A Market Design Proposal for Decoupling Carbon and Electricity Prices

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.

Figures (9)

• Figure 1: Carbon prices in major emissions trading systems
• Figure 2: Industrial retail power prices
• Figure 3: Equilibrium effect with $\mathrm{CO}_2$-prices
• Figure 4: Conditional $\mathrm{CO}_2$ proxy deduction in high-price hours
• Figure 5: Redistributed expenditures by technology, Austria and Germany (2025).