Working paper

Climate policy with electricity trade

Stefan Ambec, and Yuting Yang

Abstract

Trade reduces the effectiveness of climate policies such as carbon pricing when domestic products are replaced by more carbon-intensive imports. We investigate the impact of unilateral carbon pricing on electricity generation in a country open to trade through interconnection lines. We characterize the energy mix with intermittent renewable sources of energy (wind or solar power). Electricity trade limits the penetration of renewables due to trade-induced competition. A carbon border adjustment mechanism (CBAM) removes this limit by increasing the cost of imported power, or by deterring imports. The CBAM must be complemented by a subsidy on renewables to increase renewable generation above domestic consumption. The interconnection line is then used to export power rather than importing it when renewables are producing. We also examine network pricing and investment into interconnection capacity. A higher carbon price increases interconnection investment which further reduces the effectiveness of carbon pricing. In contrast, when renewable electricity is exported, a higher subsidy on renewables reduces further carbon emissions by expanding interconnection capacity.

Keywords

Intermittent renewables; electricity interconnection; carbon pricing; carbon border adjustment mechanism; renewable subsidy; carbon leakage;

JEL codes

  • D24: Production • Cost • Capital • Capital, Total Factor, and Multifactor Productivity • Capacity
  • F18: Trade and Environment
  • F64: Environment
  • H23: Externalities • Redistributive Effects • Environmental Taxes and Subsidies
  • Q27: Issues in International Trade
  • Q48: Government Policy
  • Q54: Climate • Natural Disasters • Global Warming

Reference

Stefan Ambec, and Yuting Yang, Climate policy with electricity trade, TSE Working Paper, n. 23-1422, March 2023, revised October 2023.

See also

Published in

TSE Working Paper, n. 23-1422, March 2023, revised October 2023