markets provide incentives that encourage reductions by the producers and consumers that can achieve the desired reductions most efficiently. The emission reductions and economic efficiencies achieved by the nation’s acid rain cap-and-trade program are well documented. 5

Under the proposed cap-and-trade program, incentives to change the way electricity is produced and consumed will be fundamentally tied to how carbon costs are reflected in electricity prices. The question will be whether or not carbon costs appropriately are aligned and transparent enough to induce electricity producers and consumers to alter their short- and long-term production and consumption decisions. Below are two characterizations—one for electricity production, one for consumption—of a successful regulatory regime for reducing carbon emissions in today’s competitive power market.

Electricity Production : In competitive wholesale markets, power producers will be rewarded financially for lower CO 2 emissions stemming from more efficient production or the use of lower carbon fuels. In the long term, new power plants will be built based on the level of investor confidence that the appropriate return on investment will be achieved, given the level of risk associated with building and operating a respective power plant. Investment will flow more towards renewable and low-carbon generation options as carbon costs reduce the financial attractiveness of higher carbon options.

Electricity Consumption : When wholesale and retail prices of electricity accurately reflect the marginal costs of CO 2 emissions, they will provide the appropriate incentives to consumers. With fuels and electricity priced to reflect their CO 2 emissions, consumers will make the informed economic trade-off decisions envisioned for GHG policies to reduce carbon. For example, accurate fuel and electricity prices ensure that consumer choices among electric, natural gas and oil-fired heating systems appropriately reflect the significant differences in CO 2 emissions associated with each option (see Figure 1) .

This article was adapted from a white paper produced for the COMPETE Coalition by Navigant Consulting, which illustrates the potential effectiveness of market-based incentives for CO 2 reduction by drawing on the historical responses of power plant owners and operators to price signals in competitive regional transmission organization (RTO) and independent system operator (ISO) electricity markets. These responses are evidenced by improved thermal conversion efficiency and increased availability of conventional power plants. In addition, the interaction and potential synergies between a competitive market structure and a market-based approach to reducing CO 2 emissions are exemplified by instances in which complementary price signals for electricity and CO 2 emissions can act in concert, achieving cleaner generation through the dispatch of lower-carbon sources and investment in renewable energy capacity.

Price Signals and Restructured Markets

Competition aligns prices with marginal costs to