Government’s analysis, assessment and research activities
Study: Regional carbon price floor for emission allowances could influence fuel choices, but also electricity production volumes and import and export balance

The price level of CO2 emission allowances has varied considerably since the introduction of the EU emissions trading scheme (ETS), which may have an impact on the guiding effect of the system in the short and long term. A regional carbon price floor (CPF) has been proposed as a means to ensure the guiding effect of emissions trading in all market situations. What has been suggested is to introduce CPF regionally, e.g. in the Nordic countries or in the Nordic and Baltic countries.

Pöyry Management Consulting Oy studied the impact of regional CPF implemented either in the Nordic countries or in the Nordic and Baltic countries on electricity generation and in the district heating sector.

CPF can be set for a specific country, region or the whole EU. It may apply to a certain individual sector, such as electricity production, or all emissions trading sectors.

Based on the study, CPF for emission allowances set for electricity generation could in some cases increase the use of emission-free fuels, but it may also reduce total electricity generation in the area where CPF is being applied. In the case of the Nordic countries the impact of CPF is quite moderate, also with respect to the market price for electricity.

Impacts assessed by modelling and case studies

The study examines the impact of CPF applied only in the Nordic countries or in the Nordic and Baltic countries on electricity markets and in the district heating sector. The study started from a situation (Base Scenario) where the market price for an emission allowance would again decrease to a low level, but a regionally set carbon price floor would guarantee the guiding effect of the ETS.

With respect to electricity markets, the study analyses the impacts of CPF from the perspective of electricity generation, export, emissions and wholesale prices. The analysis is based on the electricity market modelling developed by Pöyry.

For the district heating sector, the study uses example district heating networks to analyse the impacts of CPF on fuel choices, switches and dispatching in Finland and presents a qualitative assessment of the potential extent of the impacts in the other reference countries.

If the CPF of the emission allowance is higher than its market price, CPF raises the cost level of production that causes emissions relative to the cost level based on emission allowances traded at market price. This may have an impact on the price level of energy and on production in the electricity markets and in the district heating sector.

Impacts of CPF on electricity markets

If CPF were set only for the Nordic and Baltic countries, electricity generation based on fossil fuels and peat would be less profitable in these countries than similar production elsewhere in Europe. This means that production that causes emissions would decrease and be replaced by production elsewhere in Europe, provided that a sufficient generation and transmission capacities were in place.

According to the study, the impacts of CPF on electricity generation in Norway and Sweden would be small, because in these countries electricity generation is already strongly based on renewable energy sources. Instead, in Finland and Denmark especially the production based on coal and peat would decrease. Similarly, in the Baltic countries the impacts on electricity production in Lithuania and Latvia were quite small, while in Estonia especially electricity generation based on oil shale could decrease.

Based on the electricity market modelling, a reduction in energy production in the Nordic and Baltic countries would mainly be replaced by production based on natural gas in Western and Central Europe. The total emissions from electricity production could decrease as emissions from the production substituting for the earlier production would be lower. However, this scenario does not take account of the impact of CPF on the price of emission allowances, or the use of the emission allowances that become available in other sectors unless these are removed from production e.g. through the Market Stability Reserve (MSR).

Based on the modelling, the impact on the market price of electricity would be relatively small if CPF were applied only in the Nordic countries. Instead, CPF applied in both the Nordic and Baltic countries would have a greater impact on the market price of electricity.

Impacts of CPF in the district heating sector

In Finland fossil fuels and peat are being used in many district heating networks in both base-load and peak-load production. According to the study, CPF could have an impact especially on the use of peat for district heating. However, the potential impacts of CPF in the Finnish district heating sector are limited by the already high taxes on fossil fuels and ban on the use of coal for energy production as from 2029, which reduce the use of fossil fuels even without the introduction of CPF.

Uncertainties relating to CPF

Besides changes in the types of fuel used and in the production, CPF brings more certainty with respect to the price level in the long term, thus reducing risks associated with investments. In this study no further analysis was conducted on investments as the main focus was on assessing the impacts of CPF in a shorter term.

The study also did not assess the impacts of CPF in a scenario where this would be applied to emissions trading in sectors other than electricity production and district heating. If applied to emissions from manufacturing industry, regional CPF could increase the risk of carbon leakage in the industrial sector between the EU countries as well.

Within the emissions trading area of the EU (EU ETS area), CPF is currently being used only in the UK, where it is applicable to electricity generation. There have been proposals to introduce CPF in the Netherlands, and many other countries have also considered whether it would be necessary.

The study was conducted as part of a project analysing the impacts of measures to prevent carbon leakage in the EU emissions trading scheme (EU ETS) implemented by Pöyry Management Consulting Oy. The project is a part of the Government’s analysis, assessment and research activities.

Inquiries: Jenni Patronen, Pöyry Management Consulting Oy, tel. +358 40 754 4922, jenni.patronen(at)poyry.com and Mikko Paloneva, chair of the project steering group, Ministry of Economic Affairs and Employment, tel. +358 29 504 7063, mikko.paloneva(at)tem.fi