2008 / 62 Average power contracts can mitigate carbon leakage

The progressive relocation of part of the Energy Intensive Industries (EIIs) out of Europe is one of the possible consequences of the combination of emission charges and higher electricity prices entailed by the EU-Emission Trading Scheme (EU-ETS). In order to mitigate this effect, EIIs have asked for special power contracts whereby they would be supplied from dedicated power capacities at average (capacity, fuel, transmission and emission allowance) costs. We model this situation on a prototype power system calibrated on four countries of Central Western Europe. In order to capture the main feature of EIIs' demand, we separate the consumer market in two segments: EIIs and the rest. EIIs buy electricity at average cost price while the rest pays marginal cost. We consider two different types of EIIs' contractual arrangements: a single region wide and zonal average cost prices. We also analyze the cases where generators only rely on existing capacities or can invest in new ones. We find that these average cost contracts can indeed partially mitigate the incentive to relocate activities but with quite diverse regional impacts depending on different national power policies. Models are formulated as a non-monotone complementarity problems with endogenous energy, transmission and allowance prices and are implemented in GAMS.