Dynamic tariffs and climate policy interaction: An economic analysis of welfare implications in retail electricity markets

Retail tariffs reform in electricity markets is attracting huge attention as policymakers seek to ensure that the marginal cost of electricity generation matches with the marginal value of demand. Notwithstanding, it is increasingly recognized that in order to appropriately reflect the marginal cost principle in electricity markets, the negative externalities of electricity generation should be fully captured in retail tariffs. Therefore, taking Fujian electricity market of China as a case, this study examines how a retail rate of time-of-use (TOU) tariffs interacts with climate policy. We calibrate a dynamic partial equilibrium model of this market and finds that interacting climate policy with TOU tariffs leads to i) increase in rate structures, ii) increase in demand response or load shifting, iii) increase in producer rent, iv) decrease in consumer rent, and v) decrease in overall welfare. Our results suggest that even though TOU tariffs and climate policy interaction in electricity markets can offer social and environmental benefits, the resulting losses to consumer rent and overall welfare may potentially undermine this approach. Therefore, in order to enhance the feasibility of transitioning towards a competitive and low-carbon electricity market globally, the cost of compliance to climate policy will have to be significantly reduced.