Carbon windfall profits in the power sector. Policies to mitigate redistributive effects. (February 2009)

Reduction of emissions of greenhouse gases is one of the key goals of European Comisions´s (EC) plan about energy and climate change. Methods chosen for allocation of free carbon permits show that increase of electricity prices is an intended and expected effect in order to provide a signal to consumers, to save energy and consequently to reduce the emissions of CO₂, and to generators, to promote disinvesting in CO₂ intensive technology and to invest in non-emitting or low-emitting technologies. As a result of EU ETS implementation, two new rents appear (increase of capacity scarcity rent and carbon scarcity rent). At the same time, consumer surplus decreases as a consequence of the increase of power prices. Governments may feel tempted to limit the intensity of these redistributive effects through some regulatory measures which could distort the proper functioning of the markets and the signals derived from them. The new rents are essential to provide the necessary economic signal to promote a solution to the challenge of climate change through the development of a carbon-neutral power supply. Development of new nuclear capacity, hydro repowering, CCS and RES need an adequate price signal to be competitive.