Emissions Trading and Electricity Sector Regulation

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A conceptual framework for understanding interactions between carbon prices and electricity prices
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With the Paris Agreement’s focus on domestic action, ETS as a cost-effective instrument for emissions control is considered or scheduled in many emerging economies like Mexico, Chile, Vietnam, Thailand and the Ukraine. While in theory, ETS offers a cost effective tool to achieve emission reduction targets, in practice, different forms of electricity sector regulation interact with emissions trading in ways that may prevent or change how participants respond to the allowance price. In this report, we develop a conceptual framework to understand the interaction between allowance prices and electricity prices under different forms of power sector regulation. The framework identifies where regulation might disrupt the proper functioning of an ETS. Options to overcome regulatory barriers as well as the role of companion policies are also discussed.