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The Political Economy of a Carbon Price Floor for Power Generation

Abstract:
The EU carbon price lies well below estimates of the social cost of carbon and "target-consistent" carbon prices needed to deliver ambitious targets such as the 40% reduction target for 2030. In light of this, the UK introduced a carbon price floor (CPF) for its electricity sector in 2013 and the new Dutch Government has recently made a similar commitment, while successive French Governments have called for an EU-wide CPF. This paper analyzes the impacts and design of a power-sector CPF, both at the EU and national level, using a political-economy approach. We find a good case for introducing such a price-based instrument into the EU ETS. We suggest that a CPF should be designed to "top up" the EUA price to �25-30/tCO2, rising annually at 3-5% above inflation, at least until 2030. We argue that the new EU Market Stability Reserve enhances the value of a CPF in terms of delivering climate benefits, and discuss the potential for a regional CPF in North-West Europe. We also review international policy experience with price floors (and ceilings).

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Energy Specializations: Electricity – Policy and Regulation; Energy and the Environment – Climate Change and Greenhouse Gases; Energy and the Environment – Environmental Market Design; Energy and the Environment – Policy and Regulation

JEL Codes:
E60 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook: General
Q54 - Climate; Natural Disasters and Their Management; Global Warming
Q56 - Environment and Development; Environment and Trade; Sustainability; Environmental Accounts and Accounting; Environmental Equity; Population Growth

Keywords: Carbon pricing, Electricity markets, Market failure, Policy failure, Political economy, Price corridor, Price floor

DOI: 10.5547/01956574.40.1.dnew

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Published in Volume 40, Number 1 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.