Linking electricity prices and costs in bottom-up top-down coupling under changing market environments

Electricity market liberalization is altering pricing mechanisms in wholesale electricity markets, which will affect the effectiveness of climate and energy policies. Models used to simulate such policies must be responsive to pricing rules. We show how this can be done and simulate a tightening of climate and energy policies. We use a soft-coupled framework composed of a top-down dynamic computable general equilibrium model and a bottom-up dynamic electricity supply model. The first simulates equilibrium prices and quantities, while the second minimizes electricity generation costs. In the coupling procedure, the link between wholesale electricity prices (top-down) and generation costs (bottom-up) depends precisely on regulatory market assumptions. In the regulated market, wholesale electricity prices are "cost-plus", while they depend on marginal generation costs in the liberalized market. We show that, in Switzerland, an electricity tax is significantly more effective in reducing electricity demand in the liberalized than in the regulated market.