Decarbonizing electricity systems while maintaining reliable, affordable power supply remains a central challenge for grid operators and policymakers. A new research framework proposes an integrated market mechanism that coordinates carbon and electricity trading through strategic fuel taxation to achieve both objectives simultaneously.
The proposed system operates in three sequential stages. First, annual planning establishes initial carbon allowance allocations and pricing alongside fuel tax rates embedded into generator cost functions. The fuel tax directly increases the operating cost of fossil fuel plants, creating an economic penalty for carbon-intensive generation. Next, daily carbon market execution forecasts electricity prices and constructs bidding curves based on plant profit optimization at various carbon price levels. Finally, daily electricity market operations clear based on plant bidding responses, with any remaining allowance deficits or surpluses carried forward to subsequent periods.
Simulation results reveal significant impacts from this coordinated approach. The fuel tax mechanism raised average carbon prices from $11.80 to $17.90 per ton—a 52% increase—while renewable generation surged 115% and renewable plant profitability climbed 373.7%. Notably, fossil fuel plant profits also grew 239% due to higher wholesale electricity prices, and system-wide profits increased 271%. Annual CO₂ emissions demonstrated consistent downward trends across the simulation period.
The framework's effectiveness hinges on careful calibration of market parameters. Higher carbon prices and fuel taxes directly incentivize renewables by improving their competitive position relative to fossil generation. Simultaneously, elevated wholesale electricity prices compensate traditional generators, preserving investment incentives and system stability.
This research demonstrates that carefully designed market mechanisms can align economic incentives with decarbonization objectives without sacrificing grid reliability or generator profitability. The integrated approach addresses a critical gap in current market designs that often treat carbon and electricity trading independently, missing opportunities for coordinated price discovery and emission reduction.
