Oligopolistic Electricity Markets under Cap-and-trade and Carbon Tax

Global warming is one of the most alarming phenomena facing our planet today. There is a general consensus among scientists that in order to slow down the heating of the Earth's oceans and atmosphere, human-induced greenhouse gases (GHG) should be regulated. Being a major GHG producer, the electricity industry's emissions should form part of any global emission regulation initiative.;In this thesis, we design and test two emission regulation schemes in the context of electricity markets, one based on cap-and-trade (CAT) and the other on carbon tax (CTX). Furthermore, we compare the schemes' ability to meet emission regulation goals subject to the aforementioned complicating factors.;Under CAT, we first re-design the typical hourly oligopolistic electricity market into a joint electricity and emission permits trading market. This dual market includes Genco gaming that takes advantage of hourly production costs, Genco emission intensities, self-allocated Genco emission caps (permits), emission permits trading, and demand elasticity. In addition, under CTX, we redesign the hourly electricity market into one that includes a carbon tax penalty. Here, Genco gaming takes advantage of hourly production costs, Genco emission intensities, demand elasticity and the carbon tax penalty.;Furthermore, under CAT, we develop two novel approaches to allocate the commitment interval electricity sector cap among Gencos: (a) Gencos receive permits for free from a social planner (SP). This is done on the basis of maximizing social-welfare (SW) over the commitment interval while accounting for the effects that these permits have on the hourly operation of the electricity market; (b) Gencos receive permits based on an auction where, in addition to maximizing SW, the SP accepts bids from Gencos to influence the permit allocation, and where Gencos pay for their allocations at the auction clearing price.;The attainment of this goal is however subject to several complicating factors: (i) electricity is an essential commodity to the welfare of all modern societies, thus raising electricity prices is not an acceptable solution on its own, since such a step would have significant adverse effects on the demand-side economy; (ii) in parallel, any emission regulation scheme that significantly influences profits would have an adverse effect on the business of generating power; (iii) electricity cannot be economically stored in large quantities and, as a result, demand and generation must be continuously balanced; (iv) today, generation and demand are no longer balanced through a rate-regulated monopoly but through an hourly electricity market to which power producing companies (Gencos) and load-serving entities respectively submit supply offers and demand bids; (v) Since existing electricity markets are oligopolistic (few competing entities each being a price-maker), Gencos exercise market power by gaming through their offers. The addition of emission regulating schemes offers Gencos new opportunities to game on the basis of how polluting they are. This complicates the market-clearing process and renders its outcome more difficult to predict.;In contrast, under the CTX scheme, there is no explicit emissions cap. Rather, the desired cap is attained implicitly through an hourly tax penalty, the parameters of which are computed to maximize SW over the commitment interval. This computation accounts for the effect of the resulting hourly tax rate on Genco gaming and on the ensuing outcome of the oligopolistic marketclearing process.;Finally, the thesis provides a thorough analytic and numerical comparison of both CAT and CTX under different scenarios. Groundwork results suggest that both schemes have significantly varying effects on market power and profits, effects that contest some preconceived ideas about both regulation schemes. These results suggest that:;Under CAT, the proposed SW auction to allocate the sector cap among the competing Gencos seems to be the preferred allocation scheme over free allocation schemes based on grand-fathering and SW maximization. This is so, because the SW auction eases some of the inherent drawbacks of a cap-andtrade system, in particular, by sending appropriate economic signals to invest in emission reduction. However, the auction does introduce new uncertainties into the prediction of the market equilibrium, not only due to the permits trading aspect of cap-and-trade and the hourly self-allocation but due to uncertainty in the permits auction bidding strategies.;In contrast, under CTX, the proposed carbon tax structure not only produces the desired economic signals to invest in cleaner technologies but is subject to fewer sources of uncertainty when predicting the market outcome. Finally, when compared to an equivalent cap-and-trade scheme under the proposed auction, a carbon tax leads to higher profits for producers as well as to a higher consumer surplus. Thus, pending further studies, we conclude that the carbon tax structure proposed in this thesis is the recommended emission regulation scheme for an oligopolistic electricity market.