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.
Highlights
While many economic and environmental issues have become global, electricity markets have, to a large extent, remained local
If standard microeconomic theory would justify removing some regulation and barriers to trade, as many natural monopoly features have disappeared in the electricity sector, only a limited number of states have opted to harmonize their electricity market with that of their neighbors
Our results show that if the hydro jurisdiction were to keep its average cost pricing regulation, while the thermal jurisdiction maintained its competitive market model, trade would slightly improve total welfare, when ignoring greenhouse gases (GHG) emissions, emissions would increase with trade
Summary
While many economic and environmental issues have become global, electricity markets have, to a large extent, remained local. In the United States, for instance, in 2005, strong state-level political opposition halted the plan to implement regional transmission organizations (RTOs), all of which following a standard market design (FERC, 2005). If standard microeconomic theory would justify removing some regulation and barriers to trade, as many natural monopoly features have disappeared in the electricity sector, only a limited number of states have opted to harmonize their electricity market with that of their neighbors. Such integration would lead to price and quantity adjustments, along with associated political challenges. As was clearly established in an important literature review commis-
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