European experience in coupling carbon markets with electricity markets

China Energy Storage Network: At present, China's carbon market has been officially launched, and more than 2,200 power generation companies have been included in the country. As of December 31, 2021, the first compliance cycle of the national carbon emission rights trading market has been successfully completed, and the annual carbon emission quota trading volume has accumulated 179 million tons.

However, my country's electricity market and carbon market operate relatively independently. Faced with the timetable for carbon peak and carbon neutrality, how can the power industry make use of the two markets? Can the effect of 1+1 greater than 2 be achieved? Europe's emission reduction achievements are obvious to all, and perhaps we can find experience worth learning from them.

In 2020, the total electricity trading volume in Europe reached 1.2008 trillion kWh, with the scale of transactions and the number of market entities increasing year by year; in the European Union Emissions Trading System (hereinafter referred to as "EU-ETS"), the trading volume of two types of carbon derivatives, EU emissions quotas (EUAs) and EU aviation emissions quotas (EUAAs), reached 729 million tons of carbon dioxide equivalent, and the total carbon asset trading volume was over 7 billion tons, accounting for nearly 80% of the global carbon trading volume.

The carbon trading volume in the third phase of the EU Emissions Trading System (2013-2020) increased by 13.15% compared with the second phase (2008-2012), and the activity level has been significantly enhanced.

According to European experience, the carbon market and the electricity market jointly affect the development of power companies. The carbon market internalizes the cost of carbon dioxide emissions and narrows the gap between the cost of new energy power generation and the cost of fossil energy power generation. In the power market, the comparative advantage of new energy power generation companies in the power market has increased, squeezing the market share of fossil energy power generation companies, and the power generation structure of the power industry has gradually changed to be dominated by renewable energy. Through the "invisible hand" in the market, the government's fiscal expenditure on promoting the use of renewable energy can be reduced. Therefore, the coupling of the carbon market and the electricity market can help power generation companies achieve this goal faster. So, what is the basis for the coupling of the carbon market and the electricity market?

Why coupling?

First, the carbon market and the electricity market have similar trends in market type.

For many years, Europe has been promoting the development of carbon and electricity markets towards competitive markets. For the carbon market, EU-ETS no longer allocates free quotas to power companies, forcing them to participate in carbon market transactions, which will increase the enthusiasm of companies to reduce emissions and prevent social costs from increasing significantly due to emission reduction requirements; for the electricity market, Europe's "Third Energy Act" uses measures such as splitting up "vertically integrated" companies and strengthening antitrust supervision in the power industry to enhance the competitiveness of power generation companies, allowing companies to spontaneously improve energy efficiency and thus reduce social costs.

While continuously promoting the development of regional markets, Europe also pays attention to the connection of multiple markets.

In the carbon market, although the allocation of EU carbon quotas and the implementation of specific policies are still carried out on a national basis, enterprises participating in the carbon market can conduct cross-border carbon asset transactions through major carbon exchanges. In addition, regional carbon markets in Europe are also trying to develop jointly. For example, the connection between EU-ETS and the Swiss Carbon Trading System (ETS) will take effect in 2020 to promote the realization of Europe's overall emission reduction goals. In the electricity market, Europe not only has regional markets for enterprises and individual consumers to trade electricity, but also has cross-border power grids connecting regional markets, forming a unified European electricity market. Due to the similar functions of the two market trading products, trading centers such as the European Energy Exchange (EEX) include both electricity trading and carbon asset trading. The trend of both the electricity market and the carbon market towards unified and competitive development reflects the fundamental consistency of the two markets: to promote the transformation of the power industry to renewable energy at low cost and high efficiency.

Secondly, the product prices of the two markets are positively correlated. Whether it is the spot market or the futures market, the price changes in the electricity market and the carbon market have the same trend.

Research by some scholars shows that carbon emission rights futures (EUA futures) and electricity futures prices in Nordic Power Exchange (Nord Pool), French Energy Exchange (Powernext), German European Energy Exchange (EEX) and British Amsterdam Exchange (APX) all have the same trend of change. This is mainly because the renewable energy transformation of power companies cannot be achieved overnight, and there is a strong demand for carbon emission rights, which has driven up carbon prices. At the same time, power companies will also pass on the increased costs of purchasing carbon quotas to consumers, driving up electricity prices.

Finally, many power companies actively participate in both markets. The EU Emissions Trading System includes more than 11,000 power companies and other factories and regulates their greenhouse gas emissions.

In 2006, European power companies were allocated 35% of carbon emission quotas, but these quotas were lower than their carbon emissions and needed to participate in carbon market transactions; especially after the cancellation of free quotas in 2013, power companies needed to trade carbon assets in the carbon market. Therefore, power companies have always been active participants in the carbon market. Data from the Intercontinental Exchange (ICE) also show that the high attention of power companies to the carbon market has driven the growth of carbon futures contract trading volume. Power companies not only trade carbon quotas within the country, but also actively participate in the international carbon market. For example, in the first phase of EU-ETS, some power companies purchased more than half of their carbon quotas from other countries. At the same time, data from the Nordic Power Exchange (Nord Pool) shows that more than 370 power production companies, about 500 power distributors, and more than 380 power suppliers in the Nordic and Baltic countries participate in power trading. In 2020, the trading volume of electricity (including daytime trading and day-ahead trading) in Nord Pool alone reached 99.5 billion kWh.

On this basis, the coupling of the carbon market and the electricity market has been achieved, making up for the disadvantages of the two markets. Although the European electricity market has optimized the allocation of electricity resources, it has made thermal power, which has lower costs and higher emissions, the first choice for power companies. When the carbon market makes carbon quotas a scarce resource, it will make up for this shortcoming of the electricity market and help Europe achieve its emission reduction targets faster and better.

At the same time, although the European carbon market has made carbon dioxide emissions a commodity, the volatility of carbon prices will bring risks to corporate operations and investments. However, an investment portfolio of commodities and carbon assets may be very beneficial to reducing carbon risks and increasing returns.

“Coupling” will accelerate low-carbon transformation

From the perspective of energy utilization, the coupling of the carbon market and the electricity market can accelerate the utilization of renewable energy without increasing the abandonment rate of wind and solar power. The breakthrough in the transformation of renewable energy in the power industry will also be a good example for other industries.

From 2010 to 2015, the growth rate of renewable energy generation in most European countries was significantly faster than that from 2000 to 2005. According to relevant reports from the European power sector, the increase in the price of carbon quotas in the third phase of the EU Emission Trading System has had a great impact on the economic viability of coal-fired power plants. In 2019, power generation fueled by hard coal and lignite fell rapidly, with hard coal power generation falling by 32% and lignite power generation falling by 16%. Nearly half of the power generation lost by coal power generation was replaced by renewable energy power generation. Under this circumstance, carbon dioxide emissions from the power industry in 2019 decreased by 12% compared with 2018, a reduction of 120 million tons.

While the scale of renewable energy utilization in Europe is expanding, the problem of renewable energy consumption caused by different resource endowments and renewable energy distribution in different countries can be further improved by the interconnection of European cross-border power grids. For example, France has sufficient nuclear power, with nearly 60 nuclear power plants, and nuclear power accounted for 66.5% of its total power generation in 2019. After meeting France's domestic electricity demand, France sells additional nuclear power to neighboring countries through cross-border power grids to solve the problem of renewable energy consumption. In addition, Europe's main power load areas are in the economically developed regions of Central and Western Europe, but most of the renewable energy power generation sources are in the Nordic countries with sufficient sunlight and abundant wind resources. The interconnection of cross-border power grids helps power companies reduce the wind and light abandonment rates and save costs.