Will Capacity Mechanisms Conflict with Carbon Pricing?

Abstract

Climate change and related national mitigation targets make the decarbonization of the power sector an urgent need. The power sector faces the challenge of considering the design and interaction between emission reduction policies, which can sometimes counteract each other. This study proposes a framework that can be used to quantitatively study the qualitative link between carbon pricing and capacity pricing. The framework is validated through a case study in Hokkaido, Japan, and used to further investigate the interaction between the two policies through a System Dynamics simulation model and scenario design. The results indicate that a carbon price would promote the introduction of wind power, as well as the reduction in fossil fuels, while the capacity price will mitigate the boom-and-bust investment cycle and stabilize electricity prices. However, when the two policy-based prices act on the power system simultaneously, the advantages will be offset by each other. The existence of the capacity price partially offsets the emission reduction effect of the carbon price, and the carbon price with a lower floor will also indirectly squeeze the generation space of flexible power plants. In order to address these inefficiencies, this study proposed a capacity price focused on subsidizing flexible power plants and also coupled with a higher floor carbon price, which results in a consistent incentive. It also promotes the decommissioning of carbon-intensive base-load power plants and reduces CO₂ emissions significantly.