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The progressive relocation of part of the Energy Intensive Industries (EIIs) out of Europe is one of the possible consequences of the combination of emission charges and higher electricity prices entailed by the EU-Emission Trading Scheme (EU-ETS). In order to mitigate this effect, EIIs have asked for special power contracts whereby they would be supplied from dedicated power capacities at average (capacity, fuel, transmission and emission allowance) costs. We model this situation on a prototype power system calibrated on four countries of Central Western Europe. In order to capture the main feature of EIIs' demand, we separate the consumer market in two segments: EIIs and the rest. EIIs buy electricity at average cost price while the rest pays marginal cost. We consider two different types of EIIs' contractual arrangements: a single region wide and zonal average cost prices. We also analyze the cases where generators only rely on existing capacities or can invest in new ones. We find that these average cost contracts can indeed partially mitigate the incentive to relocate activities but with quite diverse regional impacts depending on different national power policies. Models are formulated as a non-monotone complementarity problems with endogenous energy, transmission and allowance prices and are implemented in GAMS.

Carbon leakage in this pape ris the phenomenon whereby Electricity Intensive Industries subject to harsh environmental standards move their activity or part of it to more environmentally lenient regions. Carbon leakage has been mentioned as a possible outcome of the EU Emission Trading Scheme. Different studies are underway to assess the reality of the phenomenon and to devise policies to mitigate its possible impact. One remedy, proposed by the Energy Intensive Industries is to combine free emission allowances with a pricing of electricity whereby energy émissions and transmission costs are bundled and sold on an average cost basis. The paper attempts to model this proposal. We cast the problem in a spatial model of the power sector where generators can develop new capacities, the transmission system is organized on a flowgate basis, emission allowances are auctioned, except possibly for industries, and traded. The consumer market is decomposed in two segments. Industries purchase electricity according to some form of average cost price, the rest of the market is supplied at marginal cost. These equilibrium models are non convex. We present the models and discuss their properties. Companion papers report policy implications.