1 Environmental taxation under imperfect competition within electricity auctions with dominant firm Francesco Gullì Università Bocconi, Milano International Energy Workshop (IEW) June 2009, Venezia Liliya Chernyavs’ka ITS, University of Leeds

2 The topic The ability of environmental taxation to reduce carbon emissions in power sector We will try to answer this question by focusing on environmental taxation and power sector Taxation is one of the most important instruments of environmental policy (together with the ETS) Power generation is one of the largest environmentally regulated markets  The performance of the EP significantly depends on power industry behaviour (mainly in the case of carbon emissions) On this topic there is a controversial debate, especially with regard to their relationship with market structures  perfectly competitive markets  Imperfectly competitive markets (endogenous market power)

3 Two questions and related literature How can the EP impact on the degree of market power in electricity markets? Literature:  most contributions adopt exogenous market power and one- shot models (Requate, 2005) How can the EP affect aggregate emissions in the short run? Literature  environmental policy can contribute to increase pollution under certain conditions in terms of demand if there is imperfect competition and firms are sufficiently asymmetric (Levin, 1985; Requate, 2005)

4 Model setting: basic assumptions Environmental regulation. Taxation proportional to emissions. The tax rate is τ. Abatement is impossible (short run analysis). Power demand. Represented by a typical load duration curve Power market. Spot market, uniform first price auction, price threshold (more or less insensitive to the tax rate) Market structure and competition model. Dominant firm facing competitive fringe model Power supply. Two groups of plants, a and b and two technological scenarios - coal versus CCGT plants (Trade-off)

5 Model output: scheme

6 Question1 : Impact on market power

7 Question 2: The impact on aggregate emissions (effects) The EP affects aggregate emissions in the short- run by means of two effects:  The effect due to the change in power prices and consequently in power demand (and production)  The effect due to the possible switch in the merit order of the generating plants Under imperfect competition we have an additional effect:  The effect due to the change in the degree of market power

8 Question 2: The impact on aggregate emissions (results) Proposition. Under imperfect competition and for particular intervals of tax rate, taxation may increase pollution under the following conditions:  with trade-off in the plant mix and  Price threshold sufficiently insensitive to the tax rate Otherwise the EP always decreases emissions, but this decrease may be higher or lower than that under perfect competition depending on the combination of the demand and market power effects, i.e. again depending on the structural factors of power markets Decreasing market power Necessary and almost sufficient condition for increasing pollution

9 Decreasing market power Peak off- change hours On change hours Off-peak off- change hours

10 On-change hours Before taxation After taxation

11 Peak Off-change hours Before taxationAfter taxation

12 Off-peak off-change hours After taxationBefore taxation

13 Increasing emissions Peak off- change hours On change hours Off-peak off- change hours if

14 How likely is this result? Coal vs. CCGT

15 Conclusions With regard to the impact on emissions  Imperfect competition may lessen the emissions reduction compared to perfect competition  If certain conditions are satisfied, under imperfect competition the EP might increase pollution (in the short run) This is more likely to occur:  Under trade-off in the plant mix  If the price threshold is insensitive or low sensitive to the tax- rate  The higher the fuel cost of the least polluting installations Under certain conditions imperfect competition makes it more difficult to achieve the environmental targets Under certain conditions environmental policy can increase pollution. These conditions are not unlikely