Charging for carbon emissions may not be effective for state-owned companies

Economists generally consider carbon charging to be an excellent way to reduce emissions. However, an analysis of the Italian market shows that if there are large, state-controlled companies in the market, they may not be effective. And the vast majority of the world's largest electricity producers are state-controlled.

Climate change mitigation is currently a major political priority. Experts usually agree that market-based instruments using emissions charging are more appropriate than tough regulations where the government sets emission standards.

A properly set price for carbon theoretically motivates companies to reduce emissions effectively, because in the short term, companies consider the price of carbon when deciding on production and prices. And in the long run, they are also effective through companies investing in carbon-reducing technologies.

In the context of these theoretical assumptions, charging for carbon emissions through carbon taxes or emissions trading schemes is being promoted as a policy worldwide. In 2019, approximately 15% of global greenhouse gas emissions were charged, and approximately half of them were traded under one of the 20 emission allowance schemes operating worldwide. Currently, the largest emissions trading system is the European one, which covers installations generating almost 50% of CO 2 emissions in the EU.

However, the effectiveness of carbon charging depends crucially on the (usually implicit) assumption that regulated firms maximize profits. Without this condition, carbon charging is not effective. In fact, firms, especially the largest state-run players, can pursue goals other than maximizing profits in carbon markets. This is particularly the case in the electricity sector, which generates more than 40% of global CO 2 emissions from fuel combustion and which accounts for more than 60% of emissions in the Emissions Trading Scheme.

The authors of the analysis first focused on how companies in the Italian market pass on the carbon price resulting from emission allowances to end customers. We find that there is a difference between the state-run Enel and all other companies. While for all companies the transfer is almost complete (93.3%), for Enel it is much closer to zero (28.6%). And the transfer of fuel costs is similar to emissions costs. State Enel bears less than 40% of the costs, but other companies bear about 80% of the costs.

This difference in transmission could be due to two reasons. First, differences in competitive conditions between firms, probably due to different cost functions. Or, secondly, differences in the internalisation of costs, which could result from different objective functions based on company ownership, and thus from different motivations of state-owned companies.

Let's take a look at the bidding model. Enel internalises only about 15% of the marginal cost of emissions and about 25% of the marginal cost of fuel. Other electricity producers internalize about 75% at both marginal costs. And while margins on other producers are broadly in line with profit maximization, the state-owned Enel does not appear to be making strategic offers. As a result, the marginal costs of reducing emissions are not equal between companies (and across sectors), which undermines the effectiveness of regulation, at least in the short term.

What is the motivation for different behavior between the state Enel and other electricity producers?

The obtained data support the hypothesis that state-owned companies are trying to reduce market price volatility for political reasons. State-owned companies, especially when their strategies are visible and important to citizens, affect the likelihood of the government remaining in power. These political incentives can lead state-owned companies to focus on reducing price volatility.

Enel's strategy differs from that of its competitors also in terms of investment. Both the carbon intensity of fuels used for inputs (especially coal) and investments in renewables are less affected by Enel's allowance prices than by its counterparts. As a result, carbon charging is not effective for state-owned companies, even in providing effective long-term investment incentives.

Source: Vox.eu