IEEE Power & Energy Magazine - January/February 2021 - 58

biomass generator, subsequently provides the required ramping
flexibility at t = 3. As a result, there is no need to activate the more
expensive and pollutive gas generator at t = 3, and thus, although
the total wind output is reduced by 25% with respect to the scenario with wind dispatch prioritization, the total operating costs
and CO2 emissions are reduced by 3.2% and 100%, respectively.
This simple example has demonstrated that the strict prioritization of renewable generation in the merit-order dispatch
is not always the most effective strategy in terms of both
operating costs and CO2 emissions. Although this particular
example is driven by the ramping requirements of electricity
systems, a recent study conducted by the Netherlands Organisation for Applied Scientific Research has presented numerous examples where renewable generation flexibility constitutes an effective market strategy in reducing both operating
costs and CO2 emissions. By adopting similar smart curtailment strategies, renewable generation can be transformed
from the cause of flexibility problems to part of the solution
(such as contributing to ramping requirements in the above
example), thus lowering the system flexibility dependency on
conventional generation.

Carbon Pricing
Another crucial policy instrument toward incorporating the
ambitious emissions reduction targets within the deregulated market environment is the introduction of carbon markets, which effectively penalize the production of emissions
and incentivize investment in low-carbon technologies. In
Europe, such a market mechanism, the EU Emissions Trading System (EU ETS), was established in 2005 and remains
the EU's flagship policy toward a market-based reduction of
emissions. The EU ETS is based on cap and trade principles,
meaning that a maximum (cap) is set on the total amount
of emissions that can be produced by the system (which is
reduced over time to gradually achieve the carbon reduction
targets), and a certain number of EU emissions allowances
covering this cap are then auctioned and can subsequently be
traded. Participants emitting greenhouse gases need to purchase sufficient allowances, lest they face significant fines.
In electricity markets, given that the carbon allowance price
is passed on by fossil-fueled generators in the electricity
price, the revenues of low-carbon generators are increased,
partially addressing their missing money problem.
The effectiveness of the EU ETS has been demonstrated
in practice, with the EU estimating that the emissions from
sectors covered by the system have been reduced by 21% in
2020 with respect to the 2005 levels. However, certain questions have arisen around the long-term economic efficiency of
this mechanism, particularly regarding the variability of the
CO2 allowances price. Although the gradual reduction of the
CO2 cap should theoretically lead to an increasing CO2 price
over time, in practice, this price has been unstable. After the
global financial crisis of 2007-2008, the CO2 price dropped
from around 25 €/ton to as low as 5 €/ton in 2013; after many
years, the price exceeded the 20 €/ton level in 2018, but if
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the current COVID-19 crisis causes a sustained reduction of
energy demand, the price may decline again.
This CO2 price variability creates significant uncertainties
and risks for both potential investors in low-carbon technologies as well as electricity consumers. The potential of a very
low CO2 price discourages investments in low-carbon generation, while the potential of a very high CO2 price implies an
undesired increase in the consumers' energy bills and their subsequent resistance to emissions reduction policies. Although a
market stability reserve has been recently introduced to address
this challenge by adjusting the number of auctioned allowances,
its effect on CO2 prices is indirect and thus uncertain.
In this context, new designs for reducing the price risks
of the EU ETS have been lately brought forward, including
the introduction of CO2 price floors and price ceilings (i.e.,
minimum and maximum CO2 price limits). A price floor has
already been implemented in the United Kingdom and has
been announced in The Netherlands. In an effort to analyze
the impacts of these CO2 market designs, Delft University
of Technology has conducted a study through the agentbased model EMLab that simulates self-interested companies' generation investment decisions in alternative technologies (e.g., coal, gas, nuclear, carbon capture and storage,
and renewables). Figure 5 presents key results of this study,
including the (a) emerging CO2 prices and (b) CO2 emissions
in Europe in different years (x-axis) under alternative CO2
market designs (Original ETS, Price Floor, and Price Floor
and Ceiling); these results include median CO2 prices and
emissions as well as 50%/90% envelopes as Monte Carlo
simulations have been carried out to capture the uncertainties around the evolution of demand levels and fuel prices.
Under all market designs, the CO2 price is relatively
low, and the CO2 emissions are relatively high during the
early years due to the higher CO2 cap. After about 10 years,
however, the CO2 cap becomes stricter, and thus CO2 prices
increase significantly, reaching very high values in scenarios
with high demand growth. Consequently, with a delay corresponding to investment lead times, investments in lowcarbon technologies start emerging, and CO2 emissions start
dropping. After two investment cycles, the market stabilizes,
and emissions decline steadily.
Under the current market design with neither price floors
nor ceilings (Original ETS in Figure 5), the CO2 price variability is immense, particularly with respect to the extremely
high prices (reaching an extreme value of 500  €/ton)
observed after the first 10 years in scenarios with high
demand growth. Under a market design with a price floor,
the CO2 price variability is drastically reduced in terms of
avoiding both the very low (nearly zero) levels as well as the
very high levels observed under the Original ETS design. As
a result, the risks associated with low-carbon investments
are reduced, such investments emerge sooner, and CO2 emissions drop faster. Consequently, when the CO2 cap becomes
stricter, part of the required investments has already taken
place, and the CO2 price remains at lower levels.
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