Abstract
In well-functioning markets, economic agents are incentivized to take into account all effects of their decisions. Sometimes this is not possible because of externalities. Examples of externalities in energy markers are the environmental effects of using fossil energy and the impact of importing fossil energy on security of supply. This chapter first discusses how the various types of externalities in energy markets distort market outcomes (Sect. 8.2). Then, the chapter goes into the design of environmental taxes (Sect. 8.3), support schemes (Sect. 8.4) and emissions trading schemes (Sect. 8.5), before discussing how these three types of environmental regulation affect electricity markets and how they interact with each other (Sect. 8.6). The chapter concludes by discussing the regulation of security of supply externalities (Sect. 8.7).
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Notes
- 1.
This theory was first formulated by the English economist Pigou.
- 2.
Note that firm D is indifferent between reducing its own emissions and buying allowances when its marginal abatement costs are equal to the carbon price. However, if this firm choses to reduce its own emissions, the market demand for allowances will be lower, resulting in a lower carbon price. Consequently, firm D will have an incentive to buy allowances as its marginal abatement costs exceed the carbon price. This market mechanism makes that the carbon price will actually be below the marginal abatement costs of firm D, but above the one of firm C. If firm D stands for a group of many firms having the same technological options, then the market price in this example will be slightly below 30 euro/tonne, because of the competitive process.
- 3.
- 4.
This is comparable to the usage of the LOLE in the analysis of investments in electricity generation (see Sect. 7.5).
- 5.
- 6.
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Mulder, M. (2023). Externalities in Production and Consumption in Energy Markets. In: Regulation of Energy Markets. Lecture Notes in Energy, vol 80. Springer, Cham. https://doi.org/10.1007/978-3-031-16571-9_8
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