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Two major historic processes of the last four decades have shaped current electricity markets worldwide. First, the unbundling of vertically integrated utilities resulted in imperfectly competitive electricity markets characterised by oligopolistic ownership structures (Wilson, 2002). Second, concerns about the effect of greenhouse gases (GHGs) on climate change led to carbon pricing through transferable property rights, e.g., allowances or permits. As with any other market, that for carbon allowances can also be subject to the exercise of market power. Kolstad and Wolak (2003)’s empirical study suggests that NOx permits might have been used as a vehicle for producers to exert market power by offering electricity at higher prices in the California market in 2001. Moreover, if a dominant power producer can additionally withhold NOx permits, then it may further increase its profit while driving up the permit price for rivals as demonstrated in a leader-follower case study of the Pennsylvania-New Jersey-Maryland (PJM) Interconnection (Chen et al., 2006). We are interested in the economic and environmental effects of market power on electricity and permit markets in regional electricity markets where participants are not all subject to the same CO2reduction policies. An example is the South-East Europe Regional Electricity Market (SEE-REM), which comprises both EU members subject to the emissions cap of the EU Emissions Trading System (ETS) and non-EU members exempt from such a cap. In a perfectly competitive setting, Višković et al. (2017) demonstrate that between 6% and 40% of the CO2 emission reduction in the ETS portion of SEE-REM may be leaked into the non-ETS portion as nonETS producers with a relatively dirty generation portfolio receive the price signal to increase their exports. In this paper, we examine how a dominant firm, i.e., Enel with ca. 20% of the SEE-REM market share, can (i) gain an economic advantage and (ii) affect carbon leakage by manipulating both the electricity and permit prices.

Economic and Environmental Consequences of Market Power in the South-East Europe Regional Electricity Market