Effects of internalising external production costs in a North European power market

The aim of integrating national power markets is to improve the overall efficiency thereby making a potential for reducing electricity prices. However, efficiency is not necessarily improved if external environmental production costs are neglected. In this paper, we analyse the effects of regulating an integrated power market by using environmental producer taxes based on external production costs. The analysis is based on an empirical equilibrium model for the North European power market. The results show that internalising external costs will increase electricity producer prices by 40–50% in the period from 1995 to 2020. Further, demand for electricity will be reduced by 10%. We conclude, however, that in order to achieve the national Kyoto targets of reducing CO 2 emissions, further regulation is needed, such as national CO 2 taxes or cost efficient mechanisms like tradable permits and joint implementation.