Evaluating the impact of average cost based contracts on the industrial sector in the European emission trading scheme

The inception of the emission trading scheme in Europe has contributed to power price increases. Energy intensive industries have reacted by arguing that this may affect their competitiveness and will induce them to leave Europe. Taking up a proposal of these industrial sectors, we explore the possible application of special contracts, where electricity is sold at average generation cost to mitigate the impact of CO2 cost on power prices. The model supposes fixed generation capacities. We first consider a reference model representing a perfectly competitive market where all consumers (industries and the rest of the market) are price-takers and buy electricity at short-run marginal cost. We then change the market design by assuming that energy intensive industries pay power either at a regional or at a zonal average cost price. The analysis is conducted with simulation models applied to the Central Western European power market. The models are implemented in GAMS/PATH.