S.E.R.G. WP Series #12-2025: "Long-term contracts in carbon and electricity markets with frictions"

2025 - Matthieu Delacommune, Simon Quemin, Sébastien Lepaul and Yannick Perez

In the context of the urgent need for decarbonization, this paper lays the fundation for investigation the interaction between long-term contracts and carbon pricing in the electricity sector, focusing on their effects on investment dynamics and de- carbonization. An hybrid modeling framework is developed with an optimization model and a simulation model. It endogenizes the carbon price to study these in- teractions under various market conditions (optimization and simulation models). The results indicate that intertemporal flexibility through emissions banking stabilizes carbon prices and supports sustained investment. Market frictions, such as limited foresight, are shown to impede decarbonization and investment, but a complementarity remuneration mechanism for decarbonized assests such as long-term contracts can mitigate these deficits. The findings underscore the importance of well-designed policies and contracts for achieving optimal decarbonization paths. Allowing banking in a quantity-based carbon policy leads to lower system costs even in presence of market frictions such as limited foresight.

Carbon price; Banking effect; Limited foresight; Markets with frictions; Optimization Model; Simulation model.