Linking electricity prices and costs in bottom-up top-down coupling under changing market environments
Energy market liberalization is changing pricing mechanisms for wholesale electricity. This work shows that it is essential to appreciate and mirror these changes in the modeling of electricity markets for policy assessment. We develop a framework composed of two models - (1) a dynamic computable general equilibrium (CGE) model of the Swiss economy and (2) a TIMES model of electricity supply - coupled through a soft link. As part of the link, the electricity generation costs from TIMES have to be translated into wholesale electricity prices in the CGE model. To investigate the influence of the way costs and prices are linked, we analyze a policy scenario under two alternative market assumptions: (1) a regulated market, where wholesale electricity is priced such that suppliers recuperate their costs and receive an adequate profit, i.e. 'average cost plus' pricing; (2) a progressive evolution to a fully liberalized market, where prices are formed through marginal cost pricing. We show that assumptions on the evolution of electricity market regulation have an important impact on the scenario results. Changes in cost level due to climate policies modify prices to a different extent, which translates into different levels of electricity demand.