The impact of electricity demand reduction policies on the EU-ETS: Modelling electricity and carbon prices and the effect on industrial competitiveness

The European electricity market is linked to a carbon market with a fixed cap that limits greenhouse gas emissions. At the same time, a number of energy efficiency policy instruments in the EU aim at reducing the electricity consumption. This article explores the interactions between the EUʹs carbon market on the one hand and instruments specifically targeted towards energy end-use efficiency on the other hand. Our theoretical analysis shows how electricity demand reduction triggered by energy efficiency policy instruments affects the emission trading scheme. Without adjustments of the fixed cap, decreasing electricity demand (relative to business-as-usual) reduces the carbon price without reducing total emissions. With lower carbon prices, costly low emission processes will be substituted by cheaper high emitting processes. Possible electricity and carbon price effects of electricity demand reduction scenarios under various carbon caps are quantified with a long-term electricity market simulation model. The results show that electricity efficiency policies allow for a significant reduction of the carbon cap. Compared to the 2005 emission level, 30% emission reductions can be achieved by 2020 within the emission trading scheme with similar or even lower costs for the industrial sector than were expected when the cap was initially set for a 21% emission reduction.