A Market Design Proposal for Decoupling Carbon and Electricity Prices

2026-03-26

AI Summary

This study addresses the pass-through of carbon allowance costs from marginal fossil-fuel generators to electricity prices in European day-ahead markets, which inflates consumer expenditures and generates excessive inframarginal rents for zero-emission units. To mitigate this, the authors propose a threshold-triggered differentiated settlement mechanism: when zonal clearing prices exceed a predefined threshold, zero-emission generators are settled at the clearing price minus a fixed proxy for carbon costs, while all other units remain subject to the uniform market price. This approach achieves partial decoupling of carbon costs from electricity pricing within a unified clearing framework, redistributing carbon rents without compromising market efficiency. Hourly-resolution simulations indicate that, by 2025, average consumer expenditures could be reduced by approximately 8.5% in Austria and 4.7% in Germany, with the mechanism demonstrating robustness even under extreme scenarios such as energy crises.

Abstract

In European day-ahead electricity markets, carbon allowance costs passed through by marginal fossil plants raise consumer expenditure and generate inframarginal rents for non-emitting generators. We propose a settlement modification: when the zonal day-ahead price exceeds a threshold, non-emitting generation is remunerated at the clearing price minus a fixed CO2 proxy deduction, while all other units continue to receive the uniform price. The mechanism thus reallocates a part of the inframarginal rents to consumers. Using hourly data we estimate static average expenditure reductions of about 8.5% in Austria and 4.7% in Germany in 2025. We discuss bidding incentives around the threshold, interactions with Contracts for Difference, implementation in coupled bidding zones, and a gas-cost variant for the 2022 energy crisis.

Problem

• carbon pricing
• electricity markets
• inframarginal rents
• price decoupling
• consumer expenditure

Innovation

• market design
• carbon pricing decoupling
• inframarginal rents
• electricity market settlement
• CO2 proxy deduction