Transforming Europe: Germany's Electricity Mix and Welfare in Light of EU ETS Certificate Prices

The European Union Emission Trading System (EU ETS) was enacted in 2003 in the wake of the Kyoto Protocol. Based on a cap and trade system, EU member states establish national limits on greenhouse gas (GHG) emissions via what is being referred to as National Allocation Plans (NAPs). Subsequently, CO2 certificates (i.e. emission allowances (EUAs)) are being auctioned off (or allocated for free) and factories, power plants as well as other installations subject to these NAPs may either reduce their emissions or buy EUAs at the market to ensure their right to continue emitting GHGs. Hence, climate policy may have an increasing effect on the electricity production sector and thus, this paper is examining the possible influences of carbon emission pricing on the electricity production mix as well as electricity prices by means of a simulation model. We focus our analysis on the German electricity market and calibrate our simulation model with respect to the regulation in the electricity production sector but also with respect to the national allocation plans and Germany’s CO2 reduction targets. In particular we analyze the impact of varying CO2 certificate prices on the electricity production mix, electricity prices and welfare. We find that CO2 certificate price gains result in a decline of carbon-emitting primary energy sources and an increase of the share of renewable energy sources. Consequently, the most important policy implication of our findings is that the establishment of CO2 as scarce resource (i.e. by introduction the EU ETS) really does enable regulators and policymakers to positively influence the electricity production mix.