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Integrating Thermal and Hydro Electricity Markets: Economic and Environmental Costs of not Harmonizing Pricing Rules

Open Access Article

Abstract:
The electricity sector is the largest source of greenhouse gases (GHG) emissions in the world, and reducing these emissions can often be costly. However, because electricity markets remain integrated at a shallow level (with different pricing regulations), many gains from deeper integration (adoption of marginal cost pricing everywhere) are yet to be realized. This paper assesses the benefits of deep integration between a "hydro" jurisdiction and a "thermal" one. It also underscores the inefficiency of trade when pricing rules differ. Our detailed hourly model, calibrated with real data from the provinces of Ontario and Quebec, Canada, estimates price, consumption, emissions and welfare changes associated with fully integrating electricity markets, under transmission constraints. A negative abatement cost of $37/tonne of CO2 was found (for more than 1 million tonnes), clearly illustrating the untapped potential of wealth creation in carbon reduction initiatives. Furthermore, given the inefficiency of shallow integration between markets, we found that removing interconnections between markets offers a relatively affordable CO2-reduction opportunity, at $21.5/tonne.

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Energy Specializations: Energy Modeling – Sectoral Energy Demand & Technology; Electricity – Markets and Prices ; Energy Modeling – Energy Data, Modeling, and Policy Analysis; Energy Modeling – Forecasting and Market Analysis

JEL Codes:
Q55 - Environmental Economics: Technological Innovation
D42 - Market Structure, Pricing, and Design: Monopoly
E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination
D4 -

Keywords: Market Integration, Regulation, Electricity Trade, Environmental Impacts

DOI: 10.5547/01956574.37.1.edev

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Published in Volume 37, Number 1 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.